User:CheshireKatz/Tax

http://www.ilrg.com/students/outlines/download/FederalIncomeTax-Georgetown-Pearlman-Fall2005.doc

http://www.ilrg.com/students/outlines/download/Federal_Income_Tax-Yale-Zolt-Fall2005.doc

Open book multi-choice exam. Practice '03: Pg.11 #61, AGI $900K

If problem describes wealthy TP, presume phaseout provisions will make them ineligible.

Income Tax Code subpage here.

Zolt subpage here.

Sections

106, 167, 183, 265, 274, 461, 1001, 1033, 1041, 1211

Income Tax in Brief

1. Does taxpayer (TP) have income?

   Three definitions

   1. Eisner (capital or labor)
   2. Glenshaw Glass
   3. Haig-Smimons

2. Is it a gift? (Duberstein)
3. Can I divide it into sticks of ownership / different rights (i.e., Inaja)

   Don’t do where impractical to apportion basis (as in settlement for polluted discharge in Inaja)

4. Exclude fringe benefit

Timing – is it income now?

1. Need realization (§ 1001)
2. Cash method – report when received (actually or constructively)

   Constructive receipt (§ 1341 / N. Am. Oil v. Burnet)

   Can’t contract away after you have them (but can contract before – See Olmstead)

   Need right to receive (see Amend)

   Economic benefit (Pulsifer)

   But must be technically set aside (See Olmstead)

3. Accrual – report when accrued

   All events have occurred and amount determined with reasonable certainty (Reg. § 1.446-1)

4. Open v. closed transaction

   Installment sale (take %)

Is the income/expense capital or ordinary?

1. Indopco – capitalize if longterm benefit unless ordinary – see PNC Bancorp
2. Is it depreciable (§ 167)

   only depreciate off what you have (See Estate of Franklin – tried to depreciate off whole thing)

What is the basis?

Is there an applicable deduction?

1. Business expenses (§ 162)

   Gilmore – must have origins in business (also primary purpose, but for test)

   Ordinary and necessary

   Prefer objective test (see Pevsner)

2. Hobby losses (§ 183) (limited to profits) and investment (§ 212)

   2% requirement

3. Personal (e.g., medical, casualty, charitable)

Is the TP eligible for credits?

Do we want to tax this sort of transaction?

Three options: (1) tax; (2) don’t tax; (3) tax part

NOTE: separate out transactions (e.g., Tufts)

Is it administratively feasible to tax?

Should the tax system try and tax such arrangements? (What would be the result of a rigid application of the rules?)

Relevant rights

• right to exclude
• right to improve
• right of gain
• right of reversion
• benefit of use
• risk of loss

Individual taxpayer's liability

Gross Income (GI); § 61 – “all income from whatever source derived”

Gross Income is the remainder of Compensation (C) after Basis (B)

Certain Above the Line Deductions (ALD);

Adjusted Gross Income (AGI);

Standard or Itemized Below the Line Deduction (BLD)

Personal Exemptions (PE)

Taxable Income (TI)

Tax Rates (TR); 10% to 35% for ordinary income; 5% to 28% capital gain

Tentative Tax (TT)

Tax Credits (TC)

Tax Due (TD) or Tax Refund (TR)

${\begin{cases}C-B=GI\\GI-ALD=AGI\\AGI-BLD-PE=TI\\TI\times TR=TT\\TT-TC=TD\end{cases}}$

What is income?

Income does not include

1. Loans
2. Weekly carpool pot contributions
3. Sale of assets for less than their basis
4. Gain from sale of principal residence → §121(a)
5. Rebates and discounts received after sale
6. Employment benefits
   1. Qualified employee benefits → §132(a)
   2. No-additional-cost services in one's line of business → §132(b)
   3. Deminimus fringe benefits → §132(e)
   4. Qualified transportation fringes → §132(f)
   5. Employer provided medical coverage

      For oneself → §106(a)

      For one's spouse & dependents → §152(a)

7. Profits from "good deals" on items prior to realization by resale
8. Covered travel, food, & lodging costs pursuant to a business purpose

Class Notes

Vocabulary

Kinds of Taxes

1. Income - [ Base(Taxable Income) x Rate = Income Tax ]
2. Capital Gains - Different Rate than Income Tax
3. Gifts - detached and disinterested generosity)
4. Estates -
5. Sales -
6. Luxury - Excise tax (sales tax on selected items)
7. Property -
8. Tariff - Tax on importation of goods
9. Head tax - Based on existence (everyone pays the same amount)
10. Consumption Taxes (nothing more than an income tax that gives a deduction for savings)

    Rationale: If you're consuming more, you're in a better position to bear societal burdens

    1. Value-Added Tax VAT (Europe sales tax - collected along the way)
    2. National Sales (Flat) Tax

Income Tax Rates

1. Proportional/Flat Rate – Fixed % for all; everyone pays the same proportion of income.
2. Progressive Rate – As base goes up, you pay more tax in absolute dollars but the rate at which you are taxed increases. When you move to a different tax bracket, you pay marginal rates, not the entire %. Our income tax is progressive:

   100,000 = 10%

   100,001 = 20%

   201,000 = 30%

3. Regressive rate – the rate will go down as the base goes up
   1. Not really a good tax policy
   2. One major regressive tax – social security tax
4. Nominal/marginal rate – dollar value is associated w/ particular rate. Eg. tax system w/ 2 rates of tax:

   10% on first $20,000 of income

   20% on anything above $20,000

5. Effective rate – tax divided by total income – since some of dollars are taxed at less than highest rate, always lower than marginal rate
6. Social security tax - is capped at a certain amount of income

Terms of Art

1. Gross Income (GI) = All income from whatever source derived
2. Above-the-Line Deductions (AtLD) = Everyone eligible, Mostly cost of earning, but also student loans, retirement, & health insurance
3. Adjusted Gross Income (AGI) = GI minus AtLD
4. Below-the-Line Deductions (BtLD) = Lower income eligibility, itemized (public policy-motivated) deductions or a standard (fixed) deduction.
5. Personal Exemptions (PE) =
6. Taxable Income (TI) = AGI - [BtLD (SD or ID) + PE]

   Defined as (1) undeniable accession of wealth (2) clearly realized (3) over which TP has complete dominion

1. Gift = §1015
2. Appreciation =
3. Depreciation =
4. Cost Basis = Your $ Value investment in property at time of purchase
5. Fair Market Value = Dollar value of property at transfer

1. Business-related expense (§162(a)) = An expense incurred, whether for one's own gratification or others, for which there exists evidence of a connection to a business purpose.

   §274(d) requires businesses to maintain adequate records of such expenses.

   §274(a) requires such expenses to be "directly related" to the taxpayer's business or precedes or follows a "bona fide business discussion."

How do we decide to raise revenue? → design criteria

1. Change must raise enough money
2. Change must be economically efficient

   Does it encourage/discourage economic growth?

   At some level, lower taxes lead to economic growth – further question is whether this difference is significant

   Lower taxes and higher growth don’t have a strong correlation – not supported by strong economic evidence

   Does change distort decision-making?

3. Change must be administrable

   Cost of collection v. benefit

   As rate increases, incentive to cheat increases – more policing effort needed

4. Change must be fair

   Benefit principle – what you pay ought to be proportionate to what you get in return from government

   Not used to rationalize the major taxes b/c judicial system, police protection, etc. are hard to measure

   But it comes up in popular political discourse on tax

   Ability to pay – typically we say people should pay in proportion to their ability – taxes is a way to proportion the common burdens of society (equal burden principle)

   Horizontal equity

   Tax should be the same for those in a similar standing

   Income makes it easy but addition of other bases (Home ownership, Medical expenses, etc.) makes it tough

   Tough to level the playing field in the same standing

   Vertical Equity

   Dissimilarly situated people should pay different tax

   Progressive tax is an attempt to create vertical equity

Miscellaneous

Amending a return requires a "mere error," not a mistake of fact.

Structured settlements are better than lump sums for tax purposes b/c you end up not having to include the interest in income

Valuable Rights to Income (Two doctrines)

Economic Benefit: when moneys are accruing interest on your behalf even if not immediately accessible

Constructive Receipt: when moneys are readily available for you with little obstacle

Examples

1. If a check written, even if it can't clear in the bank within this year, EB & CR
2. If invited to come in & have a check written, CR
3. If account opened in your name, accruing interest, EB
4. If contract in writing promising future payment, neither.

Retirement Savings

Constructive receipt doctrine overridden in the case of 401(k)s/defined benefit plans

ERISA - Ensure safety of investment (funding requirements), impose vesting requirements

IRAs - (§408) Deductable and grows tax free. When value is realized, taxed as income.

Maximum deductable amount contributed is $4000/yr (or $8000 for married couples).

After 50 yrs,

Only permissible for lower tax bracket individuals

IRA AGI w/o plan < $156,000

IRA AGI w/ plan < $83,000 Married or $52,000 Single

ROTH IRA - Non-deductable, but grows tax free and is not taxed as income when realized

5-year minimum, money may be taken out tax free later for certain expenditures (home-purchase, college, et al.)

§72(t) 10% penalty & exceptions

ROTH IRA < $156,000 Married or $99,000 Single

The value of deducting today is equal to not paying taxes on that income

Roth IRA uses after tax dollars allowing you to shelter more.

Formulae

Calculating Gross Income

Gross Receipts (GR); Cost of Goods Sold (CG) GI = GR – CG

Tax on Tax

A offers B payment of $100K + income tax liability for all payments made by A to B. What will A pay B?
A offers B the sum of $X + $Y, such that given $X, $Y equals all income taxes due from payments by A to B (leaving B with $X wholly intact after taxes). Given $X, what is $X + $Y?

[ $X / (1 - TR )] = $X + $Y
[$100K / (1 - 0.35)] = $153,846

Annuities

§§61(a)(9), 72

To determine amount of annuity payment that is excluded from gross income multiply payment by exclusion ratio

Exclusion ratio = (investment in the contract / total expected return under the contract) - § 72

ratio = % of each payment that is income

ratio undertaxes interest in early years and overtaxes in later years so net saving (defer taxation)

if live less than expected life, can take loss at death

if live longer than expected life, entire amount subject to income tax

alternatives (not adopted)

investment-first – treat initial payments as return to capital until basis recovered

income-first – treat initial payments as income and later as return

Amounts w/drawn prior to annuitization are usually income

favorable strategy b/c money you put in now accumulates tax free by insurance company; in savings account pay tax every year

Like-kind exchange formula

§1031 - Like-kind exchange refers to transfers of like-property

Like-property refers to character of property not quality (City land traded for farm land are like-kind)

Post-Exchange Basis (PoXB) = Pre-Exchange Basis (PrXB) + Gain Recognized (GR) Boot Basis (BB) = Fair Market Value (FMV)

Boot: other shit tossed in to deal to balance out (whether cash, goods, or other property)

Numbers
Xfarm Basis	110K	130K	50K	80K	50K
YFarm FMV	100K	100K	100K	60K	60K
Boot	Cash 15K	Cash 15K	Cash -10K
	Tractor 8K	Tractor 8K
Amt Real	123K	123K		60K	60K
Basis	110K	130K		80K	50K
Real Gain/Loss	13K	-7K		-20K	10K

Basis Y

Orig Basis = 110
Gain Rec = 13
Total Basis alloc = 123
Cash + Tractor = 23
Basis in Y = 100
Gain if Y for (100) =
Gain prev rec =
Sum should be gain real =

Installment Payments formula

§453 - Pro rata recognition (installment method)

Sale Price = $8000
Basis = $1000
Gross Profit (Gain) = $7000
Inclusion ratio: 7000 / 8000 = 87.5%
Pay taxes on 87.5% of installment payments received each year.

Income should be recog from any year where you have that proportion where the gross profit