Applicable Tax Rate A: Impact of filing status IRC 1(a)-(d); 1(f)(8) Tax liability is based on individuals filing status

and his or her taxable income. Married filing jointly: every married individual who makes a single return jointly with his spouse and every surviving spouse. Surviving spouse: An individual whose spouse died in either of the two prior years and who maintains a home that is also the principal residence of his or her child or stepchild. Head of household: one who both maintains his or her home as the principal residence of a dependent and is neither married nor a surviving spouse. Unmarried and not head of household: unmarried individuals who do not qualify as head of households or a surviving spouse. B: Tax rates and progressivity IRC 1(f)(1)-(2), (i) Federal income is progressive as income increases so does rate of tax. Sales tax is regressive bc all taxpayers pay the same amount Effective tax rate: a taxpayers tax liability as a percentage of taxable income. Marginal tax rate: rate of tax applicable to the taxpayers last dollar of taxable income. Bc taxpayers always get the benefit of the lower tax rates on 1st dollar of taxable income, a taxpayers effective tax rate will always be less than (or equal to) his or her marginal tax rate. Three arguments in favor of progressive tax rates (reflect the preference that all taxpayers should feel the same amount of pain): (1) Ensure that an individuals tax liability is based on his or her ability to pay (theory based on declining marginal utility of money) (2) Wealthier individuals should bear a higher percentage of the total tax burden bc they receive more benefits from the use of those tax dollars. (3) Progressivity accomplishes some degree of wealth redistribution. Three arguments against progressive taxes. (1) Progressivity necessarily makes federal income tax system more complex.
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(2) Progressive tax rates often distort a taxpayers decisions (eg taxpayer decides not to work bc extra income will place him/her at a higher bracket-> countered by flat tax w/high rate would disincentive additional work.) (3) Progressive tax rates can cause inequalities between similarly-situated taxpayers. (eg A earns a salary of $50,000 in yrs 1 & 2. B earns $100,000 in yr 1 but nothing in yr 2. A & B have the same amount of income in the 2 yrs but total tax bills will vary) C: Liability for tax and innocent spouse rules IRC 6013(d); 6015 (a)-(c)(3). Treasury reg 1.6015-1 through 5 IRC 6013(d) for purposes of this section (1) The status as husband and wife of 2 individuals having taxable years beginning on the same day shall be determined (A) If both have the same taxable yr-as of the close of such yr; or (B) If one dies before the close of the taxable yr of the others- as of the time of such death (2) An individual who is legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married; and (3) If a joint return is made, the tax shall be computed on the aggregate income and the liability with respect to the tax shall be joint and several IRC 6015 relief from joint & several liability on joint return. Relief can be granted if i. ii. iii. Joint return has been made for a taxable yr; On such return theres an understatement of tax attributable to erroneous items of 1 individual filing the joint return; The other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement (spouse fails to satisfy knowledge requirement in erroneous deduction cases if a reasonably prudent taxpayer in her position at the time she signed the return could be expected to know that the return contained the substantial understatement): (a) items to consider in determining liability of spouse-> 1) couples financial situation 2) requesting spouses educational background along with business experience, participation in activity that led to erroneous
2

iv.

v.

item, 3) failure to inquire about items on return or omitted from return that a reasonable person would question, 4) whether erroneous item represented a departure from recurring pattern reflected in prior yrs returns Taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable yr attributable to such understatement; and The other individual elects the benefits of this subsection not later than the date which is 2 yrs after the date the Secretary has begun collection activities with respect to the individual making the election.

Apportionment of relief: if an individual who, but for paragraph (1)(c), would be relieved of liability under paragraph (1), establishes that in signing the return such individual did not know, and had no reason to know, the extent of such understatement, then such individual shall be relieved of liability for tax for such taxable year to the extent that such liability is attributable to the portion of such understatement of which such individual did not know and had no reason to know. Computing liability for tax A: Determining taxable income IRC 61(a), 62 (a), 63, 67 (a)-(b), 151, 161 IRC 61(a) gross income means all income from whatever source derived, including (but not limited to) (1) Compensation for services, including fees, commissions, fringe benefits, and similar items (2) Gross income derived from business (3) Gains derived from dealings in property (4) Interest (5) Rents (6) Royalties (7) Dividends (8) Alimony & separate maintenance payments (9) Annuities (10) Income from life insurance and endowment contracts (11) Pensions (12) Income from discharge of indebtedness (13) Distributive share of partnership gross income (14) Income in respect of a decedent; and
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(15)

Income from an interest in an estate or trust

Haig-Simons: the sum of taxpayers consumption plus his or her change in wealth for a particular period. IRC 62 adjusted gross income: gross income minus the following deductions (1) Trade & business deductions (2) Certain trade & business deductions for employees (a) Reimbursed expenses of employees (b) Certain expenses for performing artists (c) Certain expenses of officials (d) Certain expenses of elementary and secondary school teachers (e) Certain expenses of members of reserve components of armed forces (3) Losses from sale or exchange of property (4) Deductions attributable to rents & royalties (5) Certain deductions of life tenants & income beneficiaries of property (6) Pension, profit-sharing & annuity plans of self-employed individuals (7) Retirement savings (8) Repealed (9) Penalties forfeited bc of premature withdraw of funds from time savings accounts/deposits (10) Alimony (12)Certain required repayments of supplemental unemployment compensation benefits (13)Jury duty pay remitted to employer (15)Moving expenses (allowed under sec 217) (17Interest on education loans (allowed under sec 221) (18)Higher education expenses (allowed under sec 222) (19)Health savings accounts (allowed under sec 223) (20)Costs involving discrimination suits IRC 63 taxable income (a) taxable income: gross income minus deductions allowable (b) Individuals who do not itemize their deductions-> adjusted gross income minus (1) Standard deduction, and (2) Deduction for personal exemptions (c) Standard deduction
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(1) The sum of (a) Basic standard deduction, (b) Additional standard deduction, (c) Real property tax deduction (beginning in 08/09) (d) Disaster loss deduction; and (e) Motor vehicle sales tax deduction (2) Basic std deduction (a) 200 percent of the dollar amount in effect for taxable yr in case of i. A joint return, or ii. A surviving spouse (b) $4,400 in case of head of household (c) $3,000 in any other case (d) Itemized deductions-> deductions allowable under this chapter other than (all deductions other than above the line deductions & personal exemptions) (1) Deductions allowable in arriving at adjusted gross income (2) Deductions for personal exemptions TAX LADDER Gross income 61(a) Less: Deductions listed in 62 (a) Equals: adjusted gross income Less: personal exemptions And less: Either Std deduction or Itemized deduction Equals: Taxable income IRC 67 2 percent floor on miscellaneous itemized deductions (a) Miscellaneous itemized deductions for any taxable yr shall be allowed only to the extent that the aggregate of such deductions exceeds 2 percent of adjust gross income (eg taxpayer has miscellaneous itemized deductions totaling $3,000 for Yr 1 and an adjusted gross income for yr 1 of $100,00. Taxpayer may only deduct $1,000 of miscellaneous itemized deductions ($3,000-$2,000) which is 2% of adjusted gross income.) (b) Miscellaneous itemized deductions-> itemized deductions other than (1) Deductions relating to interest (2) Relating to taxes (3) Deduction for casualty or theft losses (4) Deductions relating to charitable contributions & gifts & amounts paid or permanently set aside for a charitable purpose (5) Medical or dental expenses (6) Any deduction allowable for impairment-related work expenses (7) Deduction for estate tax in case of income in respect of a decedent
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(8) Any deduction allowable in connection with personal property used in a short sale (9) Deduction relating to computation of tax where taxpayer restores substantial amount held under claim of right (10) Deductions where annuity payments cease before investment recovered (11) Deduction for amortizable bond premium (12) Deductions in connection with cooperative housing operations (eg

IRC 68 Overall limitation on itemized deductions (a) In the case of an individual whose adjusted gross income exceeds the applicable amount, the amount of the itemized deductions otherwise allowable for the taxable yr shall be reduced by the lesser of(1) 3 percent of the excess of adjusted gross income over the applicable amount, or (2) 80 percent of the amount of the itemized deductions otherwise allowable for such taxable yr (eg taxpayer has $543,950 of adjusted gross income & $50,000 of itemized deductions 68 (a) reduces taxpayers itemized deductions by the lesser of (i) $12,000 (3% of $400,000 of adjusted gross income in excess of the $145,950 applicable amount or (ii)$40,000 (80% of the taxpayers itemized deductions). Thus 68(a) limits taxpayers itemized deductions to $38,000 ($50,000 itemized deductions less the $12,000 reduction under 68(a) (eg2 unmarried taxpayer has an adjusted gross income of $200,000 for yr 1 & that taxpayers itemized deductions (after applying 2% haircut) for that yr total $10,000. Taxpayer must reduce itemized deductions by $3,000 (3% of $100,000) over applicable amount ($100,000) Taxpayer can only claim $7,000 of the $10,000 in total itemized deductions. (b) Applicable amount (1) Applicable amount means $100,000 ($50,000 in case of a separate return by married individual) (c) Exception for certain itemized deductions (itemized deductions does not include) (1) Deductions relating to medical, etc expenses (2) Any deduction for investment interest, and (3) Deductions for casualty or theft losses (f) Phaseout limitation B: Personal exemptions
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IRC 151 Allowance of deductions for personal exemptions (a) Allowance of deduction: in the case of an individual, the exemptions provided by this section shall be allowed as deductions in computing taxable income. (b) Taxpayer & spouse: an exemption of the exemption amount for the taxpayer; and an additional exemption of the exemption amount for the spouse of the taxpayer if a joint
return is not made by the taxpayer & his spouse, and if the spouse, for the calendar yr in which the taxable yr of the taxpayer begins, has no gross income & is not the dependent of another taxpayer. (c) Additional exemption for dependents: an exemption of the exemption amount for each individual who is a dependent of the taxpayer for the taxable yr (dependents egs qualifying child/relative) (d) Exemption amount (1) In general: except as otherwise provided in this subsection, exemption amount means $2,000 (2) Exemption amount disallowed in case of certain dependents: in case of an individual w/respect to whom a deduction under this section is allowable to another taxpayer for a taxable yr beginning in the calendar yr in which the individuals taxable yr begins, the exemption amount applicable to such individual for such individuals taxable yr shall be zero. (3) Phaseout (A) In general: in the case of any taxpayer whose adjusted gross income for the taxable yr exceeds the threshold amount, the exemption amount shall be reduced by the applicable percentage. (B) Applicable percentage: applicable percentage means 2% points for each $2,500 by which the taxpayers adjusted gross income for the taxable yr exceeds the threshold amount. In the case of a married individual filing a separate return, the preceding sentence shall be applied by substituting $1,250 instead o f$2,500. In no event shall the applicable percentage exceed 100%. (C) Threshold amount means: (i) $150,000 in the case of a joint return or a surviving spouse (ii) $125,000 in the case of a head of household (iii) $100,000 in the case of an individual who is not married and who is not a surviving spouse or head of household. (iv) $75,000 in the case of a married individual filing a separate return. Treas. Reg. 151-1(b) IRC 151 (b) allows an exemption for the taxpayer and an additional exemption for the spouse of the taxpayer if a joint return is not made by the taxpayer and his spouse, & if the spouse, for the calendar yr in which the taxable yr of the taxpayer begins, has no gross income, and is not dependent of another taxpayer. Since, in the case of a joint return, there are 2 7

taxpayers, two exemptions are allowed on such return, one for each taxpayer spouse. If in any case a joint return is made by the taxpayer & his spouse, no other person is allowed an exemption for such spouse even though such other person would have been entitled to claim an exemption for such spouse as a dependent if such joint return had not been made. Treas. Reg. 152-1(a)(2)(i) General definition of a dependent For purposes of determining whether or not an individual received, for a given calendar yr, over half of his support from the taxpayer, there shall be taken into account the amount of support received from the taxpayer as compared to the entire amount of support which the individual received from all sources, including support which the individual himself supplied. Support food, shelter, clothing, medical & dental care, education, & the like. Amount of an item of support will be the amount of expense incurred by the one furnishing the item. Getting to taxable income. (1) (2) (3) (4) Start with gross income (income from whatever sources derived) Subtract items in IRC 62 (a) Calculate adjusted gross income by subtracting items in 62(a) from gross income Calculate personal exemptions from IRC 151 (a) Exemption usually is $2,000 per person unless they are subject to phaseout (b) Phase out applies to individuals whose adjusted gross income exceeds threshold amounts ($150,000 in case of joint return/surviving spouse or $125,000 in case of head of household, $100,000 for individual whos not married & not a surviving spouse or head of household, $75,000 for married filing separate return) (c) To determine applicable percentage for personal exemption subtract threshold amount from adjusted gross income. Divide difference between adjusted gross income and threshold amount by $2500. Multiply value by 2%. Take percentage and multiply by $4,000. Remaining figure is amount to be used for personal exemption (if percentage exceeds 100% then taxpayer(s) has no personal exemptions. (5) Take new value from step 4 and use either std deduction or itemized deduction. (a) Std deduction IRC 63 (c) i. Basic std deduction-> 200% of dollar amount in case of (1) Joint return, or (2) Surviving spouse ii. $4,400 in case of head of household iii. $3,000 in any case (1) New figure equals taxable income for taxpayer using std deduction (b) Itemized deductions 8

A. Regular itemized deductions are found in IRC 67(b) (1) Items found in 67(b) are then subtracted from adjusted gross income B. Items found outside 67(b) are miscellaneous itemized deductions that must exceed 2% of adjusted gross income otherwise cant be used in computing taxable income (1) Limitation on itemized deductions i. In case of individual whose adjusted gross income exceeds applicable amount ($100,000 or $50,000 for separate return for married individual) ii. Amount of itemized deductions shall be reduced by the lesser of a. 3% of the excess of adjusted gross income over the applicable amount, or b. 80% of the amount of the itemized deductions otherwise allowable for such taxable yr. C. Exceptions for certain itemized deductions: itemized deductions does not include 1. Deductions relating to medical expenses 2. Deductions relating to investment interest 3. Deductions relating to casualty or theft (c) Take amount from regular itemized deductions and subtract from adjusted gross income to determine taxable income for taxpayer. A. If applicable add amount from miscellaneous itemized deductions (must exceed 2% of adjusted gross income) IRC 161 Allowance of deductions In computing taxable income under section 63, there shall be allowed as deductions the items specified in this part subject to the exceptions provided in IRC 261 & following, relating to items not deductible. C: Overview of credits A credit reduces tax liability dollar for dollar, while a deduction only produces a tax savings equal to the amount of the deduction multiplied by the taxpayers marginal tax rate (rate at which the last dollar of taxable income is taxed). Credits benefit all taxpayers equally. Household and dependent care credit Generally a taxpayer can credit anywhere from 20% 35% of such costs against the taxpayers federal income tax liability. Applicable percentage will depend upon the taxpayers AGI. Maximum credit amt under IRC 21 $3,000 (or $6,000, if the taxpayer household contains more than one dependent.) Taxpayer must furnish over one-half of the total cost of maintaining the household. Types of dependents which care for whom will trigger credit 9

(1) Dependents under age 13 (2) Dependents of any age who share the same principal place of abode as the taxpayer & are physically or mentally incapable of caring for themselves (3) Spouses of any age who share the same principal place of abode as the taxpayer & are physically or mentally incapable of caring for themselves. Hope scholarship credit and lifetime learning credit Available for tuition & related expenses incurred during the first 2 yrs of post-secondary education. Student MUST go to school on at least a half-time basis (credit is lost if convicted of a felony drug offense)

The meaning of gross income Treas. Reg 1.61-2(d)(1) If services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation. If services are paid for in exchange for other services, the fair market value of such other services taken in payment must be included in income as compensation. Imputed income: benefits resulting from a taxpayers personal efforts (eg lawyer painting his own house no gross income for service) Treas. Reg 1.61-14(a) Punitive damages such as treble damages under the anti-trust laws and exemplary damages for fraud are gross income. Another persons payment of the taxpayers income taxes constitutes gross income to the taxpayer unless excluded by law (eg Old Colony Trust). Eisner v. Macomber-> a stock dividend was not w/in the meaning of income as used in the 16th Amend. In order for the taxpayer to have income from property, the taxpayer must receive some right or asset that is sufficiently distinct from the property (realization of profits) Rule of realization postpones taxation: (1) until taxpayer has adequate resources to pay the tax; and (2) until the amount of gain or profit can be measured with reasonable certainty. Cesarini v US-> gross income means all income from whatever sources derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services. The finder of treasure-trove is in receipt of taxable income, for Fed income tax purposes, to the extent of its value in US currency, for the taxable year in which it is reduced to undisputed possession. James v. US-> unlawful gain of money is taxable (eg embezzled money) Glenshaw Glass test: Clear accession to wealth, complete dominion, realization? Yes -> gross income. 10

B. Compensation for Services (1) Payments to 3rd parties Old Colony Trust v. Commissioner-> Another persons payment of the taxpayers income taxes constitutes gross income to the taxpayer unless excluded by law. McCann v. US & US v. Gotcher-> Can trip be considered a reward? 1. Yes trip can be treated as a reward-> taxable 2. No trip cant be treated as a reward-> primary benefit to VW therefore not income to Gotcher but yes to his wife. Primary benefit doctrine examines who benefits in determining if an event is taxable. Treas. Regs. 1.61-2(a)(1) Compensation for services, including fees, commissions, & similar items. Wages, salaries, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, termination or severance pay, rewards, jury fees, marriage fees & other contributions received by a clergyman for services, pay of persons in the military or naval forces of the US, retired pay of employees, pensions, & retirement allowances are income to the recipients unless excluded by law. Treas. Regs. 1.61-2(d)(1)-(2)(i) Compensation paid other than in cash: If services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation. If services are paid for in exchange for other services, the fair market value of such other services taken in payment must be included in income as compensation. Property transferred to employee or independent contractor: if property is transferred by an employer to an employee or independent contractor as compensation for services, for an amount that is less than its fair market value, then regardless of whether the transfer is in the form of a sale or exchange, the difference between the amt paid & the amt of its fair market value at the time of transfer is compensation & shall be included in the gross income of the employee or independent contractor. Treas. Reg. 1.61-14 Miscellaneous items of gross income. In addition to the items enumerated in IRC 61(a), there are many other kinds of gross income. Punitive damages as treble damages under the antitrust laws & exemplary damages for fraud are gross income, as well as another persons payment of the taxpayers income taxes, illegal gains, and treasure trove, to the extent of its value in US currency, constitutes gross income for the taxable yr in which its reduced to undisputed possession. 11

(2) Meals and lodging furnished on employers premises Basic test of exclusion is whether the meals or lodging are furnished primarily for the convenience of the employer (and thus excludable) or whether they were primarily for the convenience of the employee (and thus taxable) IRC 119 (applies only to meals/lodging furnished in kind-> any cash allowances received by employee will be includable in gross income to the extent that such allowances constitute compensation Commissioner v. Kowalski ) Meals or lodging furnished for the convenience of the employer (a) Meals and lodging furnished to employee, his spouse, & his dependants, pursuant to employment. There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependants by or on behalf of his employer for the convenience of the employer, but only if: (1) In the case of meals, the meals are furnished on the business premises of the employer, or (2) In the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment. (b) For purposes of subsection (a) 1. The provisions of an employment K or of a state statute fixing terms of employment shall not be determinative of whether the meals or lodging are intended as compensation when determining if the meals/lodging are furnished for the convenience of the employer. 2. The fact that a charge is made for meals, & the fact that the employee may accept or decline meals shall not be taken into account in determining whether the meals are furnished for the convenience of the employer. 3. Certain fixed charges for meals A. If I. An employee is REQUIRED, to pay on a periodic basis a fixed charge for his meals, and II. Such meals are furnished by the employer for the convenience of the employer, there shall be excluded from the employees gross income an amt equal to such fixed charge. B. Subparagraph A shall apply i. Whether the employee pays the fixed charge out of his stated compensation or out of his own funds, and ii. Only if the employee is required to make the payment whether he accepts or declines the meals. 4. All meals furnished on the business premises of an employer to such employers employees shall be treated as furnished for the convenience of the employer if, more than half of the employees to whom such meals are furnished on such premises are furnished such meals are furnished for the convenience of the employer.

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Adams v. US: Test examines if i. Is there an explicit required to accept the residence ii. Does a condition of employment exist(due to the nature of the employers business, a certain type of residence for the employee is required & that it would not be reasonable to suppose that the employee would normally have available such lodging for the use of his employer) The convenience of the employer test is satisfied were theres a direct nexus between the housing furnished the employee & the business interests of the employer served thereby. iii. Was lodging on the business premises of the employer? Determination if the residence is on business premises is based on if: a. The residence was built & owned by the employer b. It was designed, in part, to accommodate the business activities of the employer c. The employee is required to live in the residence d. There were many business activities for the employee to perform after normal working hours in his home bc of the extensive nature of the employers business & the high-ranking status of the employee e. The employee did perform business activities in the residence, and f. The residence served an important business function of the employer. (d ) Lodging furnished by certain educational institutions to employees 1. In the case of an employee of an educational institution, gross income shall not be include the value of qualified campus lodging furnished to such employee during the taxable yr. 2. Paragraph 1 shall not apply to the extent of the excess of A. The lessor of i. 5 percent of the appraised value of the qualified campus lodging, or ii. The average of the rentals paid by individuals (other than employees or students of school) during such calendar yr for lodging provided by the educational institution which is comparable to the qualified campus lodging provided to the employee, over B. The rent paid by the employee for the qualified campus lodging during such calendar yr The appraised value under A(i) shall be determined bas of the close of the calendar yr in which the taxable yr begins, or, in the case of a rental period not greater than 1 yr, at any time during the calendar yr in which such period begins. 3. Qualified campus lodging a. Located on, or in the proximity of, a campus of the educational institution, AND b. Furnished to the employee, his spouse, & any of his dependents by or on behalf of such institution for use as a residence 13

Treas. Regs. 119 The value of meals furnished to an employee by his employer shall be excluded from the employees gross income if 2 tests are met Meals are furnished on the business premises of the employer Meals are furnished for the convenience of the employer a. Meals are furnished for a substantial non-compensatory business reason of the employer: 1. Generally meals furnished before or after working hours WILL NOT be regarded as furnished for the convenience of the employer UNLESS employee was not able to obtain a meal during his working hrs (during after hours) 2. Meals are furnished to the employee during his working hours to have the employee available for emergency call during his meal period (must be shown that emergencies have actually occurred, or can be reasonably expected to occur) 3. The employers business is such that the employee must be restricted to a short meal period (30 or 45 mins) & bc employee could not be expected to eat elsewhere in such a short meal period 4. When the employee cant obtain otherwise secure proper secure meals within a reasonable meal period 5. If meals are provided which an employee may or may not purchase-> meals will not be regarded as furnished for the convenience of the employer. 6. If flat charge is made by employer regardless of whether employee obtains meals furnished amt made by employer for such meals IS NOT part of compensation includible in gross income for employee (3) Statutory fringe benefits IRC 132 Certain Fringe Benefits (a) Gross income shall not include any fringe benefit which qualifies as (1) No-additional-cost service i. Such service is offered for sale to customers in the ordinary course of the line of business of the employer which the employee is performing services, and ii. The employer incurs no substantial additional cost (including forgone revenue) in providing such service to the employee (determined w/o regard to any amt paid by the employee for such service) (2) Qualified employee discount: any employee discount with respect to qualified property or services to the extent such discount doesnt exceed i. In the case of property, the gross profit percentage of the price at which the property is being offered by the employers to customers, or ii. In the case of services, 20% of the price at which the services are being offered by the employee to customers. Gross profit percentage: percent which 14 i. ii.

i.

ii.

The excess of the aggregate sales price of property sold by the employer to customers over the aggregate cost of such property to the employer, is of The aggregate sale price of such property.

b. gross profit percentage shall be determined on the basis of i. all property offered to customers in the ordinary course of the life of business of the employer in which the employee is performing services (or a reasonable classification of property selected by the employer) and ii. the employers experience during a representative period Employee discount: the amt by which i. ii. The price at which the property or services are provided by the employer to an employee for use by such employee, is less than The price at which such property or services are being offered by the employer to customers.

Qualified property or services: any property (other than real property and other than personal property of a kind held for investment) or services which are offered for sale to customers in the ordinary course of the line of business of the employer in which the employee is performing services. (3) Working condition fringe i. Any property or services provided to an employee of the employer to the extent that,, if the employee paid for such property or services, such payment would be allowable as a deduction under 162 (trade or business expense) or 167 (depreciation) (4) De minimis fringe i. Any property or service the value of which is ( after taking into account the frequency with which similar fringes are provided by the employer to the employers employees) so small as to make accounting for it unreasonable or administratively impracticable. ii. The operation by an employer of any eating facility for employees shall be treated as a de minimis fringe if a. Such facility is located on or near the business premises of the employer, AND b. Revenue derived from such facility normally equals or exceeds the direct operating costs of such facility (5) Qualified transportation fringe: any of the following provided by an employer to an employee (does not include working condition fringe and de minimis fringe)

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a. Transportation in a commuter higher vehicle if such transportation is in connection with travel between the employees residence and place of employee. i. Any highway vehicle with the seating capacity of at least 6 adults (not including driver) ii. At least 80% of the mileage use of which can reasonably be expected to be for purposes of transporting employees between their residences & place of employment AND on trips during which the number of employees transported for such purposes is at least of the adult seating capacity of such vehicle (not including driver) b. Any transit pass: any pass, token, farecard, voucher, or similar item entitling a person to transportation (or transportation at a reduced price) if such transportation is i. On mass transit facilities (public or private), or ii. Provided by any person in the business of transporting persons for compensation or hire if such transportation is provided in a vehicle qualifying as a commuter highway vehicle. c. Qualified parking: parking provided to an employee on or near the business premises of the employer or on or near a location from which the employee commutes to work by transportation. Such term shall not include any parking on or near property used by the employee for residential purposes. d. Any qualified bicycle commuting reimbursement (6) Qualified moving expense reimbursement Any amount received (directly or indirectly) by an individual from an employer as a payment for (or a reimbursement of) expenses which would be deductible as moving expenses under sec 217 if directly paid or incurred by the individual. Such term shall not include any payment for (or reimbursement of) an expense actually deducted by the individual in a prior taxable yr. (7) Qualified retirement planning services. Treas. Reg. 132-2(a) 1.132-2(a) No-additional-cost services a) Gross income does not include the value of a no-additional-cost service-> service provided by an employer to an employee for the employees personal use if i. The service is offered for sale by the employer to its customers in the ordinary cost of the line of business of the employer in which the employee performs substantial services, AND 16

ii. The employer incurs no substantial additional cost in providing the service to the employee (including forgone revenue & excluding any amt paid by or on behalf of the employee for the service) 1.132-2(C) Assume that a commercial airline permits its employees to take personal flights on the airline at no charge & receive reserved seating, Bc the employer forgoes potential revenue by permitting employees to reserve seats, employees receiving such free flights are not eligible for the no-additionalcost exclusion. 132-3(a)(1)-(4) Qualified employee discount a) (1) Gross income does not include the value of a qualified employee discount-> any employee discount with respect to qualified property or services provided by an employer to an employee for use by the employee to the extent the discount does not exceed i. The gross profit percentage multiplied by the price at which the property is offered to customers in the ordinary course of the employers line of business, for discounts on property, or ii. 20% of the price at which the service is offered to customers, for discounts on services. (2) Qualified property or services: any property or services that are offered for sale to customers in the ordinary course of the line of business of the employer in which the employee performs substantial services. i. Qualified property does not include real or personal property of a kind commonly held for investment. An employee may not exclude gross income the amount of an employee discount provided on the purchase of securities, commodities or currency, or of either residential or commercial real estate, whether or not the particular purchase is made for investment purposes. ii. Property & services not offered in ordinary course of business doesnt include any property or services of a king that is not offered for sale to customers in the ordinary course of the line of business. (3) No reciprocal agreement: the exclusion for a qualified employee discount does not apply to property or services provided by another employer pursuant to a written reciprocal agreement that exists between employers to provide discounts on property & services to employees of the other employer. (4) Property or services provided w/o charge, at a reduced price, or by rebates: the exclusion for a qualified employee discount applies 17

whether the property or service is provided at no charge (in which case only part of the discount may be excludable as a qualified employee discount) or at a reduced price. The exclusion also applies if the benefit is provided through a partial or total cash rebate of an amt paid for the property or service. 1.132-4(a)(1)(i) Line of business limitation a. A no-additional-cost service or a qualified employee discount is ONLY available with respect to property or services that are offered for sale to customers in the ordinary course of the same line of business in which the employee receiving the property or service performs substantial services. 1.132-4(a)(1)(iv) Performance of services that directly benefit more than one line of business An employee who performs substantial services that directly benefit more than one line of business of an employer is treated as performing substantial services in ALL such lines of business. 132-6(a)-(c) De minimis fringes (a) Any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employers employees) so small as to make account for it unreasonable or administratively impracticable (b) Frequency is determined by reference to the frequency with which the employer provides the fringes to each individual employee. i. If an employer provides a free meal in kind to one employee on a daily basis, but not to any other employee, the value of the meals is not de minimis w/respect to that one employee even though w/respect to the employers entire workforce the meals are provided infrequently. ii. The frequency with which similar fringes are provided by the employer to the employers employees is determined by reference to the frequency with which the employer provides the fringes to the workforce as a whole. (c) Administrability: the value of any fringe benefit that would not be unreasonable or administratively impracticable to account for is includible in the employees gross income. IRC 83 Property transferred in connection with performance of services a. If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of (1) the fair market value of such property at the 1st time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over (2) the amount (if any) paid for such property

18

Shall be included in the gross income of the person who performed such services in the 1st taxable year in which the rights of the person having the beneficial interest in such property are transferrable AND.?.?.?.? are not subject to a substantial risk of forfeiture, whichever is applicable. If such person sells or otherwise disposes of such property in an arms length transaction before his rights in such property become transferable or not subject to a substantial risk or forfeiture, then the performance of services SHALL NOT be included in gross income for that individual. b. 1. Any person who performs services in connection with which property is transferred to any person may elect to include in his gross income, for the taxable yr in which such property is transferred, the excess of (a) Fair market value of such property at the time of transfer, over (b) Amt (if any) paid for such property. If such election is made, subsection (a) shall not apply with respect to the transfer of such property, & if such property is subsequently forfeited, no deduction shall be allowed in respect of such forfeiture. c. The rights of a person in property are subject to a substantial risk of forfeiture if such persons rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual i. Transferability of property: the rights of a person in property are transferable only if the rights in such property of any transferee are not subject to a substantial risk of forfeiture. ii. Subject to forfeiture: a substantial risk of forfeiture exists where rights in property Treas. Reg. 1.83-1(a) Property transferred in connection with the performance of services. The employee or independent contractor shall include as compensation the excess amount of the fair market value of the property & what amount (if any) was paid for such property. The compensation shall be for the taxably yr in which the property becomes substantially vested. Any income from such property shall be deemed as additional compensation to the employee or independent contractor for the taxable yr in which such income is received or such use is made available. Problem 3-11 Corky is the president & sole shareholder of a corporation that manufactures & sells rocking chairs. The corporation employees several workers, including Mr. McFeely and Lady Aberlin (a) To reward McFeely for his good work & long service, the corporation awarded McFeely 100 shares of stock. McFeely signed a so-called restrictive stock agreement that prohibited any transfers of the stock until McFeelys termination or retirement. Does McFeely have gross income upon receipt of the shares? 19

McFeely does have gross income upon receipt of the shares bc the shares can be construed as property thats transferred in connection with the performance of services. An argument could be made that bc theres a restrictive stock agreement for the shares McFeely receives then a substantial vesting has not occurred & therefore there is no gross income?.?.?.? (b) Lady Aberlin also received 100 shares of stock in recognition of her being named employee of the year. Under the terms of her restrictive stock agreement, Ablerin must forfeit her shares (transfer the stocks back for no consideration) if she voluntarily terminates her employment before reaching 65. She must also forfeit the shares if she is terminated for cause prior to retirement. If Aberlin transfers her shares to any 3rd party, the 3rd party is also subject to the risk of losing the shares if Aberlin voluntarily terminates her employment or is terminated for cause. Does Aberlin have gross income upon receipt of the shares? Lady Aberlins receipt of shares can be deemed to not be gross income bc of the restrictive nature surrounding the transfer of the shares. Theres a substantial risk of forfeiture bc the condition of the transfer is based upon future performance of substantial services by Lady Aberlin bc she if she voluntarily terminates her employment she losses the shares along. An argument for the Lady Aberlins shares to be considered as income is that the shares are vested bc a substantial risk of forfeiture does not exist if she is terminated for cause. Treas. Reg. 1.83-2(a) If property is transferred in connection with performance of services, the person performing such services may elect to include in gross income under IRC 83(b) the excess (if any) of the fair market value of the property at the time of transfer over the amount (if any) paid for such property, as compensation for services. Treas. Reg. 1.83-3(c) Substantial risk of forfeiture Whether a risk of forfeiture is substantial or not depends upon the facts & circumstances. A substantial risk of forfeiture exists where rights in property that are transferred are conditioned, directly or indirectly, upon the future performance (or refraining from performance) of substantial services by any person, or occurrence of a condition related to a purpose of the transfer, & the possibility of forfeiture is substantial if such condition is not satisfied. Property is not transferred subject to a substantial risk of forfeiture to the extent that the employer is required to pay the fair market value of a portion of such property to the employee upon the return of such property. The risk that the value of property will decline during a certain period of time does not constitute a substantial risk of forfeiture. C. Gifts & bequests 102 a. Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance b. Income-> gross income shall be 1. Income from any property; or 20

2. Where the gift, bequest, devise, or inheritance is of income from property, the amount of such income. Where, under the terms of the gift, bequest, devise or inheritance, the payment, crediting, or distribution thereof is to be made at intervals, then, to the extent that it is paid or credited or to be distributed out of income from property, it shall be treated as a gift, bequest, devise, or inheritance of income from property. c. Employee gifts-> any amount transferred by or for an employer to, or for the benefit of an employee shall be considered as gross income. Treas. Reg. 1.102-1 Gifts & inheritance 1. Prizes & awards shall not be excluded from gross income, certain de minimis fringe benefits, any amount transferred by or for an employer to, or for the benefit of an employee, or a qualified scholarship. 2. Extraordinary transfers to the natural objects of an employers bounty will not be considered transfers to, or for the benefit of, an employee if the employee can show that the transfer was not made in recognition of the employees employment. Amounts transferred between related parties shall be excluded from income if the purpose of the transfer can be substantially attributed to the familial relationship of the parties & not to the circumstances of their employment. IRC 74 Prizes & awards (a) Gross income includes amounts received as prizes & awards (b) Gross income does not include amounts received as prizes & awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement, but only if (1) The recipient was selected w/o any action on his part to enter the contest or proceeding (2) The recipient is not required to render substantial future services as a condition to receiving the prize or award; AND (3) The prize or award is transferred by the payor to a govt unit or organization (c) Exceptions for certain employee achievement awards (1) If the cost to the employer of the employee achievement award does not exceed the amount allowable as a deduction to the employer for the cost of the employee achievement award, then gross income shall not be included by the taxpayer. (2) Gross income to the taxpayer will be the greater of (A) or (B) when the cost of the award exceeds the amount allowable as a deduction to the employer for the cost of the award.

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(A) An amount equal to the portion of the cost to the employer of the award thats not allowed as a deduction to the employer, or (B) The amount by which the value of the award exceeds the amount allowable as a deduction to the employer. IRC 274 (j)(3)-(4) Employee achievement award 3. (A) Employee achievement award means an item of tangible personal property which is i. Transferred by an employer to an employee for length of service achievement or safety achievement ii. Awarded as part of a meaningful presentation, and iii. Awarded under conditions & circumstances that do not create a significant likelihood of the payment of disguised compensation. (B) Qualified plan award i. an employee achievement award awarded as part of an established written plan or program of the taxpayer which does not discriminate in favor of highly compensated employees ii. If the average cost of the all employee achievement awards which are provided by the employer during the year & which would be qualified plan awards exceed $400 the award shall not be treated as a qualified plan.

The transfer of property by gift is seen as personal consumption by the donor. Commissioner v. Duberstein: Duberstein provided names of potential customers for Mohawk Metal Corporation. As a way of showing appreciation for the recommendations by Duberstein Mohawk gave Duberstein a Cadillac which it claimed as an expense for its business. Duberstein did not include the value of the car in gross income deeming it as a gift. Ct states that car is income. Test developed was to see if there was a detached & disinterested generosity, affection, effect to taxpayer. D. Loans & cancellation of debt IRC 108 Income from discharge of indebtedness (a) Exclusion from gross income (1) Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of the indebtedness of the taxpayer if (a) Discharge occurs in a title 11 case (b) Discharge occurs when the taxpayers insolvent (c) The indebtedness discharged is qualified farm indebtedness (d) In the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or 22

(e) The indebtedness is discharged is qualified principal residence indebtedness which is discharged before 1/1/2013 (2) Coordination of exclusions (3) Insolvency exclusion limited to amount of insolvency In case of a discharge, the amount excluded shall not exceed the amount by which the taxpayer is insolvent. (b) Reduction of tax attributes Axioms for loans & cancellation of debt 1. A loan is not gross income to the borrower In a bona fide loan arrangement, the borrower has the obligation to repay the amount received as a loan. Borrower does not have accession to wealth from a loan, proceeds to borrower are offset by the liability to repay the same amount. 2. The lender may not deduct the amount of the loan Suppose a taxpayer loans $100 to an unrelated party in a bona fide transaction. From the lenders perspective, the loan merely converts one asset (cash) into another asset (a promise of repayment) 3. The amount paid to satisfy the loan obligation is not deductible by the borrower. Although the outlay made to satisfy a repayment obligation does not serve to create a new or different asset, repayment of a loan does not represent a real cost to the borrower, for the repayment of the principal amount represents merely a return of the borrowed amount. 4. Repayment of the loan is not gross income to the lender The repayment represents merely a return of capital to the lender. In effect, the promise of repayment is converted back to cash, with no accession to wealth by the lender. If lender gets less than originally loaned may deduct amount of deficiency. 5. Interest paid to the lender is included in the lenders gross income IRC 61(4) requires inclusion of interest as gross income. Interest paid to a lender is compensation for the use of lenders money or property & thus represents profit or an accession to wealth in the hands of the lender. 6. Interest paid to the lender may be deductible by the borrower Section 163 governs the deductibility of interest payments. Interest paid in connection with borrowers business activity will be deductible, while interest paid on loans used for personal activities or expenses will not be deductible (with major exception of interest paid on a home mortgage.) Cancellation of debt: if a lender forgives or cancels an outstanding debt, there may be income tax consequences to the borrower. Kirby Lumber: If the corporation purchases & retires any of such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the purchase price is gain or income for the taxable yr. 23

Zarin v. Commissioner: Plaintiff had $3.435 million in debt from gambling. Plaintiff was able to dispose of the debt by paying $500,000. The commissioner & the tax ct determined that Zarin had recognized income from the discharge of indebtedness from his gambling. The Court of Appeals for the 3rd circuit reversed the order & stated that Zarin was not liable for the remaining amount from his lease of indebtedness. Ct finds that IRC 108 is not satisfied bc Zarin was not liable for the debt he owed bc the debt was unenforceable & bc Zarin did not hold property. The chips from the casinos were nonproperty in Zarins hands & once he returned them to the casinos he no longer had possession of them. Zarin did not hold property subject to the debts to the casino & bc of that he cant have income from the discharge of his debt. E. Gains from dealings in property IRC 109 Improvements by lessee on lessors property Gross income does not include (other than rent) derived by a lessor of real property on the termination of a lease, representing the value of such property attributable to buildings erected or other improvements made by the lessee. IRC 1001 Determination of amount of & recognition of gain or loss a. Computation of gain or loss: The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis, and the loss shall be the excess of the adjusted basis over the amount realized. b. Amount realized: the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property(other than money) received. In determining the amount realized (1) There shall not be taken into account any amount received as reimbursement for real property taxes, AND, (2) There shall be taken into account amounts representing real property taxes which are imposed on the taxpayer if such taxes are to be paid by the purchaser. c. Recognition of gain or loss: Except as otherwise provided in this subtitle, the entire amount of the gain or loss, on the sale or exchange of property shall be recognized. IRC 1011 Adjusted basis for determining gain or loss (a) The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis adjusted as provided in 1016. IRC 1012 Basis of property- cost The basis of property shall be the cost of such property. The cost of real property shall not include any amount in respect of real property taxes which are treated as imposed on the taxpayer. IRC 1017 Discharge of indebtedness 24

If an amount is excluded from gross income under subsection (a) of IRC 108 (relating to discharge of indebtedness) and under subsection (b)(2)(E), (b)(5), or (c) (1) of IRC 108, any portion of such amt is to be applied to reduce basis, then such portion shall be applied in reduction of the basis of any property held by the taxpayer at the beginning of the taxable yr following the taxable yr in which the discharge occurs. Treas. Reg. 1.61-6(a) Gains derived from dealings in property Gain realized on the sale or exchange of property is included in gross income, unless excluded by law. Property includes tangible items (buildings), & intangible items (goodwill). When a part of a larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among the several parts, & the gain realized or loss sustained on the part of the entire property sold is the difference between the selling price & the cost or other basis allocated to such part. Eg-> B purchases for $25,000 property consisting of a used car lot & adjoining filling station. At the time, the fair market value of the filling station is $15,000 & the fair market value of the used car lot is $10,000. Five years later B sells the filling station for $20,000 at a time when $2,000 has been properly allowed as depreciation thereon. Bs gain on this sale is $7,000, since $7,000 is the amount by which the selling price of the filling station exceeds the portion of the cost equitably allocable to the filling station at the time of purchase reduced by the depreciation properly allowed. Treas. Reg. 1.263(a)-2(e) Treatment of capital expenditures Amts required to be capitalized under this section are capital expenditures & must be taken into account through a charge to capital account or basis, or in the case of property that is inventory in the hands of a taxpayer, through inclusion in inventory costs. Treas.Reg. 1.1012(c)(1) Sale of stock If shares of stock in a corporation are sold or transferred by a taxpayer who purchased or acquired lots of stock on different dates or at different prices, and the lot from which the stock was sold or transferred cannot be adequately identified, the stock sold or transferred shall be charged against the earliest of such lots purchased or acquired in order to determine the cost or other basis of such stock and in order to determine the holding period of such stock for purposes of subchapter P chapter 1 of the Code. If on the other hand, the lot from which the stock is sold or transferred can be adequately indentified, the rule stated in the preceding sentence is not applicable.

Treas. Reg. 1001 Determination & recognition of Gain or Loss (a) The gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as 25

income or as loss sustained. The amount realized from a sale or other disposition of property is the sum of any money received plus the fair market value of any property (other than money) received. (e)Transfers in part a sale & in part a gift. Where a transfer in property is in part a sale & in part a gift, the transferor has a gain to the extent that the amount realized by him exceeds his adjusted basis in property. However, no loss is sustained on such a transfer if the amount realized is less than the adjusted baisis. Eg-> A transfers property to his son for $30,000. Such property in As hands has an adjusted basis of $60,000 (and a fair market value of $90,000) A has no gain or loss, & has made a gift of $60,000, the excess of $90,000, the fair market value, over the amount realized, $30,000. Eg 2-> A transfers property to his son for $60,000. Such property in the hands of A has an adjusted basis of $30,000 (and a fair market value of $90,000). As gain is $30,000, the excess of $60,000, the amount realized, over the adjusted basis, $30,000. He has made a gift of $30,000, the excess of $90,000, the fair market value, over the amount realized $60,000. Eg 3-> A transfers property to his son for $30,000. Such property in As hands has an adjusted basis of $30,000 (and a fair market value of $60,000). A has no gain & has made a gift of $30,000, the excess of $60,000, the fair market value, over the amount realized $30,000. Eg 4-> A transfers property to his son for $30,000. Such property in As hands has an adjusted basis of $90,000 (and a fair market value of $60,000). A has sustained no loss, & has made a gift of $30,000, the excess of $60,000 the fair market value, over the amount realized, $30,000. Amount realized is the value of what the taxpayer receives in the exchange, & the adjusted basis is the cost of what the taxpayer gives up in the exchange. Section 1001 ONLY applies when there is an exchange and where the taxpayer receives money or other property in the transaction. A key concept to understanding a taxpayers amount realized is to identify when an exchange has occurred. Helvering v. Bruun: Realization of gain not need be in cash derived from the sale of an asset. Ct identifies four events that trigger realization of gain or loss. 1. 2. 3. 4. A property exchange Relief of a legal obligation owed to a 3rd party Relief of a legal obligation owed to the party receiving property Other profit transactions

To recognize a gain simply means to include it in computing gross income. Important difference between realized gains & recognized gains; not all realized gains are recognized. Philadelphia Park Amusement Co. v. US-> Three morals 26

1. Following a taxable exchange, the taxpayers basis in property received in the exchange is always equal to the fair market value of the property received. 2. Every taxable yr stands alone 3. Where the taxpayer does not know & cannot readily ascertain the value of property received in the exchange, the taxpayer may look to the value of the property surrendered in the exchange. Amount Realized minus Adjusted Basis ___________________ Realized Gain IRC 1014 Basis of property acquired from a decedent (a) The basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedents death by such person, be (1) The fair market value of the property at the date of the decedents death (2) In the case of an election under either section 2032 or section 811(j) of the IRC of 1939 where the decedent died after Oct. 21, 1942, its value at the applicable valuation date prescribed by those sections (3) In the case of an election under section 2032A, its value determined under such section, or (4) To the extent of the applicability of the exclusion described in section 2031(c), the basis in the hands of the decedent (b) The following property shall be considered to have been acquired from or to have passed from the decedent: (1) Property acquired by bequest, devise, or inheritance, or by the decedents estate from the decedent; (2) Property transferred by the decedent during his lifetime in trust to pay the income for life to or on the order or direction of the decedent, with the right reserved to the decedent at all times before his death to revoke the trust; (3) In the case of decedents dying after Dec. 31, 1951, property transferred by the decedent during his lifetime in trust to pay the income for life to or on the order or direction of the decedent with the right reserved to the decedent at all times before his death to make any change in the enjoyment thereof through the exercise of a pwr to alter, amend, or terminate the trust; (4) Property passing w/o full & adequate consideration under a general pwr of appointment exercised by the decedent by will (e) Appreciated property acquired by decedent by gift w/in 1 yr of death (1) In the case of a decedent dying after Dec. 31, 1951 if Adjusted Basis minus Amount Realized _______________________ Realized Loss

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(A) appreciated property (any property whose fair market value exceeds its adjusted basis) was acquired by the decedent by gift during the 1yr period ending on the date of the decedents death, and (B) such property is acquired from the decedent by ( or passes from the decedent to) the donor of such property (or the spouse of such donor) The basis of such property in the hands of such donor (or spouse) shall be the adjusted basis of such property in the hands of the decedent immediately before the death of the decedent. (f) This section shall not apply with respect to decedents dying after Dec. 31, 2009 IRC 1015 Basis of property acquired by gifts & transfers in trust Gifts after Dec. 31, 1920 (a): if property was acquired by gift after 12/21/20 the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift, except that if such basis is greater than fair market value of the property at the time of the gift, then the purpose of determining loss the basis shall be such fair market value. (d) Increased basis for gift tax paid (1) If (A) The property is acquired by gift on or after 09/2/58, the basis shall be the basis determined under when it was in the hands of the donor, increased by the amount of gift tax paid with respect to such gift, or (B) The property was acquired by gift before 09/2/58, & has not been sold, exchanged, or otherwise disposed of before such date, the basis of the property shall be increased by such date by the amount of gift tax paid with respect to such gift, but such increase shall not exceed an amount equal to the amount by which the fair market value of the property at the time of the gift exceeded the basis of the property in the hands of the donor at the time of the gift (2) Amount of gift tax paid with respect to gift Treas. Reg. 1.1015-1 Basis of property acquired by gift after 12/31/1920 (a) In the case of property acquired by gift after 12/31/20 (whether by a transfer in trust or otherwise), the basis of the property for the purpose of determining gain is the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift. The same rule applies in determining loss unless the basis is greater than the fair market value of the property at the time of the gift. In such case, the basis for determining loss is the fair market value at the time of the gift. Eg. A acquires by gift income-producing property which has an adjusted basis of $100,000 at the date of the gift. The fair market value of the property at the 28

date of the gift is $90,000. A later sells the property for $95,000. In such case there is neither gain nor loss. The basis for determining loss is $90,000; therefore theres no loss. Furthermore theres no gain since the basis for determining gain is $100,000. Treas. Reg. 1.1015-4 Transfers in part a gift & in part a sale (a) Where a transfer in property is in part a sale & in part a gift, the unadjusted basis of the property in the hands of the transferee is the sum of(1) Whichever of the following is the greater i. The amount paid by the transferee for the property, or ii. The transferors adjusted basis for the property at the time of the transfer, AND (2) The amount of increase, if any, in the basis is authorized by 1015(d) for gift tax paid Eg1. If A transfers property to his son for $30,000, & such property at the time of the transfer has an adjusted basis of $30,000 in As hands (and a fair market value of $60,000) the unadjusted basis for the property in the hands of the son is $30,000. Eg2. If A transfers property to his son for $60,000, & such property at the time of transfer had an adjusted basis of $30,000 in As hands (& a fair market value of $90,000), the unadjusted basis for such property in the hands of the son is $60,000. Eg3. If A transfers property to his son for $30,000, & such property at the time of transfer has an adjusted basis in As hands of $60,000 (& a fair market value of $90,000), the unadjusted basis of such property in the hands of the son is $60,000. Eg4. If A transfers property to his son for $30,000 & such property at the time of transfer has an adjusted basis of $90,000 in As hands (and a fair market value of $60,000), the unadjusted basis of the property in the hands of the son is $90,000. However, since the adjusted basis of the property in As hands at the time of the transfer was greater than the fair market value at that time, for the purpose of determining any loss on a later sale or other disposition o f the property by the son its unadjusted basis in his hands is $60,000. Donees basis for computing GAIN Donors AB Donors AB Donees basis for computing LOSS Donors AB FMV (loss does not carry over)

FMV>or= to Donors AB at time of gift FMV< Donors AB at time of gift

Transfer in satisfaction of an obligation 29

US v. Davis: Mr. Davis transferred 500 shares of stock to his spouse pursuant to a separation agreement. In exchange the then Mrs. Davis agreed to relinquish all of her claims & marital rights against Mr. Davis property. Mr. Davis basis in the shares of stock transferred to Mrs. Davis was approximately $75,000 & the transferred shares were worth $82,000. An introduction to the flavor of income Capital gain is the gain from the sale or exchange of a capital asset (generally property held for investment or personal use purposes (not for the conduct of an active business) usually qualifies as a capital asset. IRC 1221 Capital asset defined Capital asset: property held by the taxpayer (whether or not connected with his trade or business) but DOES NOT INCLUDE (1) Stock in trade of the taxpayer or other property of a kind which would properly included in the inventory of the taxpayer if on hand at the close of the taxable yr, or property held by the taxpayer primarily for sale to customers in the ordinary course of his business (2) Property used in his trade or business of a character which is subject to the allowance for depreciation or real property used in his trade or business (3) A copyright, a literary, musical, or artistic composition, a letter or memorandum or similar property held by (a) A taxpayer whose personal effects created such property (b) In the case of a letter, memorandum, or similar property, a taxpayer for whom such property was prepared or produced,, or (c) A taxpayer in whose hands the basis of such property is determined, for the purposes of determining gain from a sale or exchange, in whole or part by reference to the basis of such property in the hands of the taxpayer described in part (a) or (b) (4) Accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph 1 (5) A publication of the US govt which is received from the US govt or agency thereof, other than by purchase at the price at which its offered for sale to the public & which is held by (a) A taxpayer who received such publication, or (b) A taxpayer in whose hands the basis of such publication is determined, for purposes of determining gain from a sale or exchange, in whole or in part by reference to the basis of such publication in the hands of a taxpayer described in subparagraph (a) (6) Any commodities derivative financial instrument held by a commodities derivatives dealer unless 30

(a) Its established to the satisfaction of the Secretary that such instrument has no connection to the activities of such dealer as a dealer, and (b) Such instrument is clearly identified in such dealers records as being described in subparagraph (a) before the close of the day on which it was acquired, originated, or entered into (or such other time as the secretary may by regulations prescribe.) (7) Any hedging transaction which is clearly identified as such before the close of the day on which it was acquired, originated, or entered into; or (8) Supplies of a type regularly used or consume by the taxpayer in the ordinary course of a trade or business IRC 1222 Other terms relating to capital gain & losses (1) Short-term capital gain: gain from the sale or exchange of a capital asset held for not more than 1 yr, if and to the extent such gain is taken into account in computing gross income. (2) Short-term capital loss: loss from the sale or exchange of a capital asset held for not more than 1 yr, if and to the extent that such loss is taken into account in computing taxable income. (3) Long-term capital gain: gain from the sale or exchange of a capital asset held for more than 1 yr, if and to the extent such gain is taken into account in computing gross income. (4) Long-term capital loss: loss from the sale or exchange of a capital asset held for more than 1 yr, if and to the extent that such loss is taken into account in computing taxable income. (5) Net short-term capital gain: the excess of short-term capital gains for the taxable yr over the short-term capital loss for such yr. (6) Net short-term capital loss: the excess of short-term capital losses for the taxable yr over the short-term capital gains for such yr. (7) Net long-term capital gain: excess of long-term capital gains for the taxable yr over the longterm capital losses for such yr (8) Net long-term capital loss: excess of long-term capital losses for the taxable yr over the longterm capital gains for such yr. (9) Capital gain net income: excess of gains from sales or exchanges of capital assets over the losses from such sales or exchanges (10)Net capital loss: excess of the losses from sales or exchanges of capital assets over the summer allowed under 1211 limitation on capital losses. IRC 1211 Limitation on capital losses (a) Corporations: losses from sales or exchanges of capital assets shall be allowed only to the extent of gains from such sales or exchanges (b) Other taxpayers: losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges, plus (if such losses exceed such gains) the lower of

31

$3,000 ($1,500 in the case of a married individual filing a separate return), or ii. The excess of such losses over such gains (11)Net capital gain: excess of net long-term capital gain for the taxable yr over the short-term Preferential rates will apply ONLY to gains from the sale or exchange of capital assets held for more than 1 yr. If an individual sells a capital asset for a gain but only held the asset for 1 yr or less, the gain will be taxed as ordinary income. Preferential rates were justified on the grounds of inflation bc basis is not adjusted to take inflation into account. Preferential rates for long-term capital gains was necessary to accommodate for the hardships of taxing gains due to inflation instead of real economic growth. Bunching is another rationale for the preferential rate. Bunching all of the gain into a sgl yr increases the risk that gain will be taxed at a higher rate. By limiting the tax rate applicable to long-term capital gains, the rate of tax may better approximate the amount of tax that wouldve been collected if the gain had been taxed as it accrued. Preferential rate is also applied to dividend income bc its designed to alleviate the double taxation of corporate time (once at the corporate level & again at the shareholder level upon a dividend distribution) Double taxation is improper where the SAME taxpayer pays two taxes on the same income. QPAI (qualified production activities income): portion of taxpayers taxable income equal to the excess of domestic production gross receipts over (i) (ii) (iii) Cost of goods sold Deductions directly allocable to domestic production gross receipts, AND A proportionate share of other general deductions like overhead & administrative expenses

i.

DPGR (domestic production gross receipts): taxpayers gross receipts from (i) Any lease, rental, license, sale, exchange or other disposition of tangible personal property, computer software, or sound recording that is produced or grown in whole or in significant part w/in the US A qualified film( non-sexually explicit film where more than half of the compensation related to its production was paid for services performed w/in US) Electricity, natural gas, or potable water produced by the taxpayer in the US Construction performed w/in the US; or Engineering or architectural services performed in the US for the construction projects w/in the US.

(ii) (iii) (iv) (v)

An introduction to the timing of income 32

A current dollar is worth more than a future dollar. When it comes to costs a future cost is better than a current cost. Claim of right doctrine: If a taxpayer has an obligation to repay an amt received from another person, the taxpayer does not have gross income. The transaction is properly characterized as a loan absent some other facts. When a taxpayer acquires earnings, lawfully or unlawfully, w/o the consensual recognition, express or implied, of an obligation to repay & w/o restriction as to their disposition, he had received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, & even though he may still be adjudged liable to restore its equivalent. North American Oil v. Burnet. Customer deposit: The proper approach to determining the appropriate tax treatment of a customer deposit is to look at the primary purpose of the deposit based on all the facts & circumstances. When the purpose of the deposit is to guarantee the customers payment of amts owed to the creditor, such a deposit is treated as an advance payment (treated as taxable income), but when the purpose of the deposit is to secure a property interest of the taxpayer the deposit is regarded as a true security deposit. An advance payment concededly protects the seller against the risk that it would be unable to collect money owed it after it has furnished goods or services. Advanced payment protects against the risk that the purchaser will back out of the deal before the seller performs. A customer submitting a deposit made no commitment to purchase a specified quantity of electricity, or indeed to purchase any electricity at all. Under these circumstances, IPLs dominion over the fund is far less complete than is ordinarily the case in an advance payment situation. Commissioner v. Indianapolis Pwr & Light Company. Determination of whether payments for deposits or advance payments constitute income when received depends upon the parties rights & obligations at the time the payments are made. Assignment of income Income from services: generally, income from services is taxed to the party who performed the services. Cash basis taxpayer ordinarily realizes income in the yr of receipt rather than the yr when earned. A taxpayer who assigns future income for consideration in a bona fide commercial transaction will ordinarily realize ordinary income in the year of receipt. The substance of a transaction & not the form determines the taxable consequences of that transaction. A litigants recovery constitutes income; the income includes the portion of the recovery paid to the attorney as a contingent fee. IRC 62(a)(20) allows a taxpayer in computing adjusted gross income, to 33

deduct attorney fees & ct costs paid by or on behalf of, the taxpayer in connection with any action involving a claim of unlawful discrimination. Personal No deduction 263(a) but taxpayer gets basis Business No deduction 263(a) but taxpayer gets basis And the taxpayer may be able to recover the cost over time 167(a); 168; 197 Deduction 162(a) Investment No deduction 263 (a) but taxpayer gets basis And the taxpayer may be able to recover the cost over time 167(a); 168;197 Deduction 212

Capital expenditures( those that (1) are used to acquire an asset or some other long-lasting benefit; or (2) permanently improve or extend the useful life of that asset or benefit) Expenses (outlays that are not capital expenditures) Realized losses(loss recognized upon the sale, exchange, or other disposition of an asset)

Generally no deduction 262 Generally, no deduction 262

Deduction 165 (c) (1)

Deduction 165 (c)(2)

Tax treatment of taxpayer costs The question of whether a cost is deductible depends upon two factors (1) The nature of the cost I. Capital expenditure long term benefit to taxpayer. Incurred to acquire II. expenses costs that do not acquire, improve, or prolong the life of an asset a. paid or incurred with respect to business & investment activities are generally deductible. (2) The type of activity to which that cost relates IRC 161 Allowance of deductions There shall be allowed deductions the items specified subject to exceptions provided. IRC 162 Trade or business expenses (a) There shall be allowed as a deduction all the ordinary & necessary expenses paid or incurred during the taxable yr in carrying on any trade or business (1) A reasonable allowance for salaries or other compensation for personal services actually rendered (2) Traveling expenses (including amts expended for meals & lodging other than amts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business: and

34

(3) Rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity. (b) No deduction shall be allowed for any contribution or gift which would be allowable as a deduction under section 170 were it not for the percentage limitations, dollar limitations, or the requirements as to the time of payment. (c) illegal bribes, kickbacks, & other payments (1) illegal payments to govt officials (e) denial of deduction for certain lobbying & political expenditures (f ) fines & penalties paid to the govt for violation of any law (I ) special rules for health insurance costs of self-employed individuals (1) allowance of deduction: there shall be allowed as a deduction under this section an amt equal to the amt paid during the taxable yr for insurance which constitutes medical care for (a) the taxpayer, (b) the taxpayers spouse, (c) the taxpayers dependents, and (d) any child (2) limitations (a) dollar amt no deduction shall be allowed to the extent that the amt of such deduction exceeds the taxpayers earned income derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established (b) other coverage no deduction shall apply to any taxpayer for any calendar month for which the taxpayer is eligible to participate in any subsidized health plan maintained by any employer of the taxpayer or of the spouse of, or any dependent, or individual with respect to the taxpayer. IRC 165 Losses 165 (c) limitation on losses of individuals deduction shall be limited to (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected to a trade or business; and (3) except as provided in treatment of casualty gains & losses, losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft IRC 212 Expenses for production of income

35

In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable yr (1) for the production or collection of income (2) for the management, conservation, or maintenance of property held for the production of income; or (3) in connection with the determination, collection, or refund of any tax IRC 262 Personal, living, and family expenses (a) except as otherwise expressly provided, no deduction shall be allowed for personal, living, or family expenses (b) for purposes of subsection (a), in the case of an individual, any charge (including taxes thereon) for basic local telephone service with respect to the 1st telephone line provided to any residence of the taxpayer shall be treated as a personal expense. Treas. Reg. 162 1.162-3 Costs of materials: Taxpayers carrying materials and supplies on hand should include in expenses the charges for materials and supplies ONLY in the amount that they are actually consumed and used in operation during the taxable yr for which the return is made, provided that the costs of such materials and supplies have not been deducted in determining the net income or loss or taxable income for any previous yr. If a taxpayer carries incidental materials or supplies on hand for which no record of consumption is kept or of which physical inventories at the beginning and end of the yr are not taken, it will be permissible for the taxpayer to include in his expenses and deduct from gross income the total cost of such supplies and materials as were purchased during the taxable yr for which the return is made, provided the taxable income is clearly reflected by this method. 1.162-4 Repairs: The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinary efficient operation condition, may be deducted as an expense, provided the cost of acquisition or production or the gain or loss basis of the taxpayers plant, equipment, or other property is not increased by the amount of such expenditure. Repairs in the nature of replacements, to the extent that they arrest deterioration & appreciably prolong the life of the property, shall either be capitalized & depreciated or charged against the depreciation reserve if such an account is kept. Four types of expenditures that MUST be capitalized (1) (2) (3) (4) new buildings permanent improvements intended to increase value restoration costs; and expenditures that will give rise to exhaustion deductions (depreciation & amortization)

36

Examples of capital expenditures a. amt paid to acquire or produce real or personal tangible property b. amt paid to improve real or personal tangible property c. amt paid or incurred to facilitate an acquisition of a trade or business, a change in capital structure of a business entity, and certain other transactions d. amt paid to acquire or create interests in land e. amt assessed & paid under an agreement between bondholders or shareholders of a corp. to be used in a reorganization of the corp. or voluntary contributions for any corp. purpose f. amt paid by a holding company to carry out a guaranty of dividends at a special rate on the stock of a subsidiary corp. for the purpose of securing new capital for the subsidiary & increasing the value of its stockholdings in the subsidiary. g. Except in case of dealers in property, commissions & other transaction costs paid to facilitate the sale of property generally must be capitalized. IRC 263 purpose is to reflect basic principle that a capital expenditure may not be deducted from current income. Improvements to tangible property proposed regulations provide that taxpayers must capitalize costs to improve tangible property if the costs materially add to the propertys value or restore the property to like-new conditions. Routine maintenance egs inspection, cleaning, testing of the unit of property, & replacement of parts of the unit of property with comparable and commercially available & reasonable replacement parts. Routine at the time the unit of property is placed into service, the taxpayer reasonably expects to perform the activities more than once during the class life of the unit of property (consider industry practice, manufacturers recommendations, taxpayers experience, & taxpayers treatment of activity when determining a taxpayer is performing routine maintenance.) Routine maintenance does not include 1) amts paid for the replacement of a component of a unit of property if the taxpayer has properly deducted a loss for that, 2) replacement of a component of a unit of property if the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component 3) amts paid for repair of damage to a unit of property for which the taxpayer has taken a basis adjustment as a result of a casualty loss or relating to a casualty event 4) amts paid to return a unit of property to its former ordinarily efficient operating condition, if the property has deteriorated to a state of disrepair & is no longer functional for its intended use. Determining unit of property

37

(1) does taxpayer & industry treat component part as part of the larger unit of property for regulatory, market, management or accounting purposes (2) whether economic useful life of component part is coextensive with the economic useful life of the larger unit or property (3) whether the larger unit of property & smaller unit of property can function without each other (4) whether the component part can be & is maintained while affixed to the larger unit of property. Additions to value 1) pre-existing defects the cost ameliorates a condition or defect that existed prior to the propertys acquisition or production by the taxpayer, no matter whether the taxpayer knew of this condition or defect at the time 2) pre-use costs cost relates to work performed on the property prior to the date the property is placed in service by the taxpayer 3) adaptations cost adapts the property to a new or different use, no matter whether the cost permanently alters the structural composition of the property a. Mt. Morris Drive-In Theater Co. v. CommissionerIt was obvious at the time when the drivein theater was constructed, that a drainage system would be required to properly dispose of the natural precipitation normally to be expected, & until this was accomplished, taxpayers capital investment was incomplete. No mere restoration or rearrangement of the original capital asset, but there was the acquisition & construction of a capital asset which the taxpayer had not previously had (drainage system) 4) betterments cost results in a betterment of the property or a material addition to the property (includes costs that improve the propertys quality or strength, or cause the property to be expanded or enlarged.) 5) increased productivity cost results in a material increase in the propertys capacity, productivity, or efficiency. Restoration/improvement deduction is deferred bc the cost is added to the propertys basis. Proposed regulations 1.263(a)(1) No deduction is allowed for: (1) any amt paid for new buildings or for permanent improvements or betterments made to increase the value of any property or estate, or (2) any amt paid in restoring property or in making the exhaustion thereof for which allowance is or has been made. Amts paid to sell property except in cases of dealers in property, commissions and other transaction costs paid to facilitate the sale of property generally must be capitalized.

38

Amts capitalized from commissions and other transaction costs paid to facilitate the sale of property are treated as a reduction in the amt realized and generally are taken into account either in the taxable yr in which the sale occurs or in the taxable yr in which the sale is abandoned if a loss deduction is permissible. Proposed Reg. 1.263(a)-2 Amts paid to acquire or produce tangible property A taxpayer must capitalize amts paid to acquire or produce a unit of real or personal property, including leasehold improvement property, land and land improvements, buildings, machinery and equipment, and furniture and fixtures. Amts paid to acquire or produce a unit of real or personal property include the invoice price, transaction costs, and costs for work performed prior to the date that the unit of property is placed in service by the taxpayer. A taxpayer must also capitalize amts paid to acquire real or personal property for resale and to produce real or personal property. Amts paid to defend or perfect title to real or personal property within the meaning of this section must be capitalized. Proposed Reg. 1.263(a)-3 Amts paid to improve tangible property A taxpayer must capitalize the aggregate of related amts paid to improve a unit of property, whether the improvements are made by the taxpayer or by a third party, and whether the taxpayer is an owner or lessee of the property. Safe harbor for routine maintenance An amt paid for routine maintenance performed on a unit of property is deemed not to improve that unit of property. If a taxpayer needs to replace part of a unit of property that cannot practicably be replaced with the same type of part, the replacement of the part with an improved but comparable part does not by itself, result in a betterment of the unit of property. Treas. Reg. 1.263(a)-4 Amts paid to acquire or create intangibles A taxpayer must capitalize: (a) (b) (c) (d) (e) amt paid to acquire an intangible amt paid to create an intangible amt paid to create or enhance a separate and distinct intangible asset amt paid to create or enhance a future benefit identified as an intangible; and amt paid to facilitate an acquisition or creation of an intangible.

IRC 265(a)(1) Expenses and interest relating to tax-exempt income No deduction shall be allowed for any amt otherwise allowable as a deduction which is allocable to one or more classes of income other than interest wholly exempt from the taxes imposed by this subtitle, or any amt otherwise allowable under IRC 212 (expenses for production of income) which is allocable to interest wholly exempt from taxes imposed by this subtitle. 39

IRC 274(h)(7) Disallowance of certain entertainment, etc expenses No deduction shall be allowed under IRC 212 (expenses for production of income) for expenses allocable to a convention, seminar, or similar meeting. Treas. Reg. 1.212-1 Nontrade or nonbusiness expenses An expense may be deducted under IRC 212 (expenses for the production of income) ONLY IF (1) it has been paid or incurred by the taxpayer during the taxable yr(i) for the production or collection of income which, if and when realized, will be required to be included in income for Fed income tax purposes, or (ii) for the management, conservation or maintenance of property held for the production of such income, or (iii) in connection with the determination, collection, or refund of any tax; AND (2) its an ordinary and necessary expense Expenses paid or incurred in managing, conserving, or maintaining property held for investment may be deductible even though the property is NOT currently productive and there is no likelihood that the property will be sold at a profit or will otherwise will be sold at a profit or will otherwise be productive of income and even though the property is held merely to minimize a loss with respect thereto. IRC 195 Start-up expenditures (a) capitalization of expenditures no deduction shall be allowed for start-up expenditures (b) election to deduct (1) allowance of deduction if a taxpayer elects the application of this subsection with respect to any start-up expenditure (A) the taxpayer shall be allowed a deduction for the taxable yr in which the active trade or business begins in an amt equal to the lesser of (i) the amt of start-up expenditures with respect to the active trade or business, or (ii) $5,000, reduced (but not below zero) by the amt by which such start-up expenditures exceed $50,000, AND (B) the remainder of such start-up expenditures shall be allowed as a deduction ratably over the 180-month period beginning with the month in which the active trade or business begins (2) disposition before close of amortization period in any case in which a trade or business is completely disposed of by the taxpayer before the end of the period to which paragraph (1) applies, any deferred expenses attributable to such trade or business which were not allowed as a deduction by reason of this section may be deducted to the extent allowable under IRC 165 (losses) (c) definitions (1) start-up expenditures the term start-up expenditure means any amt 40

(A) paid or incurred in connection with (i) investigating the creation or acquisition of an active trade or business, or (ii) creating an active trade or business, or (iii) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business, and (B) which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the trade or business referred to in subparagraph (A)), would be allowable as a deduction for the taxable yr in which paid or incurred. (2) beginning of trade or business (d) election (1) time for making election an election under subsection (b) shall be made not later than the time prescribed by law for filing the return for the taxable yr in which the trade or business begins (2) scope of election the period selected under subsection (b) shall be adhered to in computing taxable income for the taxable yr for which the election is made and all subsequent taxable yrs. Treas. Reg. 1.263(a)-5 Amts paid or incurred to facilitate an acquisition of a trade or business, a change in the capital structure of a business entity, and certain other transactions (a) a taxpayer must capitalize an amt paid to facilitate each of the following transactions, w/o regard to whether the transactions comprised of a single step or a series of steps carried out as a part of a single plan and w/o regard to whether the gain or loss is recognized in the transaction (1) an acquisition of assets that constitute a trade or business (whether the taxpayer is the acquirer in the acquisition or the target of the acquisition) (2) an acquisition by the taxpayer of an ownership interest in a business entity IF, immediately after the acquisition, the taxpayer and the business are related (defined in 267(b)) (3) an acquisition of an ownership interest in the taxpayer (4) a restructuring, recapitalization, or reorganization of the capital structure of a business entity (5) a transfer (6) a formation or organization of a disregarded entity (7) an acquisition of capital (8) a stock issuance (9) a borrowing (any issuance of debt) (b) an amt is paid to facilitate a transaction if the amt is paid in the process of investigating or otherwise pursuing the transaction. In determining whether the amt paid is to facilitate a transaction, the fact that the amt would (or would not) have been paid but for the transaction is relevant, but not determinative.

41

An amt paid to another party in exchange for tangible or intangible property is not an amt paid to facilitate the exchange. (d) Simplifying conventions employee compensation, overhead, and de minimis costs are treated as amts that do not facilitate a transaction (e) Certain acquisitive transactions Amts paid by the taxpayer in the process of investigating or otherwise pursuing a covered transaction facilitates the transaction ONLY IF the amt relates to the activities performed on or after the earlier of i. the date on which a letter of intent, exclusivity agreement, or similar written communication (other than a confidentiality agreement) is executed by representatives of the acquirer and the target; or the date on which the material terms of the transaction (as tentatively agreed to by representatives of the acquirer and the target) are authorized or approved by the taxpayers board of directors (or committee of the board of directors) or, the date on which material terms of the transaction (as tentatively agreed to by representatives of the acquirer and the target) are authorized or approved by the appropriate governing officials of the taxpayer ( if the taxpayer is not a corporation.)

ii.

IRC 167 Depreciation (a) there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) (1) of property used in the trade or business, or (2) of property held for the production of income (b) for determination of depreciation deduction in case of property see IRC 168 (accelerated cost recovery system) (c) basis for depreciation (1) the basis on which exhaustion, wear and tear, and obsolescence are to be allowed with respect to any property shall be the adjusted basis (for determining gain or loss) for the purpose of determining the gain on the sale or other disposition of such property (2) if any property is acquired subject to a lease (A) no portion of the adjusted basis shall be allocated to the leasehold interest, and (B) the entire adjusted basis shall be taken into account in determining the depreciation deduction (if any) with respect to the property subject to the lease. IRC 168 Accelerated cost recovery system (a) except as otherwise provided in this section, the depreciation deduction provided by IRC 167(a) for any tangible property shall be determined using (1) the applicable depreciation method (2) the applicable recovery period, and (3) the applicable convention 42

(b) Applicable depreciation method (1) The applicable depreciation method is (A) The 200% declining balance method, (B) Switching to the straight line method for the 1st taxable yr for which using the straight line method with respect to the adjusted basis as the beginning of such yr will yield a larger allowance (2) 150% declining balance method in certain cases paragraph (1) shall be applied by substituting 150% for 200% in the case of (A) Any 15-yr 0r 20yr property not referred to in paragraph (3) (B) Any property used in a farming business (w/in the meaning of IRC 263A(e)(4) (C) Any property (other than property described in paragraph (3)) which is a qualified smart electric meter or qualified smart electric grid system, or (D) Any property (other than property described in paragraph (3)) with respect to which the taxpayer elects under paragraph (5) to have the provisions of this paragraph apply (3) Property to which straight line method applies (A) Nonresidential real property (B) Residential rental property (C) Any railroad grading or tunnel bore (D) Property with respect to which the taxpayer elects under paragraph (5) to have the provisions of this paragraph apply (E) Property described in subsection (e)(3)(D)(ii) (F) Water utility property described in subsection (e)(5) (G) Qualified leasehold improvement property described in subsection (e)(6) (H) Qualified restaurant property described in subsection (e)(7) (I) Qualified retail improvement property described in subsection (e)(8) (4) Salvage value treated as zero (5) Election an election under paragraph (2)(c) or (3)(D) may be made with respect to 1 or more classes of property for any taxable yr and once made with respect to any class shall apply to all property in such class placed in service during such taxable yr. Such an election, once made, shall be irrevocable. (c) Applicable recovery period shall be determined in accordance with the table provided on page 187 (d) Applicable convention (1) Except as otherwise provided in this subsection, the applicable convention is the half-yr convention (2) Real property (A) Nonresidential property (B) Residential rental property, and (C) Any railroad grading or tunnel bore The applicable convention is the mid-month convention (3) Special rule where substantial property placed in service during last 3 months of taxable yr (A) Except as provided in the regulations, if during any taxable yr 43

The aggregate bases of property to which this section applies placed in service during the last 3 months of the taxable yr, exceed (ii) 40% of the aggregate bases of property to which this section applies placed in service during such taxable yr The applicable convention for all property to which this section applies placed in service during such taxable yr shall be mid-quarter convention (B) Certain property not taken into accountfor purposes of subparagraph (A), there shall not be taken into account (i) Any nonresidential real property and residential rental property and railroad grading or tunnel bore, and (ii) Any other property placed in service and disposed of during the same taxable yr (4) Definitions (A) Half-yr convention a convention which treats all property placed in service during any taxable yr (or disposed of during any taxable yr) as placed in service (or disposed of) on the mid-point of such taxable yr (B) Mid-month convention a convention which treats all property placed in service during any month (or disposed of during any month) as placed in service (or disposed of) on the mid-point of such moth. (C) Mid-quarter convention a convention which treats all property placed in service during any quarter of a taxable yr (or disposed of during any quarter of a taxable yr) as placed in service (or disposed of) on the mid-point of such quarter (e) Classification of property (1) Classification of property is based on table on page 188 (2) Residential rental or nonresidential real property (A) Residential rental property (i) Residential rental property means any building or structure if 80% or more of the gross rental income from such building or structure for the taxable yr is rental income from dwelling units (ii) Definitions Dwelling unit a house or apartment used to provide living accommodations in a building or structure, but does not include a unit in a hotel, motel, or other establishment more than one-half of the units in which are used on a transient basis, and If any portion of the building or structure is occupied by the taxpayer, the gross rental income from such building or structure shall include the rental value of the portion so occupied. (B) Nonresidential real property property which is not (i) Residential rental property, or (ii) Property with a class life of less than 27.5 yrs (3) Classification of certain property 44

(i)

(A) Term 3-yr property includes (i) Any race horse (1) Which is placed in service before 1/1/2014, and (2) Which is placed in service after 12/31/2013, and which is more than 2 yrs old at the time such horse is placed in service by such purchaser (ii) Any race horse other than a race horse which is more than 12 yrs old at the time its placed in service, and (iii) Any qualified rent-to-own property (B) Term 5-yr property includes (i) Any automobile or light general purpose truck (ii) Any semi-conductor manufacturing equipment (iii) Any computer-based telephone central office switching equipment (iv) Any qualified technological equipment (g ) Alternative depreciation system for certain property (1) In general in the case of (A) Any tangible property which during the taxable yr is used predominantly outside the US (B) Any tax-exempt use property (C) Any tax-exempt bond financed property (D) Any imported property covered by an Exec order under paragraph (6), and (E) Any property to which an election under paragraph (7) applies The depreciation deduction provided by IRC 167(a) shall be determined under the alternative depreciation system (2) Alternative depreciation system for purpose of paragraph (1), the alternative depreciation system is depreciation determined using (A) The straight line method (w/o regard to salvage value) (B) The applicable convention determined under subsection (d), and (C) A recovery period determined under the following table (found on page 192) (3) Special rules for determining class life (A) Tax-exempt use property subject to lease in the case of any tax-exempt use property subject to a lease, the recovery period used for purposes of paragraph (2) shall in no event be less than 125% of the lease term. (B) Special rule for certain property assigned to classes for purposes of paragraph (2) in the case of property described in any of the following subparagraphs of subsection (e)(3), the class life shall be determined as follows table found on pg 193 (C) Qualified technological equipmentIn the case of any qualified technological equipment, the recovery period used for purposes of paragraph (2) shall be 5 yrs (D) Automobiles, etc in the case of any automobile or light general purpose truck, the recovery period used for purposes of paragraph (2) shall be 5 yrs

45

(E) Certain real property in the case of any IRC 1245 property (gain from dispositions of certain depreciable property) which is real property with no class life, the recovery period used for purposes of paragraph (2) shall be 40 yrs. (7 ) election to use alternative depreciation system (a) If the taxpayer makes an election under this paragraph with respect to any class of property for any taxable yr, the alternative depreciation system under this subsection shall apply to all property in such class placed in service during such taxable yr. Notwithstanding the preceding sentence, in the case of nonresidential real property or residential rental property, such election may be made separately with respect to each property (b) An election under subparagraph (A), once made, shall be irrevocable. IRC 1016 Adjustments to basis (a)(2) In respect of any period since 2/28/1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent of the amt (A) Allowed as deductions in computing taxable income under this subtitle or prior income tax laws, and (B) Resulting (by reason of the deductions so allowed) in a reduction for any taxable yr of the taxpayers taxes under this subtitle (other than chapter 2, relating to tax on self-employment income), or prior income, war-profits, or excess-profit tax laws But not less than the amt allowable under this subtitle or prior tax laws. Where no method has been adopted under IRC 167 (depreciation deduction), the amt allowable shall be determined under the straight line method. Subparagraph (B) of this paragraph shall not apply in respect of any period since 2/28/1913 and before 1/1/1952, unless an election has been made under IRC 1020 (as in effect before the date of the enactment of the Tax Reform Act of 1976.) Where for any taxable yr before the taxable yr of 1932 the depletion allowance was based on discovery value or a percentage of income, then the adjustment for depletion for such yr shall be based on the depletion which wouldve been allowable for such yr if computed w/o reference to discovery value or a percentage of income.

Treas. Reg. 1.167(a)-2 Tangible property The depreciation allowance in the case of tangible property applies only to that part of the property which is subject to wear and tear, to decay or decline from natural causes, to exhaustion, and to obsolescence. The allowance does not apply to inventories or stock in trade, or to land apart from the improvements added to it. The allowance does not apply to natural resources which are subject to the allowance for depletion provided in IRC 611. No deduction for depreciation shall be allowed on automobiles or other vehicles used solely for pleasure, on a building used by the taxpayer solely as his residence, or on furniture or furnishings 46

therein, personal effects or clothing; BUT properties and costumes used exclusively in a business, such as a theatrical business, may be depreciated. IRC 179 Election to expense certain depreciable business assets (a) Treatment as expenses a taxpayer may elect to treat the cost of any IRC 179 property as an expense which is not chargeable to capital account. Any cost so treated shall be allowed as a deduction for the taxable yr in which the IRC 179 property is placed in service. (b) Limitations (1) Dollar limitation the aggregate cost which may be taken into account under subsection (a) for any taxable yr shall not exceed %25,000 ($250,000 in the case of taxable yrs beginning after 2007 and before 2011) (2) Reduction in limitation the limitation under paragraph (1) for any taxable yr shall be reduced (but not below zero) by the amt by which the cost of IRC 179 property placed in service during such taxable yr exceeds $200,000 ($800,000 in the case of taxable yrs beginning after 2007 and before 2011) (3) Limitation based on income from trade or business (A) The amt allowed as a deduction under subsection (a) for any taxable yr (determined after the application of paragraphs (1) and (2)) shall not exceed the aggregate amt of taxable income of the taxpayer for such taxable yr which is derived from the active conduct by the taxpayer of any trade or business during such taxable yr. (B) Carryover of disallowed deductions the amt allowable as a deduction under subsection (a) for any taxable yr shall be increased by the lesser of (i) The aggregate amt disallowed under subparagraph (A) for all prior taxable yrs (to the extent not previously allowed as a deduction by reason of this subparagraph), or (ii) The excess (if any) of 1. The limitation of paragraphs (1) and (2) (or if lesser, the aggregate amt of taxable income referred to in subparagraph (A)) over 2. The amt allowable as a deduction under subsection (a) for such taxable yr w/o regard to this subparagraph. (C) Computation of taxable income taxable income derived from the conduct of a trade or business shall be computed w/o regard to the deduction allowable under this section (4) Married individuals in the case of a husband and wife filing separate returns for the taxable yr (A) Such individuals shall be treated as 1 taxpayer for purposes of paragraph (1) and (2), and (B) Unless such individuals elect otherwise, 50% of the cost which may be taken into account under subsection (a) for such taxable yr (before application of paragraph (3)) shall be allocated to each such individual (5) Limitation on cost taken into account for certain passenger vehicles (A) In general the cost of any SUV for any taxable yr which may be taken into account under this IRC shall not exceed $25,000 47

(B) SUV for purposes of subparagraph (A) i. Any 4-wheeled vehicle 1. Which is primarily designed or which can be used to carry passengers over public streets, roads, or highways (except any vehicle operated exclusively on a rail or rails), 2. Which is not subject to IRC 280 F, and 3. Which is rated at no more than 14,000 pounds gross vehicle weight ii. Certain vehicles excluded such term does not include any vehicle which 1. Is designed to have a seating capacity of more than 9 persons behind the drivers seat. 2. Is equipped with a cargo area of at least 6 ft in interior length which is an open area or is designed for use as an open area but is enclosed by a cap and is not readily accessible directly from the passenger compartment, or 3. Has an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating rearward of the drivers seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield. (c) Election (1) An election under this section for any taxable yr shall (A) Specify the items of IRC 179 property to which the election applies and the portion of the cost of each of such items is to be taken into account under subsection (a), and (B) Be made on the taxpayers return of the tax imposed by this chapter for the taxable yr Such election shall be made in such manner as the Secretary may by regulations prescribe (2) Election irrevocable ANY election made under this section, and any specification contained in any such election, may not be revoked EXCEPT with the consent of the Secretary. Any such election or specification with respect to any taxable yr beginning after 2002 and before 2011 may be revoked by the taxpayer with respect to any property, and such revocation, once made, shall be irrevocable. (d) Definitions and special rules (1) Section 179 property means property (A) Which is (i) Tangible property (to which IRC 168 [accelerated cost recovery system] applies), or (ii) Computer software (as defined in IRC 197(e)(3)(B) which is described in IRC 197(e)(3)(A)(i), to which IRC 167 [depreciation] applies, and which is placed in service in a taxable yr beginning after 2002 and before 2011 Such term shall not include any property described in section 50(b) and shall not include air conditioning or heating units. (B) Which is IRC 1245 property (gain from dispositions of certain depreciable property) (C) Which is acquired by purchase for use in the active conduct of a trade or business (2) Purchase defined any acquisition of property, but only if 48

(A) The property is not acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under IRC 267 (losses, expenses, and interest with respect to transactions between related persons) or 707 (b) (certain sales or exchanges of property with respect to controlled partnerships) (but in applying IRC 267 (b) and (c) for purposes of this section paragraph (4) of IRC 267 (c) shall be treated as providing that the family of an individual shall include only his spouse, ancestors, and lineal descendants) (B) The property is not acquired by one component member of a controlled group from another component member of the same controlled group, and (C) The basis of the property in the hands of the person acquiring it is not determined (i) In whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired, or (ii) Under IRC 1014 (relating to property acquired from a decedent) (3) Cost for purposes of this section, the cost of property does not include so much of the basis of such property as is determined by reference to the basis of other property held at any time by the person acquiring such property (4) Section not to apply to estates and trusts (10) Recapture in certain cases The secretary shall, by regulations, provide for recapturing the benefit under any deduction allowable under subsection (a) with respect to any property which is not used predominantly in a trade or business at any time. IRC 280F Limitation on depreciation for luxury automobiles; limitation where certain property used for personal purposes. (a) Limitation on amt of depreciation for luxury automobiles (passenger autos also) (1) Depreciation (A) Limitation the amt of the depreciation deduction for any taxable yr for any passenger automobile shall not exceed (i) $2,560 for the 1st taxable yr in the recovery period (ii) $4,100 for the 2nd taxable yr in the recovery period (iii) $2,450 for the 3rd taxable yr in the recovery period, and (iv) $1,475 for each succeeding taxable yr in the recovery period (B) Disallowed deductions allowed for years after recovery period (i) Except as provided in clause (ii), the unrecovered basis of any passenger automobile shall be treated as an expense for the 1st taxable yr after the recovery period. Any excess of the unrecovered basis over the limitation of clause (ii) shall be treated as an expense in the succeeding taxable yr (ii) $1,475 limitation the amt treated as an expense under clause (i) for any taxable yr shall not exceed $1,475 (iii) Property must be depreciable no amt shall be allowable as a deduction by reason of this subparagraph with respect to any property for any taxable yr

49

unless a depreciation deduction would be allowable with respect to such property for such taxable yr. (iv) Amt treated as depreciation deduction for purposes of this subtitle, any amt allowable as a deduction by reason of this subparagraph shall be treated as a depreciation deduction allowable under IRC 168 (accelerated cost recovery system.) (C) Special rule for certain clean fuel passenger automobiles (i) Modified automobiles in the case of a passenger automobile which is propelled by a fuel which is not a clean-burning fuel and to which is installed qualified clean-fuel vehicle property (as defined in IRC 179A(c)(1)(A) for purposes of permitting such vehicle to be propelled by a clean burning fuel (as defined in IRC 179A(e)(1), subparagraph (A) shall not apply to the cost of the installed qualified clean burning vehicle property (ii) Purpose built passenger vehicles In the case of a purpose build passenger vehicle (as defined in IRC 4001(a)(2)(C)(ii), each of the annual limitations specified in subparagraphs (A) and (B) shall be tripled. (iii) Application of subparagraph this subparagraph shall apply to property placed in service after 8/5/1997 and before 1/1/2007 (2) Coordination with reductions in amt allowable by reason of personal use, etc this subsection shall be applied before (A) The application of subsection (b), and (B) The application of any other reduction in the amt of an deprecation deduction allowable under IRC 168 (accelerated cost recovery system) by reason of any use not qualifying the property for such credit or depreciation deduction (b) Limitation where business use of listed property not greater than 50% (1) Depreciation If any listed property is not predominantly used in a qualified business use for any taxable yr, the deduction allowed under IRC 168 (accelerated cost recovery system) with respect to such property for such taxable yr and any subsequent taxable yr shall be determined under 168 (g)(relating to alternative depreciation system) (2) Recapture (A) Where business use percentage does not exceed 50% IF (i) Property is predominantly used in a qualified business use in a taxable yr in which it is placed in service, and (ii) Such property is not predominantly used in a qualified business use for any subsequent taxable yr, Then the excess depreciation shall be included in gross income for the taxable yr referred to in clause (ii), and the depreciation deduction for the taxable yr referred to in clause (ii) and any subsequent taxable yrs shall be determined under IRC 168(g)(relating to alternative depreciation system) (B) Excess depreciation the excess (if any) of

50

(i)

(ii)

the amt of the depreciation deductions allowable with respect to the property for taxable yrs before the 1st taxable yr in which the property was not predominantly used in a qualified business use, over the amt which would have been so allowable if the property had not been predominantly used in a qualified business use for the taxable yr in which it was placed in service

(3) Property predominantly used in qualified business use for purposes of this subsection, property shall be treated as predominantly used in a qualified business use for any taxable yr if the business use percentage for such taxable yr exceeds 50%. (d ) Treas. Reg. 1.179-1 Election to expense certain depreciable assets (a) IRC 179(a) allows a taxpayer to elect to expense the cost, or a portion of the cost, of IRC 179 property (as defined in 1.179-4(a)) for the taxable yr in which the property is placed in service. The election is not available for trusts, estates, and certain noncorporate lessors. (b) The expense deduction under IRC 179 is allowed for the entire cost or a portion of the cost of one or more items of IRC 179 property. (c) Proration not required the expense deduction under IRC 179 is determined w/o any proration based on (i) The period of time IRC 179 property has been in service during the taxable yr; or (ii) The length of the taxable yr in which the property is placed in service (d) Partial business use if a taxpayer uses IRC 179 property for trade or business as well as other purposes, the portion of the cost of the property attributable to the trade or business use is eligible for expensing under IRC 179 provided that more than 50% (e) (1) Change in use; recapture if a taxpayers IRC 179 property is not used predominantly in a trade or business fo the taxpayer at any time before the end of the taxpayers recovery period, the taxpayer must recapture in the taxable yr in which the IRC 179 property is not used predominantly in a trade or business any benefit derived from expensing such property. The benefit derived from expensing the property is equal to the excess of the amt expensed under this section over the total amt that would have been allowable for prior taxable yrs and the taxable yr of recapture as a deduction (2)Property will be treated as not used predominantly in a trade or business of the taxpayer if 50% or more of the use of such property during any taxable yr w/in the recapture period is for a use other than in a trade or business of the taxpayer. (f) A taxpayer who elects to expense under IRC 179 MUST reduce the depreciable basis of the IRC 179 property by the amt of the IRC 179 expense deduction. IRC 167 (f) Treatment of certain property excluded from IRC 179

51

(1) Computer Software (A) If a depreciation deduction is allowable under subsection (a) with respect to any computer software, such deduction shall be computed by using the STRAIGHT LINE METHOD and a useful life of 36 months. (B) Computer software is defined in IRC 179)(e)(3)(B); except that such term shall not include any such software which is an amortizable IRC 179 intangible (C) Tax-exempt use property subject to lease in the case of computer software which would be tax-exempt use property as defined in subsection (h) of IRC 168 if such section applied to computer software, the useful life under subparagraph (A) shall not be less than 123% of the lease term (w/in the meaning of IRC 168(i)(3). (2) Certain interests or rights acquired separately If a depreciation deduction is allowable under subsection (a) with respect to any property described in subparagraph (B), (C), or (D) of IRC 197(e)(4), such deduction shall be computed in accordance with regulations prescribed by the Secretary. If such property would be tax-exempt use property as defined in subsection (h) of IRC 168 if such section applied to such property, the useful life under such regulations shall not be less than 125% of the lease term (w/in the meaning of IRC 168(i)(3)). (3) Mortgage servicing rights if a depreciation deduction is allowable under subsection (a) with respect to any right described in IRC 197(e)(6), such deduction shall be computed by using the straight line method and a useful life of 108 months. IRC 197 Amortization of goodwill and certain other intangibles (a) A taxpayer shall be entitled to an amortization deduction with respect to any amortizable IRC 179 intangible. The amt of such deduction shall be determined by the amortizing the adjusted basis (for purposes of determining gain) of such intangible ratably over the 15-yr period beginning with the month in which such intangible WAS ACQUIRED. (b) No other depreciation or amortization deduction allowable except as provided in subsection (a), no deprecation or amortization deduction shall be allowable with respect to any amortizable IRC 197 intangible. (c) Amortizable IRC 197 intangible (1) Amortizable IRC 197 intangible means any IRC 197 intangible (A) Which is acquired by the taxpayer after the date of the enactment (Aug. 10, 1933) of this section, and (B) Which is held in connection with the conduct of a trade or business or any activity described in IRC 212(expenses for production of income) (2) Exclusion of self-created intangibles amortizable IRC 197 shall not include any IRC 197 intangible (A) Which is not described in subparagraph (D), (E), or (F) of subsection (d)(1), and (B) Which is created by the taxpayer

52

This paragraph shall not apply if the intangible is created in connection with a transaction (or series of related transactions) involving the acquisition of assets constituting a trade or business or substantial portion thereof. (3) Anti-churning rules (d) IRC 197 Intangible (1) IRC 197 intangible means (A) Good will, (B) Going concern value, (C) Any of the following intangible items (i) Workforce in place including its composition and terms and conditions (contractual or otherwise) of its employment (ii) Business books and records, operating systems, or any other information base (including lists or other information with respect to current or prospective customers) (iii) Any patent, copyright, formula, process, design, pattern, knowhow, format, or other similar item (D) Any license, permit, or other right granted by a governmental unit or any agency or instrumentality thereof, (E) Any covenant not to compete (or other arrangement to the extent such arrangement has substantially the same effect as a covenant not to compete) entered into in connection with the acquisition (directly or indirectly) of an interest in a trade or business or substantial portion thereof, and (F) Any franchise, trademark, or trade name (2) Customer based intangible (A) Customer based intangible means (i) Composition of market, (ii) Market share, and (iii) Any other value resulting from future provision of goods or services pursuant to relationships (contractual or otherwise) in the ordinary course of business with customers (B) Special rule for financial institutions in the case of a financial institution, the term customer based intangible includes deposit base and similar items (3) Supplier based intangible (e) Exceptions the term IRC 197 intangible shall not include any of the following (1) Financial interests any interest (A) In a corporation, partnership, trust, or estate, or (B) Under an existing futures contract, foreign currency contract, notional principal contract, or other similar financial interest (2) Land ANY interest in land (3) Computer software (A) ANY

53

(4)

(5)

(6)

(7)

(8)

Computer software which is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified, and (ii) Other computer software which is not acquired in a transaction (or series of related transactions) involving the acquisition of assets constituting a trade or business or substantial portion thereof. (B) computer software defined any program designed to cause a computer to perform a desired function. Such term shall not include any data base or similar item unless the data base or item is in the public domain and is incidental to the operation of otherwise qualifying computer software Certain interests or rights acquired separately any of the following not acquired in a transaction (or series of related transactions) involving the acquisition of assets constituting a trade business or substantial portion thereof (A) Any interest in a film, sound recording, video tape, book, or similar property (B) Any right to receive tangible property or services under a contract or granted by a governmental unit or agency or instrumentality thereof (C) Any interest in a patent or copyright (D) To the extent provided in regulations, any right under a contract (granted by a governmental unit or agency or instrumentality thereof) if such right (i) Has a fixed duration of less than 15 yrs, or (ii) Is fixed to amt and , w/o regard to this section, would be recoverable under a method similar to the unit-of-production method. Interests under leases and debt instruments any interest under (A) An existing lease of tangible property, or (B) Except as provided in subsection (d)(2)(B), any existing indebtedness Treatment of sports franchises a franchise to engage in professional football, basketball, baseball or other professional sport, and any item acquired in connection with such a franchise Mortgage servicing any right to service indebtedness which is secured by residential real property unless such right is acquired in a transaction (or series of related transactions) involving the acquisition of assets (other than rights described in this paragraph) constituting a trade or business or substantial portion thereof. Certain transaction costs any fees for professional services, and any transaction costs, incurred by parties to a transaction with respect to which any portion of the gains or loss is not recognized under part III of subchapter C.

(i)

Treas. Reg. 1.167(a)-(3) Intangibles (a) If an intangible asset is known from experience of other factors to be of use in the business or in the production of income for only a limited period, the length of which can be estimated with reasonable accuracy, such an intangible asset may be the subject of a depreciation allowance. Egs include patents and copyrights 54

An intangible asset, the useful life of which is not limited, is not subject to the allowance for depreciation. No allowance will be permitted, merely bc, in the unsupported opinion of the taxpayer, the intangible asset has a limited useful life. No deduction for depreciation is allowable with respect to goodwill. (b) Safe harbor amortization for certain intangible assets (1) Solely for the purposes of determining the depreciation allowance referred to in paragraph (a) of this section, a taxpayer may treat an intangible asset as having a useful life equal to 15 yrs unless (i) An amortization period or useful life for the intangible asset is specifically prescribed or prohibited by the IRC, the regulations, or other published guide in the Internal Revenue Bulletin (ii) The intangible asset is related to intangibles acquired from another person (a.263(a)-4(c) or related to created financial interests (iii) The intangible asset has a useful life the length of which can be estimated with reasonable accuracy; or (iv) The intangible asset relating to certain benefits arising from the provision, production, or improvement of real property, in which case the taxpayer may treat the intangible asset as having a useful life equal to 25 yrs solely for purposes of determining the deprecation allowance referred to in paragraph (a) of this section (2) Applicability to acquisitions of a trade or business, changes in the capital structure of a business entity, and certain other transactions the safe harbor useful life provided in paragraph (b)(1) of this section does not apply to an amt required to be capitalized relating to amts paid to facilitate an acquisition of a trade or business, a change in the capital structure of a business entity, and certain other transactions (3) Depreciation method a taxpayer that determines its depreciation allowance for an intangible asset using the 15-yr useful life prescribed by paragraph (b)(1) of this section (or 25-yr useful life in the case of an intangible asset described in 1.263(a)-4(d)(8)) must determine the allowance by amortizing the basis of the intangible asset (as determined under IRC 167(c) and w/o regard to salvage value) ratably over the useful life beginning on the 1st day of the month in which the intangible asset is placed in service by the taxpayer. The intangible asset is not eligible for amortization in the month of the disposition. Treas. Reg. 1.197-2 Amortization of goodwill and certain other intangibles (a) IRC 197 allows an amortization deduction for the capitalized costs of an amortizable IRC 197 intangible and prohibits any other depreciation or amortization with respect to that property. The amortization deduction under IRC 197 is determined by amortizing basis ratably over a 15-yr period under the rules of paragraph (f) of this section. (b) Except as otherwise provided in paragraph (c) of this section, the term IRC 197 intangible means any property described in IRC 197 (d)(1). 55

(1) Goodwill IRC 197 intangible includes goodwill. Goodwill is the value of a trade or a business attributable to the expectancy of continued customer patronage. (2) Going concern value is included in intangibles under IRC 197. Going concern value is the additional value that attaches a property by reason of its existence as an integral part of an ongoing business activity. Going concern value includes the ability of a trade or business to continue functioning or generating income w/o interruption notwithstanding a change in ownership, but does not include any of the intangibles described in any other provision of this paragraph (b). (3) Workforce in place is included as an intangible under IRC 197. Workforce in place includes the composition of a workforce (eg experience, education, or training of a workforce), the terms and conditions of employment whether contractual or otherwise, and any other value placed on employees or any of their attributes. Thus amt paid or incurred for workforce in place includes for example, any portion of the purchase price of an acquired trade or business attributable to the existence of a highly-skilled workforce, an existing employment contract(s), or a relationship with employees or consultants (including, but not limited to, any key employee contract or relationship.) Workforce in place DOES NOT INCLUDED any covenant not to compete or similar arrangement. (4) Any information base is included in IRC 197 intangible including a customer-related information base. An information base includes business books and records, operating systems, and any other information base (regardless of the method of recording the information) and a customer-related information base that includes lists or other information with respect to current or prospective customers. (5) Know-how IRC 197 includes intangibles such as patent, copyright, formula, process, design, pattern, know-how, format, package design, computer software, interest in a film, sound recording, videos tape, book, or other similar property. (6) Customer-based intangibles which include nay composition of market, market share, or other value resulting from the future provision of goods or services pursuant to a contractual or other relationships in the ordinary course of business with the customers. (7) Supplier-based intangibles are included in IRC 197. A supplier-based intangible is the value resulting from the future acquisition, pursuant to contractual or other relationships with suppliers in the ordinary course of business, of goods or services that will be sold or used by the taxpayer. (8) Licenses, permits, and other rights granted by governmental units are included as intangibles under IRC 197. (9) Covenants not to compete or agreements having substantially the same effect, entered into in connection with the direct or indirect acquisition of an interest in a trade or business or a substantial portion thereof is included as an IRC 197 intangible. (10)Franchises, trademarks, and trade names are included as an intangible under IRC 197. (11)Contracts for the use of, and term interests in, IRC 197 intangibles IRC 197 intangibles include any right under a license, contract, or other arrangement providing for the use of property that would be an IRC 197 intangible under any provision of this paragraph 56

(b). IRC 197 intangibles also include any term interest (whether outright or in trust) in such property. (c) IRC 107 intangible exceptions (1) IRC 197 intangibles do not include an interest in a corporation, partnership, trust, or estate. (2) An interest under an existing futures contract, foreign currency contract, notional principal contract, interest rate swap, or other similar financial contract, (3) Interests in land such as a fee interest, life estate, remainder, easement, mineral right, timber right, grazing right, riparian right, air right, zoning variance, and any other similar right such as a farm allotment, quota for farm commodities, or crop acreage base. An interest in land DOES NOT INCLUDE airport landing or takeoff right, a regulated airline route, or a franchise to provide cable tv. (4) Certain computer software that is or has been readily available to the general public on similar terms (the software may be obtained on substantially the same terms by a significant number of persons that would reasonably be expected to use the software), is subject to a nonexclusive license, and has not been substantially modified. (d) Amortizable IRC 197 intangibles are any IRC 179 intangibles acquired after Aug. 10, 1933 and held in connection with the conduct of a trade or business or production of income (doesnt include any IRC 197 intangibles created by the taxpayer [taxpayer makes payments or otherwise incurs costs for its creation, production, development, or improvement, whether actual work is performed by the taxpayer or by another person under contract with the taxpayer].) An IRC 197 intangible is not a self-created intangible to the extent that it results from the entry into (or renewal of) a contract for the use of an existing IRC 197 intangible (eg legal and other professional fees) IRC 165 Losses (a) There shall be allowed as a deduction any loss sustained during the taxable yr and not compensated for by insurance or otherwise (b) Amount of deduction for the purposes of subsection (a), the basis for determining the amt of the deduction for any loss shall be the adjusted basis provided in IRC 1011 (adjusted basis for determining gain or loss) for determining the loss from the sale or other disposition of property. (c) Limitation on losses of individuals in the case of an individual, the deduction under subsection (a) shall be limited to (1) Losses incurred in a trade or business; (2) Losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) Except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft (d) Wagering losses losses from wagering transactions shall be allowed only to the extent of the gains from such transactions 57

(e) Theft losses for purpose of subsection (a), any loss arising from theft shall be treated as sustained during the taxable yr in which the taxpayer discovers such loss. (f) Capital losses losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in IRC 1211 (limitation on capital losses) and 1212 (capital loss carrybacks and carryovers.) (g) Worthless securities (h) Treatment of casualty gains and losses (1) $100 limitation per casualty any loss of an individual described in subsection (c)(3) shall be allowed only to the extent that the amt of the loss to such individual arising from each casualty, or from each theft, exceeds $500 ($100 for taxable yrs beginning after 12/31/2001) (2) Net casualty loss allowed only to the extent it exceeds 10% of adjusted gross income (A) If the personal casualty losses for any taxable yr exceed the personal casualty gains for such taxable yr, such losses shall be allowed for the taxable yr only to the extent of the sum of (i) the amt of the personal casualty gains for the taxable yr, plus (ii) so much of such excess as exceeds 10% of the adjusted gross income of the individual (B) Special rule where personal casualty gains exceed personal casualty losses if the personal casualty gains for any taxable yr, exceed the personal casualty losses for such taxable yr (i) all such gains shall be treated as gains from sales or exchanges of capital assets, and (ii) all such losses shall be treated as losses from sales or exchanges of capital assets. (3) Special rule for losses in federally declared disasters (4) Definitions of personal casualty gain and personal casualty loss (A) Personal casualty gain means the recognized gain from any involuntary conversion of property, which is described in subsection (c)(3) arising from fire, storm, shipwreck, or other casualty, or from theft. (B) Personal casualty loss means any loss described in subsection (c)(3). For purposes of paragraphs (2) and (3), the amt of any personal casualty loss shall be determined after the application of paragraph (1). (5) Special rules (A) Personal casualty losses allowable in computing adjusted gross income to the extent of personal casualty gains In any case to which paragraph (2)(A) applies, the deduction for personal casualty losses for any taxable yr shall be treated as a deduction allowable in computing adjusted gross income to the extent such losses do not exceed the personal casualty gains for the taxable yr. (B) Joint returns for purposes of this subsection, a husband and wife making a joint return for the taxable yr shall be treated as 1 individual. (C) Determination of adjusted gross income in case of estates and trusts for purposes of paragraph (2), the adjusted gross income of an estate or trust shall be computed in the 58

same manner as in the case of an individual, except that the deductions for costs paid or incurred in connection with the administration of the estate or trust shall be treated as allowable in arriving at adjusted gross income. (D) Coordination with estate tax no loss described in subsection (c)(3) shall be allowed if, at the time of the filing the return, such loss has been claimed for estate tax purposes in the estate tax return. (E) Claim required to be filed in certain cases any loss of an individual described in subsection (c)(3) to the extent covered by insurance shall be taken into account under this section only if the individual files a timely insurance claim with respect to such loss (only theft and casualty). Treas. Reg. 1.165-1 Losses (a) In computing taxable income under IRC 63m any loss actually sustained during the taxable yr and not made good by insurance or some other form of compensation shall be allowed as a deduction subject to any provision of the internal revenue laws which prohibits or limits the amt of deduction. This deduction for losses sustained shall be taken in accordance with IRC 165 and the regulations thereunder. (b) Nature of loss allowable a loss MUST be evidenced by closed and completed transactions, fixed by identifiable events, relating to disaster losses, actually sustained during the taxable yr. (c) The amt deductible (1) of loss allowable as a deduction under IRC 165 shall not exceed the amt prescribed by Treas. Reg. 1.1011-1 as the adjusted basis for determining the loss from the sale or other disposition of the property involved. (2) The amt of loss recognized upon the sale or exchange of property shall be determined for purposes of IRC 165 in accordance with Treas. Reg. 1.1002-1 (3) A loss from the sale or exchange of a capital asset shall be allowed as a deduction under IRC 165 but only to the extent allowed in IRC 1211 (limitation on capital losses) and 1212 (capital loss carrybacks and carryovers) and in the regulations under those sections (4) In determining the amt of loss actually sustain for purposes of IRC 165 proper adjustment shall be made for any salvage value and for any insurance or other compensation received. (d) Yr of deduction (1) A loss shall be allowed as a deduction under IRC 165 only for the taxable yr in which the loss is sustained. (2) If a casualty or other event occurs which may result in a loss and in the yr of such casualty or event, there exists a claim for reimbursement with respect to which theres a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of IRC 165, until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. If in the yr of the casualty or other event a portion of the loss is not covered by a claim for reimbursement with respect to which there is a reasonable prospect of recovery, then such

59

portion of the loss is sustained during the taxable yr in which the casualty or other event occurs. If the taxpayer deducted a loss in accordance with the provisions of this paragraph and in a subsequent taxable yr receives reimbursement for such loss, he does not recomputed the tax for the taxable yr in which the deduction was taken but include the amt of such reimbursement in his gross income for the taxable yr in which received subject to IRC 111 relating to recovery of amts previously deducted. (3) Any loss arising from theft shall be treated as sustained during the taxable yr in which the taxpayer discovers the loss. However, if in the yr of discovery there exists a claim for reimbursement with respect to which theres a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of IRC 165, until the taxable yr in which it can be ascertained with reasonable certainty whether or not such reimbursement will be received. Treas. Reg. 1.165-4 Decline in value of stock (a) No deduction shall be allowed under IRC 165 solely on account of a decline in the value of stock owned by the taxpayer when the decline is due to a fluctuation in the market price of the stock or to other similar cause. No loss for a decline in the value of stock owned by the taxpayer shall be allowed as a deduction under IRC 165 except insofar as the loss is recognized under Treas. Reg. 1.1002-1 upon the sale or exchange of the stock and except as otherwise provided in Treas. Reg. 1.165-5 with respect to tock which becomes worthless during the taxable yr. Treas. Reg. 1.165-7 Casualty losses (a) Except as otherwise provided in paragraphs (b)(4) and (c) of this section, any loss arising from fire, storm, shipwreck, or other casualty is allowable as a deduction under IRC 165 for the taxable yr in which the loss is sustained. The manner of determining the amt of a casualty loss allowable as a deduction in computing taxable income under IRC 63 is the same whether the loss has been incurred in a trade or business or in any transaction entered into for profit, or whether it has been a loss of property not connected with a trade or business and not incurred in any transaction entered into for profit. (b) In the case of any casualty loss whether or not incurred in a trade or business or in any transaction entered into for profit, the amt of the loss to be taken into account for purposes of IRC 165 shall be the lesser of either (i ) the amt which is equal to the fair market value of the property immediately before the casualty reduced by the fair market value of the property immediately after the casualty or (ii ) the amt of adjusted basis prescribed in Treas. Reg. 1.1001-1 for determining the loss from the sale or other disposition of the property involved. However, if the property used in a trade or business or held for the production of income is totally destroyed by casualty, and if the fair market value of such property immediately before the casualty is less than the adjusted basis of such property, the amt of adjusted basis of such property shall be treated as the amt of loss for purposes of IRC 165. 60

Treas. Reg. 1.165-8 Theft losses (a) Allowance of deduction 1. Except as provided in paragraphs (b) & (c) of this section, any loss arising from theft shall be allowable as a deduction under IRC 165 for the taxable yr in which the loss is sustained 2. A loss arising from theft shall be treated under IRC 165 as sustained during the taxable yr in which the taxpayer discovers the loss. Thus, a theft loss is not deductible under IRC 165 (a) for the taxable yr in which the theft actually occurs unless that is also the yr in which the taxpayer discovers the loss. However, if in the yr of discovery there exists a claim for reimbursement no portion of the loss with respect to which reimbursement may be received is sustained until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. (b) Loss sustained by an estate (c) Amt deductible amt deductible under this section in respect of a theft loss shall be determined consistently with the manner prescribed in Treas. Reg. 1.165-7 for determining the amt of casualty loss available as a deduction under IRC 165(a). (d) Definitions for purposes of this section theft shall be deemed to include, but shall not necessarily be limited to, larceny, embezzlement, and robbery. IRC 267 Losses, expenses, and interest with respect to transactions between related taxpayers (a) In general 1. Deduction for losses disallowed no deduction shall be allowed in respect of any loss from the sale or exchange of property, directly or indirectly, between persons specified in any of the paragraphs of subsection (b). The preceding sentence shall not apply to any loss of the distributing corporation (or the distribute) in the case of a distribution in complete liquidation 2. Matching of deduction and payee income item in the case of expenses and interest (A) By reason of the method of accounting of the person to whom the payment is to be made, the amt thereof is not (unless paid) includible in the gross income of such person, and (B) At the close of the taxable yr of the taxpayer for which (but for this paragraph) the amt would be deductible under this chapter, both the taxpayer and the person to whom the payment is to be made are persons specified in any of the paragraphs of subsection (b) Then any deduction allowable under this chapter in respect of such amt shall be allowable as of the day as of which such amt is includible in the gross income of the person to whom the payment is made (or, if later, as of the day on which it would be allowable but for this paragraph). (b) Relationships the persons referred to in subsection (a) are 1. Members of a family, defined in subsection (c) (4)

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2. An individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual 3. Two corporations which are members of the same controlled group 4. A grantor and a fiduciary of any trust 5. A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts 6. A fiduciary of a trust and a beneficiary of such trust 7. A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts 8. A fiduciary of a trust and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust (c) Constructive ownership of stock for purposes of determining, applying subsection (b), the ownership of stock 1. Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries 2. An individual shall be considered as owning that stock owned, directly or indirectly, by or for his family 3. An individual owning (otherwise than by the application of paragraph (2) any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner 4. The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, lineal descendants, and 5. Stock constructively owned by a person by reason of the application of paragraph (1) shall, for the purpose of applying paragraph (1),(2), or (3), be treated as actually owned by such person, but stock constructively owned by an individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock. (d) Amt of gain where loss previously disallowed if 1. In the case of a sale or exchange of property to the taxpayer a loss sustained by the transferor is not allowable to the transferor as a deduction by reason of subsection (a) (1) (or by reason of IRC 24 (b) of the IRC of 1939); and 2. After Dec. 13, 1953 the taxpayer sells or otherwise disposes of such property (or of other property the basis of which in his hands is determined directly or indirectly by reference to such property) at a gain, Then such gain shall be recognized only to the extent that it exceeds so much of such loss as is properly allocable to the property sold or otherwise disposed of by the taxpayer. This subsection applies with respect to taxable yrs ending after Dec. 31, 1953. This subsection shall not apply if the loss sustained by the transferor is not allowable to the transferor as a deduction by reason of IRC 1091 (relating to wash sales) or by reason of IRC 118 of the IRC code of 1939. 62

IRC 1211 Limitation on capital losses (a) Corporations in the case of a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of gains from such sales or exchanges (b) Other taxpayers in the case of a taxpayer other than a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges, plus (if such losses exceed such gains) the lower of 1. $3,000 ($1,500 in the case of a married individual filing a separate return), or 2. The excess of such losses over such gains IRC 1212 (b) Capital loss and carrybacks and carryovers (b ) other taxpayers 1. If a taxpayer other than a corporation has a net capital loss for any taxable yr A. The excess of the net short term capital loss over the net long term capital gain for such yr shall be a short-term capital loss in the succeeding taxable yr, and B. The excess of the net long-term capital loss over the short-term capital gain for such yr shall be a long-term capital loss in the succeeding taxable yr 2. Treatment of amts allowed under IRC 1211 (b)(1) or (2) A. For purposes of determining the excess referred to in subparagraph (A) or (B) of paragraph (1), there shall be treated as a short-term capital gain in the taxable yr an amt equal to the lesser or (i. The amt allowed for the taxable yr under paragraph (1) or (2) of IRC 1211 (b), or (ii. The adjusted taxable income for such taxable yr B. Adjusted taxable income for purposes of subparagraph (A), the term adjusted taxable income means taxable income increased by the sum of (i. The amt allowed for the taxable yr under paragraph (1) or (2) of IRC 1211(b) and (ii. The deduction allowed for such yr under IRC 151 or any deduction in lieu thereof. For purposes of the preceding sentence, any excess of the deductions allowed for the taxable yr over the gross income for such year shall be taken into account as negative taxable income IRC 1221 Capital asset defined (a) For purposes of this subtitle, the term capital asset means property held by the taxpayer (whether or not connected with this trade or business), but DOES NOT INCLUDE 1. Stock in trade of the taxpayer or other property of a kind in which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable yr, or

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property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; 2. Property used, in his trade or business, of a character which is subject to the allowance for deprecation provided in IRC 167 (depreciation), or real property used in his trade or business 3. A copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property, hled by A. A taxpayer whose personal effects created such property B. In the case of a letter, memorandum, or similar property, a taxpayer for whom such property was prepared or produced, or C. A taxpayer in whose hands the basis of such property is determined, for the purposes od determining gain from sale or exchange, in whole or part by reference to the basis of such property in the hands of a taxpayer described in subparagraph (A) or (B) 4. Accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph (1) 5. A publication of the US govt (including Congressional Record) which is received from the US govt or any agency, thereof, other than by purchase at the price at which its offered for sale to the public, and which is held by A. A taxpayer who so received such publication, or B. A taxpayer whose hands the basis of such publication is determined, for the purposes of determining gain from a sale or exchange, in whole or in part by reference to the basis of such publication in the hands of a taxpayer described in subparagraph (A) 6. Any commodities derivative financial instrument held by a commodities derivatives dealer unless A. It is established to the satisfaction of the Secretary that such instrument has no connection to the activities of such dealer as a dealer, and B. Such instrument is clearly indentified in such dealers records as being described in subparagraph (A) before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe) 7. Any hedging transaction which is clearly indentified as such before the close of the day on which it was acquired, originated, entered into (or such other time as the Secretary may by regulations prescribe); or 8. Supplies of a type regularly used or consumed by the taxpayer in the ordinary course of a trade or business of the taxpayer (b) Definitions and special rules

HARD STARE IRC 74 Prizes and awards (see pg 21) IRC 117 Qualified scholarships 64

(a) Gross income does not include any amt received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization described in IRC 170(b)(1)(A)(ii) (b) Qualified scholarship 1. Qualified scholarship means any amt received by an individual as a scholarship or fellowship grant to the extent the individual establishes that, in accordance with the conditions of the grant, such amt was used for qualified tuition and related expenses 2. Qualified tuition and related expenses for purposes of paragraph (1), the term qualified tuition and related expenses means A. Tuition and fees required for the enrollment or attendance of a student at an educational organization described in IRC 170 (b)(1(A)(ii), and B. Fees, books, supplies, and equipment required for courses of instruction at such an educational organization (c) Limitation 1. Except as provided in paragraph (2), subsections (a) and (d) shall not apply to that portion of any amt received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship or qualified tuition reduction 2. Exceptions paragraph (1) shall not apply to any amt received by an individual under A. The National Health Service Corps Scholarship Program under IRC 338A(g)(1)(A) of the Public Health Service Act, or B. The Armed Forces Health Professions Scholarship and Financial Assistance program under subchapter 1 of chapter 105 of title 10, USC (d) Qualified tuition reduction 1. Gross income shall not include any qualified tuition reduction 2. Qualified tuition reduction for purposes of this subsection, qualified tuition reduction means the amt of any reduction in tuition provided to an employee of an organization described in IRC 170 (b)(1)(A)(ii) for the education (below the graduate level) at such organization (or another organization described in IRC 170 (b)(1)(A)(ii) A. Such employee, or B. Any person treated as an employee (or whose use is treated as an employee use) under the rules of IRC 132(h) 3. Reduction must not discriminate in favor of highly compensated paragraph (1) shall not apply with respect to any qualified tuition reduction provided with respect to any highly compensated employee only if such reduction is available on substantially the same terms to each member of a group of employees which is defined under a reasonable classification set up by the employer which does not discriminate in favor of highly compensated employees 4. Special rules for teaching and research assistants in the case of the education of an individual who is a graduate student at an educational organization and who is engaged in teaching or research activities for such organization, paragraph (2 shall be applied as if it did not contain the phrase below the graduate level.

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Treas. Reg. 1.117-6 Qualified scholarships (b) exclusion of qualified scholarship 1. Gross income does not include any amt received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization, subject to the rules set forth in paragraph (d) of this section. Generally, any amt of a scholarship or fellowship grant thats not excludable under IRC 117 is includable in the gross income of the recipient for the taxable yr in which such amt is received, notwithstanding the provisions of IRC 102(gifts). 2. If the amt of a scholarship or fellowship grant eligible to be excluded as a qualified scholarship under this paragraph cannot be determined when the grant is received bc expenditures for qualified tuition and related expenses have not yet been incurred, then that portion of any amt received as a scholarship or fellowship grant that is not used for qualified tuition and related expenses within the academic period to which the scholarship or fellowship grant applies must be included in the gross income of the recipient for the taxable yr in which such academic period ends. (c) Definitions 1. To be considered a qualified scholarship, the terms of the scholarship or fellowship grant need not expressly require that the amts received be used for tuition and related expenses. However, to the extent that the terms of the grant specify that any portion of the grant cannot be used for tuition and related expenses or designate any portion of the grant for purposes other than tuition and related expenses (such as for room and board, or for a meal allowance), such amts are not amts receive as a qualified scholarship. 2. Qualified tuition and related expenses are (i. Tuition and fees required for the enrollment or attendance of a student at an educational organization (ii. Fees, books, supplies, and equipment required for courses of instruction at such an educational organization In order to be treated as related expenses under this section, fees, books, supplies, and equipment must be required for all students in the particular course of instruction. Incidental expenses are not considered related expenses 3. Scholarship or fellowship grant generally a scholarship or fellowship grant is a cash amt pair or allowed to, or for the benefit or, an individual to aid such individual in the pursuit of study or research. A scholarship or fellowship grant also may be in the form of a reduction in the amt owed by the recipient to an educational organization for tuition, room and board, or any other fee. A scholarship or fellowship grant may be funded by a govtal agency, college or university, charitable organization, business, or any other source. To be considered a scholarship or fellowship grant for purposes of this section, any amt receive need not be formally designated as a scholarship. However, a scholarship or fellowship grant does not 66

include any amt provided by an individual to aid a relative, friend, or other individual in the pursuit of study or research if the grantor is motivated by family or philanthropic considerations. IRC 104 Compensation for injuries or sickness a. Except in the case of amts attributable to (and not in excess of) deductions allowed under IRC 213 (relating to medical, etc., expenses) for any prior taxable yr, gross income does not include (1) Amts received under workmens compensation acts as compensation for person injuries or sickness (2) The amt of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness (3) Amts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for personal injuries or sickness (other than amts received by an employee, to the extent such amts (A) are attributable to contributions by the employer which were not includable in the gross income of the employee, or (B) are paid by the employer) (4) Amts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active service in the armed forces of any country or in the Coast and Geodetic Survey or the Public Health Service, or a disability annuity payable under provisions of section 808 of the Foreign Service Act of 1980; and (5) Amts received by an individual as a disability income attributable to injuries incurred as a direct result of a terroristic or military action For purposes of paragraph (3), in the case of an individual who is, or has been, an employee w/in the meaning of IRC 401(c)(1) (relating to self-employed individuals), contributions made on behalf of such individual while he was such an employee to a trust described in IRC 401(a) which is exempt from tax under IRC 501(a), or under a plan described in IRC 403(a), shall, to the extent allowed as deductions under IRC 404, be treated as contributions by the employer which were not includible in the gross income of the employee. For purposes of paragraph (2) emotional distress shall not be treated as a physical injury or physical illness. The preceding sentence shall not apply to an amt of damages in excess of the amt paid for medical care (described in subparagraph (A) or (B) of IRC 213(d)(1)) attributable to emotional distress. IRC 106 Contributions by employer to accident and health plans (a) General rule except as otherwise provided in this section, gross income of an employee does not include employer-provided coverage under an accident or health. (d) Contributions to health savings accounts 67

(1) In the case of an employee who is an eligible individual ( as defined in IRC 223(c)(1)), amts contributed by such employees employer to any health savings account (as defined in IRC 223(d)) of such employee shall be treated as employer-provided coverage for medical expenses under an accident or health plan to the extent such amts do not exceed the limitation under IRC 223(b) (determined w/o regard to this subsection) which is applicable to such employee for such taxable yr. (f) Reimbursements for medicine restricted to prescribed drugs and insulin for purposes of this section and IRC 105, reimbursement for expenses incurred for a medicine or a drug shall be treated as reimbursement for medical expenses only if such medicine or drug is a prescribed drug (determined w/o regard to whether such drug is available w/o prescription) or is insulin.

TIMING IRC 446 General rule for methods of accounting (a) General rule taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Exceptions if no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income. (c) Permissible methods subject to the provisions of subsection (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting (1) The cash receipts and disbursements method (2) An accrual method (3) Any other method permitted by this chapter; or (4) Any combination of the foregoing methods permitted under regulations prescribed by the Secretary (d) Taxpayer engaged in more than one business a taxpayer engaged in more than one trade or business may, in computing taxable income, use a different method of accounting for each trade or business. IRC 448 Limitation on use of cash method of accounting (a) General rule except as otherwise provided in this section, in the case of a (1) C corporation, (2) A partnership which has a C corporation as a partner, or (3) Tax shelter Taxable income shall not be computed under the cash receipts and disbursements method of accounting (b) Exceptions 68

(1) Farming business paragraphs (1) and (2) of subsection (a) shall not apply to any farming business (2) Qualified personal service corporations paragraphs (1) and (2) of subsection (a) shall not apply to a qualified personal service corporation, and such a corporation shall be treated as an individual for purposes of determining whether the paragraph (2) of subsection (a) applies to any partnership. (3) Entities with gross receipts of not more than $5,000,000 paragraphs (1) and (2) of subsection (a) shall not apply to any corporation or partnership for any taxable yr if, for all prior taxable yrs beginning after Dec. 31, 1985 such entity (or any predecessor) met the $5,000,000 gross receipts test of subsection (c) (c) $5,000,000 gross receipts test (1) In general a corporation or partnership meets the $5,000,000 gross receipts test of the subsection for any prior taxable yr if the average annual gross receipts of such entity for the 3-taxable-yr period ending with such prior taxable yr does not exceed $5,000,000 (2) Aggregation rules all persons treated as a single employer under subsection (a) or (b) or IRC 52 or subsection (m) or (o) of IRC 414 shall be treated as one person for purposes of paragraph (1) (3) Special rules (A) Not in existence for entire 3-yr period if the entity was not in existence for the entire 3-yr period referred to in paragraph (1), such paragraph shall be applied on the basis of the period during which such entity (or trade or business) was in existence (B) Short taxable yr gross receipts for any taxable yr of less than 12 months shall be annualized by multiplying the gross receipts for the short period by 12 and dividing the result by the number of months in the short period. (C) Gross receipts gross receipts for any taxable yr shall be reduced by returns and allowances made during such yr (D) Treatment of predecessors any reference in this subsection to any entity shall include a reference to any predecessor of such entity. IRC 451 General rule for taxable yr of inclusion (a) The amt of any item of gross income shall be included in gross income for the taxable yr in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amt is to be properly accounted for as a different period (b) Special rule in case of death In the case of the death of a taxpayer whose taxable income is computed under an accrual method of accounting, any amt accrued only be reason of the death of the taxpayer shall not be included in computing taxable income for the period in which falls the date of the taxpayers death. (c) Special rule for employee tips for purposes of subsection (a), tips included in a written statement furnished an employer by an employee pursuant to IRC 6053(a) shall be deemed to be received at the time the written statement including such tips is furnished to the employer. Treas. Reg. 1.451-2 Constructive receipts 69

(a) Income although not actually reduced to a taxpayers possession is constructively received by him in the taxable yr during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it during the taxable yr if notice of intention to withdraw had been given. HOWEVER, income is not constructively received if the taxpayers control of its receipt is subject to substantial limitations or restrictions. Thus, if a corporation credits its employees with bonus stock, but the stock is not available to such employees until some future date, the mere crediting on the books of the corporation does not constitute receipt. IRC 461 General rule for taxable yr of deduction (a) The amt of any deduction or credit allowed by this subtitle shall be taken for the taxable yr which is the proper taxable yr under the method of accounting used in computing taxable income. (g) Prepaid interest (1) If the taxable income of the taxpayer is computed under the cash receipts and disbursements method of accounting, interest paid by the taxpayer which, under regulations prescribed by the Secretary, is properly allocable to any period (A) With respect to which the interest represents a charge for the use or forbearance of money, AND (B) Which is after the close of the taxable yr in which paid Shall be charged to capital account and shall be treated as paid in the period to which so allocable. (2) Exception this subsection shall not apply to points paid in respect of any indebtedness incurred in connection with the purchase or improvement of, and secured by, the principal residence of the taxpayer to the extent that, under regulations prescribed by the Secretary, such payment of points is an established business practice in the area in which such indebtedness is incurred, and the amt of such payment does not exceed the amt generally charged in such area. Treas. Reg. 1.263(a)-4(f)(1) 12 month rule Except as otherwise provided in this paragraph, a taxpayer is not required to capitalize under this section amts paid to create (or to facilitate the creation of) any right or benefit for the taxpayer that does not extend beyond the earlier of (i )12 months after the first date on which the taxpayer realizes the right or benefit; or (ii )the end of the taxable yr following the taxable yr in which the payment is made. Treas. Reg. 1.461-1(a)(1) General rule for taxable yr of deduction Taxpayer using cash receipts and disbursements method:

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Under the cash receipts and disbursements method of accounting, amts representing allowable deductions shall, as a general rule, be taken into account for the taxable yr in which paid. Further, a taxpayer using this method may also be entitled to certain deductions in the computation of taxable income which do not involve cash disbursements during the taxable yr, such as deductions for depreciation, depletion, and losses under IRC 167, 611, and 165. If an expenditure results in the creation of an asset having a useful life which extends substantially beyond the close of the taxable yr, such an expenditure may not be deductible, or may be deductible, or may be deductible only in part, for the taxable yr in which made.

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