BASIC FEDERAL INCOME TAX Professor Randall By: Kell E. Bodholt Fall 1990 TABLE OF CONTENTS I. CHAPTER 1 - INTRODUCTION TO FEDERAL INCOME TAXATION 1 A.Constitutionality 1 B.Tax Tools 1 1.Internal Revenue Code 1 2.Treasury Regulations 1 3.Treasury Revenue Rulings 1 4.Acquiescence 1 C.Judicial Hierarchy 1 1.Tax Court 1 2.Federal District Court 2 3.United States Claims Court 2 D.Limitation of Actions 2 1.Criminal 2 2.Civil 2 II. CHAPTER 2 - GROSS INCOME 61 2 A.Gross Income Defined 3 B.Examples of Gross Income 3 C.Income Without Receipt of Property 3 III. CHAPTER 3 - INCOME REALIZED IN ANY FORM 4 A.Fair Market Value (FMV) 4 IV. CHAPTER 4 - LIMITATIONS OF GROSS INCOME 4 A.Realization 4 B.Imputed Income 4 C.Bargain Purchases 4 V. CHAPTER 5 - GAINS DERIVED FROM DEALINGS IN PROPERTY 4 A.Factors in the determination of gain 4 B.Determination of Basis 4 1.Cost as Basis 4 2.Property Acquired by Gift 5 3.Property Acquired between Spouses or Incident to Divorce 5 4.Property Acquired from a Decedent 1014 6 C.The Amount Realized 1001(b) 6 1.When the basis is < the gift tax; 6 2.Transactions Which are Part Gift and Part Sale 7 3.Discharge of an Obligation with Appreciated Property 7 4.Basis is < the Transferor's Liability on the Asset 7 5.Tax Cost Basis 7 VI. CHAPTER 6 - THE EFFECT OF AN OBLIGATION TO REPAY 8 A.Claim of Right 1341 8 B.Illegal Income 8 VII. CHAPTER 7 - GIFTS, BEQUESTS, DEVISES & INHERITANCE 102 8 A.General Rule 102(a) 8 B.The Meaning of Gift 8 C.Employee Gifts 102(c) 8 D.The Income Tax Meaning of Inheritance 9 VIII. CHAPTER 9 - DISCHARGE OF INDEBTEDNESS 102, 108, 1017 9 A.General Rule 9 B.Exceptions 9 1.Insolvent Discharge of Indebtedness 108 9 2.Discharge of indebtedness as a Gift 102 9 3.Discharge of a Student Loan 108(f) 9 4.Solvent Farmers Discharged 108(g) 9 5.Gratuitous Cancellation by Shareholder- Creditors 9 IX. CHAPTER 10 - SCHOLARSHIPS AND PRIZES 74 10 A.General Rule 74(a) 10 B.Exception for Certain Prizes and Awards Transferred to Charities 74(b) 10 C.Exception for Certain Employee Achievement Awards 74(c) 10 D.Taxable Value of the Award 10 E.Scholarships & Fellowships 117(a) 10 X.CHAPTER 11 - COMPENSATION FOR INJURY & SICKNESS 11 A.Comp. for injuries/sickness 104 11 B.Amounts Received Under Accident/Health Plans 105 11 C.Medical/Dental Expense 11 XI. CHAPTER 12 - FRINGE BENEFITS 132 11 A.Fringe Benefits 132(a) 12 B.Exceptions 12 C.Exclusions for Meals & Lodging 119 12 XII. CHAPTER 13 - REPORTING INCOME 441,446,451 13 A.Annual tax accounting system 441 13 1."Cash Method" 13 2."Accrual Method" 13 B.Constructive Receipt 13 1.Elements for Const. Receipt: 14 2.Exceptions to Const. Receipt 14 C.Cash Equivalency Doctrine Reg. 1.61-1(a) 14 1.Checks 14 2.Post dated checks 14 D.Economic Benefit Doctrine 14 E.Prepayments 14 XIII. CHAPTER 15 - BUSINESS EXPENSES 162 14 A.General Rule 162(a) 14 B.Anatomy of the Business Deduction 14 1.Ordinary and necessary 14 a.Necessary 14 b.Ordinary 15 C.Trade or Business 15 D.Expenses 15 E.Carrying On the Trade or Business 15 1.General Rule 15 2.Start Up Expenditures 195 15 3.Unemployment 15 F.Specific Business Deductions 16 1.Reasonable Salaries 16 2.Travel "Away From Home" 16 3.Necessary Rental and Similar Payments 17 G.Miscellaneous Business Deductions 18 1.The Requirement to keep Good Records 274(d) 18 a.Business Meals 18 b.Entertainment 18 c.Entertainment Facilities 18 d.Uniforms 18 e.Advertising 18 f.Dues 18 2.Business Losses 165(a) 18 3.Individual Losses 165(c) 18 XIV. CHAPTER 16 - CAPITAL EXPENDITURES 263 18 A.Capital Expenditures 263 18 B.Cost of Acquisition 19 C.Repair or Improvement Reg. 1.162-4, Reg. 1.263(a)-1(b) 19 D.Prepaid Expenses Creating an Asset Reg. 1.461- 1(a) 19 E.Expansion Costs 19 XV.CHAPTER 17 - DEPRECIATION 19 A.Depreciation-167 19 B.What property is depreciable? 20 C.Recovery Period 20 D.Depreciation Methods 20 1.Strightline depr. 20 2.Accelerated Depr. 20 a.Declining Balance Method 20 (1)Double Declining Balance/200% 21 (2)Sum of the Years Digits (SOYD) 21 E.Conventions 21 F.Expending Tangible Personal Property 21 XVI.CHAPTER 18 - LOSSES AND BAD DEBTS 21 A.Losses-165 21 B.Bad Debt-166 21 1.Bad Debt: Bona Fide Debt Req-166 22 2.Bad Debt: "Worthlessness" 22 3.Bad Debt: Business or Nonbusiness Debts- 166(d) 22 4.Bad Debts: Amount Deductible 22 5.Bad Debt: Guarantee 22 XVII.CHAPTER 19 - TRAVEL EXPENSES 22 A.Travel Expenses 162 22 B.Commuting Expenses 22 C.Other Transportation Expenses 23 D.Expenses for Meals and Lodging While in Travel Status 23 E.Deduction of Travel Expenses of Spouse 23 F.Business-related Meals 24 G.Limitations of Foreign Travel 24 H.Substantiation Requirements 24 XVIII.CHAPTER 20 - ENTERTAINMENT AND BUSINESS MEALS 24 A.Business entertainment and meals 274 24 B.Entertainment Activities 274(a) 24 1."Directly related to" 24 2."Associated with" 24 3.Entertainment Facilities 24 4.Substantiation Requirements 274(d) 25 XIX.CHAPTER 21 - MOVING, CHILD CARE, LEGAL, CLOTHING EXPENSES 25 A.Moving Expenses 217, 82 25 1."In connection with the commencement of work" 25 2.Minimum Distance 25 3.Minimum Period 25 B.Child Care 21 25 C.Legal Expenses 26 1."Origin-of-the-claim" Test 26 D.Clothing and Uniforms 26 XX.CHAPTER 22 - EDUCATION EXPENSES 26 A.Deductible Education Expenses 26 B.Non-Deductible Educational Expenses 26 a.The Skill-Maintenance or Employer-Requirement Tests 26 b."Express requirement of employer, law, status, rate of comp. 27 C.The Minimum-Educational-Requirements and New-Trade- or-Business Test 27 D.Travel Expenses 27 XXI. CHAPTER 23 - HOBBY LOSSES 27 A.Hobby Losses 183 27 B.Deductions allowable under 183 28 XXII.CHAPTER 24 - HOME OFFICE, VACATION HOME AND OTHER DUAL USE PROPERTY 28 A.Home Office Deductions 280 29 B.Vacation Homes 29 C.Dual Use Property 29 1.Computers and "Listed Property" 29 2.Automobiles 29 XXIII. CHAPTER 25 - INTEREST DEDUCTION 29 A.Interest 29 B.Deduction of Personal Interest 29 C."Qualified Residence Interest" 29 1.Acquisition Indebtedness 30 2.Home Equity Indebtedness 30 D.Investment Interest 163(d)(4)(A) 30 XXIV. CHAPTER 29 - CHARITABLE DEDUCTIONS 170 30 A.Requirements for Charitable Deductions 170 30 B.Qualified Recipient 170(c) 30 C.Contribution or Gift 30 D.Actual Payment Required 170(a)(1) 31 E.Limitations on Charitable Deductions 170(b) 31 F.Contribution of Services 1.170A-1(g) 31 G.Contribution of Appreciated Property 31 XXV. CHAPTER 30 - LIMITATIONS ON DEDUCTIONS 267, 265 31 A.Losses Between Related Taxpayers 267 31 B.Wash Sales 1091 32 XXVI. CHAPTER 33 - CHARACTERIZATION (CAPITAL GAINS AND LOSSES) 32 A.Introduction 32 Requirements of a Capital Gain or Loss 32 Net Long Term or Short Term Gains or Losses 32 Excess Loss 1211(b) 32 B.The Meaning of Capital Assets 1221 32 C.Sale or Exchange 1222 33 D.Holding Period 1223 33 XXVII. CHAPTER 36 - ASSIGNMENT OF INCOME 33 A.Introduction 33 B.Income From Services 33 1.General Rule 33 2.Absolving Right to Income 34 C.Income From Property 34 1.General Rule 34 a.Bonds & Coupons 34 b.Stocks & Dividends 35 XXVIII. CHAPTER 37 - THE KIDDIE TAX 1 35 A.General Rule 35 B.Earned Income 35 C.Unearned Income 35 D.Limitations 35 XXIX. CHAPTER 39 - TAX CONSEQUENCES OF DIVORCE 36 XXX. CHAPTER 41 - LIKE KIND EXCHANGES 1031 36 A.Introduction 36 B.Scope 36 C.Application 36 D. NEW BASIS 37 1.General Rule 37 2.Boot Paid 37 XXXI. CHAPTER 42 - INVOLUNTARY CONVERSION 1033 37 A.Scope 37 B.Application 37 C.NEW BASIS 37 D.PROPERTY "SIMILARLY RELATED IN SERVICE" EFFECT OF CONDEMNATION OF REAL PROPERTY 1033 (G) 38 1.Scope 38 2.General Rule 38 XXXII. CHAPTER 43 - SALE OF A PRINCIPLE RESIDENCE 1034 38 A.General Rule 38 B.Basis in the New Residence 1034(e) 38 C.Sale of Residence for Individuals over 55 121 38 1.General Rule 38 2.Married Couples, and the Tainted Spouse Dilemma 39 XXXIII. CHAPTER 44 - INSTALLMENT SALES 453 39 A.General Rule 39 1.Election Out 39 2.Installment Sale Defined 39 B.Non-Real Property 453(i) 39 1.Recapture 39 2.Gain in Excess of Recapture 40 C.Real Property 40 1.Recapture; General Rule 40 2.Gain in Excess of Recapture 40 D.Trouble Areas with Installment Sales 40 1.Sale of Property between Related Parties 453(g) 40 2.Demand Notes 453(f)(4) 40 3.Disposition of the Installment Contract 453B 40 a.General Rule 40 b.Exception 40 XXXIV. CASES 40 UNITED STATES v. CORRELL 41 COMMISSIONER v. FLOWERS 41 HANTZIS v. COMMISSIONER 41 REVENUE RULING 75-432 42 Takahashi v. Commissioner 42 Wassenaar v. Commissioner 43 Furner v. Commissioner 44 RR 68-591 44 Sharon v. Commissioner 45 Dreicer v. Commissioner 45 Remuzzi v. Commissioner 46 Weissman v. Commissioner 47 RR 67-246 47 RR 78-38 48 McWilliams v. Commissioner 48 Miller v. Commissioner 48 I. CHAPTER 1 - INTRODUCTION TO FEDERAL INCOME TAXATION A. Constitutionality: The Internal Revenue code is constitutional. B. Tax Tools 1.Internal Revenue Code: Is the law and binding upon both the TP and the IRS. All other materials are aids to determining the meaning of the code. 2.Treasury Regulations: They are issued by the Sec'y of the Treasury under statutory authority. They provide interpretations of the IRC. However, the judiciary has the power to say whether the Regs conform to legislative intent. Thus, regs are usually absolute as to what the law might be, however they are subject to interpretation. 3.Treasury Revenue Rulings: Revenue rulings are issued under statutory authority as the Regs. Generally they are the Treasury's answer to a specific question raised by a TP concerning his tax liability. Thus, they are a predetermination upon tax consequences of actions not specifically covered by the code. Private letter rulings cannot be relied on as authority by anyone but the TP who raised the question. The effect is a contract between the Treasury and the individual party. 4.Acquiescence: This is the IRS's published approval or disapproval of the Tax Court's determination of issues adverse to the government. C. Judicial Hierarchy 1.Tax Court a.Composition: This court consists of 19 judges and permanently located in Washington D.C. The court is a traveling court. There are also 11 special trial judges who hear cases of $10,000 or less. b.Characteristics: Upon receiving a notice of deficiency, the TP has 90 days to file a claim in the tax court. The TP does not have to pay the alleged deficiency until this court makes a ruling. 2.Federal District Court The TP must pay the deficiency and then file a claim for refund in this court. This is the only court where a tax claim can be heard by a jury. Cases are appealed to the Circuit in which the court exists. 3.United States Claims Court The TP must pay the deficiency and then file a claim for refund in these court. This is also a traveling court. This court is used if the tax matter is highly technical. Cases are appealed to the Federal Circuit Court of Appeals. D. Limitation of Actions 1.Criminal: The IRS has 6 years from the time the crime was committed to bring a case for criminal penalties. This also applies to non-filed return. 2.Civil: The TP has 3 years from the date of the return or due date to recover overpaid funds. If more than 25% of the TP income has been omitted from the return, then the IRS has 6 years to recover the deficiency. Failure to file a return, there is no limitation of action if the IrS wants to bring a civil claim. Civil Fraud, there is also no limitation of action if the IRS wants to bring a civil claim. II. CHAPTER 2 - GROSS INCOME 61 Accrual Method: It is entered on the general ledger at the time the transaction occurred, i.e., sent a bill for $50 for services rendered, must be reported in the year bell was sent. Cash Method: When you actually receive the income (preferred method). A. Gross Income Defined: 61; "Except as other wise provided in this subtitle, gross income means all income from whatever source derived. Thus to the extent that it is not taxable, it is. GI is realized in instances of "undeniable accessions to wealth, clearly realized, and over which the TPs have complete dominion. B. Examples of Gross Income 1.Payment of another persons taxes is income to that person. Thus it is taxable. 2.Income which is illegally obtained is subject to income tax. For example, embezzlement is income. It is not a quasi loan. The IRS has a lien on the money for taxes, even though there may not be enough money to pay back the victim. Should the embezzler repay the money, he will get a deduction so long as it was paid back in the same year. 3.Found money is income. C. Income Without Receipt of Property 1.When you do something for yourself, you do not have to pay tax on it. But, if you own a corporation and receive money from it, you are taxed. 2.Payment in the form of services: If services are paid for other than in money, the FMV of the property or services taken in payment must be included in income. 3.Rental value of building: Owned and occupied by the TP does not constitute income with the 16th Amendment. 4.Social Security: 86-TP with income over a certain level must report part of their social security or railroad retirement payments as GI. 5.Fringe Benefits: 61(a)(1)-those fringe benefits not specifically excluded were includable in GI. 6.Unemployment Benefits: 85-requires unemployment benefits as GI, regardless of TP's income level. 7.Exclusions: 102-excludes gifts and bequests from GI. 8.Loans are Not Gross Income: Loans are based on concurrent acknowledgement obligations to repay which, offsetting the receipt, negate any "accession to wealth." However, if the borrower has no intent to repay the loan, and the lender is unaware of that fact, the loan is not a loan but a illegal accession to wealth and thus would be taxable. III. CHAPTER 3 - INCOME REALIZED IN ANY FORM A. Fair Market Value (FMV): 1.61-2(d)(1); Fair market value is defined as the price a willing buyer would pay a willing seller, with neither under a compulsion to buy or sell, and both having reasonable knowledge of relevant facts. IV. CHAPTER 4 - LIMITATIONS OF GROSS INCOME A. Realization: When the transaction occurs, you realize income i.e., sale of stock is realized at execution of sell or buy, however, the appreciation/depreciation is not a realization event. B. Imputed Income: Imputed income is not taxed, even though the IRS does not exclude. The exclusion is a matter of administrative practice (imputed income form services and imputed income from property). Ex; A & B have $100,000 to invest, B buys stock with $10,000 in interest per year. A buys house with rental value of $10,000. Each derives a $10,000 per year benefit, however B's is taxable. C. Bargain Purchases: Assume that the FMV of the asset is greater than the price just paid for it. Has one had an accession to wealth? Bargain purchases does not constitute income. V. CHAPTER 5 - GAINS DERIVED FROM DEALINGS IN PROPERTY A. Factors in the determination of gain: The measuring stick used to determine a persons gain (or loss) on the sale/transfer of an asset (tangible or intangible) is "basis." Basis, unadjusted, essentially answers the question: How much do I have in it? B. Determination of Basis 1.Cost as Basis: Property acquired by purchase has a cost basis to the buyer in the amount of what he paid for it. If there has been a taxable exchange in a medium other than money, then the "cost basis" is the FMV of the property exchanged. And it is in only rare and extraordinary cases that the value of the property exchanged cannot be ascertained with reasonable accuracy. 2.Property Acquired by Gift: Property acquired by gift costs the donee nothing, and is not includable in his gross income. Except for purposes of determining a loss on the sale of the property, the basis of property in the hands of the donee is the same basis the property had in the hands of the donor. For the purposes of determining a loss on the sale of the property, the basis of the property is the FMV of the property when the gift was made. Consequently a pre-gift appreciation remains taxable in the event of a subsequent sale or exchange by the donee. Basis always carries over for gain purposes. FMV is used for computing losses. 3.Property Acquired between Spouses or Incident to Divorce: No gain or loss shall be recognized on a transfer of property from an individual to a spouse or former spouse ( but only if the transfer is incident to divorce). the policy implemented here reflects the attitude that a husband and wife are a single economic unit, and the tax laws governing transfers of property between spouses should be as nonintrusive as possible. Tax consequences of the Transferor The transferor recognizes no gain or loss on the transfer even if the transfer was in exchange for the release of marital rights or other considerations. This applies to both separately and community owned property. Tax consequences of the Transferee The transferee recognizes no gain or loss upon receipt of the property. In all cases, the basis will be the adjusted basis of the transferor immediately prior to the transfer. This carry over basis rule applies for purposes of determining a gain or loss upon the subsequent disposition of the property. Notes: 1.1041 applies to any transfer of property between spouses regardless of whether the transfer is a gift or is a sale or exchange between spouses. 2.Transfers of services are not subject to 1041. 3.The property transferred within the year after the divorce does not have to be related to the cessation of the marriage. Thus, a transfer of property acquired after the marriage ceases may be governed by 1041. 4.A transfer of property is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument, and the transfer occurs not more than 6 years after the date on which the marriage ceases. 4.Property Acquired from a Decedent 1014: Property acquired from a decedent receives a basis equal to its fair market value on the day of the decedent's death. The effect is to give property which has appreciated during the decedent's ownership a "stepped-up" basis with no income tax cost to anyone. Thus, 1014 is a important element is estate planning. It means that, although appreciated property is fully subjected to the estate tax, the appreciation itself entirely escapes the income tax. C. The Amount Realized 1001(b): The amount realized from the sale or other disposition of property shall be the sum of any money received plus the FMV of property (other than money) received, less the adjusted basis. 1.When the basis is < the gift tax; When a gift is made, the gift tax liability falls on the donor. As a result, when a gift is made, the donor incurs a debt with the U.S. When the donee pays the tax he has relieved the donee of the debt. Thus, the debt is income to the donor. If this tax is less than the donors' basis, then the donor has realized a loss, because he is receiving less for the property (in the form of paid taxes) than what his original costs were. Thus, to the extent the gift taxes paid by the donee' exceeds the donors' adjusted basis in the property transferred, the donor has realized taxable income. 2.Transactions Which are Part Gift and Part Sale These are in transactions in which the donee pays the gift tax incurred by the donor. Thus, the sale price is the amount necessary to discharge the gift tax liability. The donee will receive, as his basis the higher of either the donor's basis or the amount he paid for the gift tax. 3.Discharge of an Obligation with Appreciated Property When you discharge an obligation with appreciated property, it is the same as selling it. Thus, the payor is subject to income tax for the appreciated property less his basis. 4.Basis is < the Transferor's Liability on the Asset When the basis is less than the transferor's liability on the asset, the transferor will be taxed upon the difference. As a result, never transfer an asset when the liability is greater than the adjusted basis. 5.Tax Cost Basis: "Suffered enough" theory; Where you steal, lie, cheat = IRS says no basis. Employer receives a car for $5000, and sells for $5500. Employees basis=$500, gain=$500. If X buys Y's home for $100,000, and X barrows $10,000 as a loan. X's basis is $10,000 because of the obligation to repay, the TP is entitled to include the amount of the loan in computing his basis. Recourse Loan: In the example above, X is liable for the $10,000 and if he fails to repay the bank can acquire X's property. Non-recourse Loan: There is no personal liability associated with borrowing. Note: (1) Liabilities, whether recourse or nonrecourse, assumed, taken subject to or otherwise incurred in the acquisition of property are included in a TP's basis; and (2) liabilities of a seller, whether recourse or nonrecourse, assumed or taken subject to by a purchaser, are included in the seller's amount realized. VI. CHAPTER 6 - THE EFFECT OF AN OBLIGATION TO REPAY A. Claim of Right 1341: Money received under a claim of right, without restriction as to disposition, is income; the contingent repayment obligation does not allow it to be treated as a loan, e.g., waitress who finds a wallet with $150, must report GI, even though she may have to repay the $150 to the person who lost the wallet. B. Illegal Income: Embezzled shall be included as GI. VII. CHAPTER 7 - GIFTS, BEQUESTS, DEVISES & INHERITANCE 102 A. General Rule 102(a): "Gross income does not include the value of property acquired by gift, bequest, devise or inheritance. B. The Meaning of Gift: Whether a transfer of money or property constitutes a gift within the exclusion of 102(a) is a issue of fact to be determined by the trial court. A gift in the statutory sense...proceeds from a "detached disinterested generosity, out of affection, respect, admiration, charity or like impulses." And in this regarded, the most critical consideration, is the transferor's intention. Thus, what controls is the intention with which payment, however voluntary has been made. C. Employee Gifts 102(c): Employer-employee transactions are not gifts except: 1.74(c); which excludes certain employee achievement awards from gross income, and 2.132(e); which excludes certain de minimis fringes from gross income. D. The Income Tax Meaning of Inheritance: Gross income does not include inherited property even if the property is to be distributed at designated intervals. But it does include income generated from inherited property regardless if the heir receives only the income, or both the property and income. VIII. CHAPTER 9 - DISCHARGE OF INDEBTEDNESS 102, 108, 1017 A. General Rule: Taxable income is realized, when indebtedness is forgiven or in other ways canceled. B. Exceptions 1.Insolvent Discharge of Indebtedness 108: No taxable income arises from discharge of indebtedness if the debtor is insolvent both before and after the transaction. If the debtor is solvent after the discharge of indebtedness, then he is taxed only to the extent of his solvency. 2.Discharge of indebtedness as a Gift 102: A debt cancellation which constitutes a gift or bequest is not treated as taxable income to the donee debtor. 3.Discharge of a Student Loan 108(f): Discharge of a student loan is not taxable income to the debtor. 4.Solvent Farmers Discharged 108(g): A debt cancellation to solvent farmers is not treated as taxable income to the farmer. 5.Gratuitous Cancellation by Shareholder-Creditors: Treasury regulations provide that the gratuitous cancellation of a corporation's indebtedness by a shareholder-creditor does not give rise to debt discharge income to the extent of the principal debt since the cancellation amounts to a contribution to capital of the corporation. IX. CHAPTER 10 - SCHOLARSHIPS AND PRIZES 74 A. General Rule 74(a): All prizes are includable as GI, unless it is a qualified scholarship. B. Exception for Certain Prizes and Awards Transferred to Charities 74(b): If the prize was made in recognition of "religious, charitable, scientific, educational, artistic, literally, or civic achievement," then it is excludable. But only if the award is transferred directly to a designated governmental unit or charity. thus the only way the winner can escape an inclusion in GI is never to receive the award. C. Exception for Certain Employee Achievement Awards 74(c): Employee achievement awards are not includable in GI within the meaning of 274(j). 274(j)(3)(A) provides that an employee achievement award is an item of tangible personal property which is: 1.For a length of service achievement, no less than 5 yrs, or a safety achievement; 2.Awarded as part of a meaningful presentation; and 3.Awarded under conditions and circumstances that do not create a significant likelihood of the payment of disguised compensation. D. Taxable Value of the Award: the taxable value of the award is based upon the FMV of the award, i.e., what could the recipient sell it for. But if there is no fair market value, as in cases of non-transferable tickets, the taxable value of the award will be its worth to the winner. Therefore, if the winner does not use the prize he has no taxable income. E. Scholarships & Fellowships 117(a): Generally scholarships are excludable from GI. However, the exclusion is limited to tuition, books, and related fees. Room and board is no longer excludable. 117(c); If the scholarship requires the student to render certain services in order to maintain his eligibility or the scholarship, then the scholarship is taxable. Exception, athletic scholarships are excludable from GI, even though the athlete must play to receive the scholarship. 127(a); GI does not include amounts (up to $5,250) received from a qualified educational assistance program. X. CHAPTER 11 - COMPENSATION FOR INJURY & SICKNESS A. Comp. for injuries/sickness 104 1.Except for deductions allowed under 213, GI does not include; a.WC for personal injuries/sickness. b."Damages" received by suit/settlement/lump sum/ periodic payments for personal injuries/sickness. c.Amounts received by accident/health insurance other than amounts received by employee, i.e., (1)Contribution by employer not included as GI of employee. (2)Paid by employer. d.Amounts received by pensions/ annuity for personal injury/sickness from active service of armed forces. e.Amounts received by disability income for "violent attack" determined by Sec. of State to be a terrorist attack while employee of U.S. in performance of duties outside of U.S. B. Amounts Received Under Accident/Health Plans 105 1.Employer contributions - amounts received by employee through accident/health plans shall be GI, to the extent: a.Attributed to contributions of employer which not included in employee's GI. b.Paid by employee. 2.Amounts expended for Medical Care - Except for amounts contributed to deductions under 213, GI does not include amounts in (a) if paid directly/indirectly to reimburse TP for what he expended. C. Medical/Dental Expense - Allowance of deduction for the expense paid, not compensated for the extent exceeds 7.5% of AGI. XI. CHAPTER 12 - FRINGE BENEFITS 132 A. Fringe Benefits 132(a): GI does not include any fringe benefit which qualifies as a; 1.Non-additional cost service; 2.Qualified employee discount; 3.Working condition fringe; 4.De minimis fringe. B. Exceptions: Fringe benefits are taxable if they are discriminatory to your counterparts, except as otherwise provided in the code. Thus, the fringe must be 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. 132(h)(1). C. Exclusions for Meals & Lodging 119: Meals and lodging furnished to an employee and or his family are excluded from GI if he following tests are met; 1. Meals-Reg. 1.119-1(a); a.The meals must be furnished on the business premises, and b.the meals are furnished for the "convenience of the employer". If these two tests are met, the exclusion applies irrespective of whether under an employment contract or a statute fixing the terms of employment such meals are furnished as compensation. 2.Lodging-Reg. 1.119-1(b); a.The lodging must be furnished on the business premises of the employer. b.The lodging must be furnished for the "convenience of the employer", and c.The employee is required to accept the lodging as a "condition of his employment." The employee must accept the lodging in order to enable him to properly perform the duties of his employment. If these three tests are met, the exclusion applies irrespective of whether under an employment contract or a statute fixing the terms of employment such lodging is furnished as compensation. XII. CHAPTER 13 - REPORTING INCOME 441,446,451 A. Annual tax accounting system 441 1."Cash Method": Cash receipts and disbursements. When you actually receive the money. 2."Accrual Method": Actual transaction date, not when you receive payment or disbursement. 446; authorizes the cash method as long as it reflects TP income. B. Constructive Receipt: Under the cash method, all items which constitute GI (cash, property, or services) are to be included for the taxable year in which actually or constructively received. The question is when he has "control" over the cash, property or services, not just possession. 1.Elements for Const. Receipt: a.The amount must be available to TP. b.TP's control over receipt must no be subjected to substantial restrictions. or limitations. 2.Exceptions to Const. Receipt: a.Prizes and Fringe benefits. C. Cash Equivalency Doctrine Reg. 1.61-1(a): Certain intangibles which have so clear a value and are so readily marketable that a cash method TP receiving them should not be entitled to defer reporting income. 1.Checks: Assuming check is honored in due course and is not subject to some condition, a check received at year end by a cash method TP must be included in income just as if cash was received. 2.Post dated checks: Viewed as a promise to make funds available, does not satisfy cash equivalency doc., and therefore its receipt will not generate income until post date. D. Economic Benefit Doctrine: An individual should be taxed on any economic benefit conferred upon him, to the extent that the benefit has an ascertainable FMV. E. Prepayments: Prepayments for services to be rendered, TP required to report in year payment received. XIII. CHAPTER 15 - BUSINESS EXPENSES 162 A. General Rule 162(a): allows the TP a deduction for all of his ordinary and necessary business expenses. Clothing; if your business clothes are adaptable to normal personal use, the deduction is not allowed. Watches are not deductible unless the TP is a railroader. B. Anatomy of the Business Deduction 1.Ordinary and necessary a.Necessary: These are expenditures which are "appropriate and helpful" to the business. b.Ordinary: Ordinary does not mean that the payments have to be habitual or normal in the sense that the same TP will have to make them often. Rather, ordinary means that the payment was the type in which others equally situated in the community might some time make. C. Trade or Business: A person is in the trade or business if he s in "good faith obtaining a regular livelihood." This was the holding in Gretzinger in which a person was held to be in the trade or business of gambling. This superseded the older definition which defined a person in the trade or business if he hold himself out to sell goods or services. D. Expenses 1.Deductible expense: is on which neither adds to the value of the property/business nor appreciably prolongs its life. Rather it is an expenditure which keeps the property/business in ordinary operating condition. 2.Repairs: which arrest deterioration and appreciably prolong the life of the property are non-deductible, but are depreciable. E. Carrying On the Trade or Business 1.General Rule: In order to be entitled to a deduction for "ordinary and necessary business expenses" the TP has to be in the trade or business. Thus, the person who is just entering the trade or business cannot deduct his expenses for entering the business. 2.Start Up Expenditures 195: allows the TP to amortize his start-up expenditures over 60 months period. 3.Unemployment: Becoming unemployed once in the trade or business does not prevent that person from being considered in the trade or business. Factors which determine whether deductions will be allowed are : (1) Duration of unemployment; (2) The duration the TP was in the trade or business before being unemployed. F. Specific Business Deductions 1.Reasonable Salaries General Rule: Deductions for salaries cannot exceed what is reasonable under the circumstances. Whether a salary is reasonable is a tactual question. Salaries of counter parts n the same profession is an indicator of a reasonable salary, however it is not conclusive. Small Corporations: This issue generally crops up here, where there is a closely knit family held corporation where the ones receiving the salaries are the one setting it. Single Person Corporations: If all the profits of the corp. are paid to the individual it is reasonable since he is the one generating that income, therefore the salary to the shareholder is deductible to the corporation. RED FLAG: when the corp. is paying very little tax as a result of high deductions, chances are the salaries are unreasonable. 2.Travel "Away From Home" Meals, Entertainment & Beverage Expenses 274(n): only allows the TP to deduct 80% of these expenses. When on a business trip, the TP has to be away from home overnight, in order to receive a deduction for his meals. However, it is not necessary that the TP incur lodging expenses. Lodging Expenses: Lodging expenses are 100% deductible. However, the TP has to be away overnight. Travel: Travel expenses are deductible. Even if the travel is between two offices within the same city. Preconditions for deduction; a.The expense must be a reasonable and necessary expense; b.The expense must be incurred while away from home; c.The expense must be in pursuit of business; d.And or course the TP must be in the trade or business. The One Year Rule: Temporary assignments away from home are deductible if they las less than a year. If it lasts more than a year, it raises a presumption that the expenses will not be deductible, 2 years=permanent. Summer Intern Living Expenses: Can a law student deduct his living expenses if he clerks out of town? 81-1-1 USTC 9144, held not deductible. 3.Necessary Rental and Similar Payments General Rule: Lease payments are deductible. Gift Lease Back: If property is given away and then leased back to the donor, then the lease payments are not deductible. EXCEPT, if the property was transferred to a trust, i.e., "CONTROL". Sale Lease Back: If the property was sold and then leased back, the lease payments are deductible. 4.Expenses for Education General Rule: Educational expenses are deductible if they are necessary to; a.Maintain or improve skills required by the individual in his employment, or b.Meet the express criteria of the employer. Exception: If the education will qualify the TP for a new trade or business then the deduction is lost. If a person already in the trade or business returns to school to receive the minimum qualification of education for that trade or business, the expenses are not deductible. What is deductible: Meals (80%), travel, living expenses. G. Miscellaneous Business Deductions 1.The Requirement to keep Good Records 274(d): All deductions must be substantiated as to amount, time, place, purpose, and business relationship. a.Business Meals: 80% deductible. Tax and tip are included as part of meal cost. The TP using the deduction must be present. b.Entertainment: Business must be discussed during or after the event. The TP can deduct only the face value of the ticket. c.Entertainment Facilities: Expenses for entertainment facilities, such as yachts, summer homes, clubs, are not deductible, unless a business relationship can be established. d.Uniforms: are deductible only if; (1) they are a condition of employment, and (2) they are not adaptable for normal use. e.Advertising: Advertising expenses of a business are deductible in year incurred. f.Dues: Dues paid to organizations directly related to one's business are deductible. 2.Business Losses 165(a): Any loss sustained during the taxable year and not compensated for by insurance or otherwise, is deductible. 3.Individual Losses 165(c): Deductible losses by individuals are limited to: a.Losses connected with the trade or business. b.Losses incurred from investment, though not in the trade or business. c.Losses of property caused by fire, storm, shipwreck, or other casualty, or form theft. 165(h). XIV. CHAPTER 16 - CAPITAL EXPENDITURES 263 A. Capital Expenditures 263: denies a deduction for expenditures that "add to value, or substantially prolong the useful life" of property, or "adapt property to a new and different use," but not to "incidental repairs and maintenance." B. Cost of Acquisition: acquisition casts constitute capital expenditures and are not deductible, i.e., purchases such as tangible property, building, machine or vehicle or partnership. the asset produces a continuing, long term benefit, and its const must be "capitalized." Expenses incurred in determining the price of stock are not deductible because the "origin of the claim" was in the acquisition of the stock." C. Repair or Improvement Reg. 1.162-4, Reg. 1.263(a)-1(b): Expenditures for repairs or maintenance, which do not materially add to value or appreciably prolong the life, are deductible; replacements or improvements are not deductible. D. Prepaid Expenses Creating an Asset Reg. 1.461-1(a): Expenditures that result in the creation of an asset having a useful life extending substantially beyond the taxable year may not be currently deductible, or may be currently deductible only in part, that is, it may have to be "capitalized." "One year rule"; under which prepaid rent may be currently deducted if it related to a period not more than 1 year. E. Expansion Costs: Generally not deductible. Cases involving establishment by banks of new branch offices. Court found that the branch banks were not "separate and identifiable asset," and it permitted the deduction of marketing and planning costs. XV. CHAPTER 17 - DEPRECIATION A. Depreciation-167; TP to write off or deduct one's capital investment (or cost) over time 167. Analysis: (1)What property is subject to depreciation. (2)Recovery Period. (3)Method of calculating depreciation. B. What property is depreciable? 167:A reasonable allowance for the exhaustion, wear and tear: 1.Property used in trade of business. 2.Property held for the production of income. Note: No deduction for personal expenses, b/c tax system is based upon taxation of net income. 3.Property must be subject to wear and tear, exhaustion or obsolescence, i.e., stock, land , goodwill do not have a determinable life or they don't decline in value; therefore not deductible. C. Recovery Period: "Useful life concept"; estimate how long the asset generally could e expected to be useful in trade or business or other income producing activity. 1.See Bulletin F = Table for common assets useful life. 2.167(m), Asset Depreciation Range (ADR)-industry- wide set of useful lives for classes of assets. 3.Accelerated Cost Recovery System (ACRS)-168; 5 useful life categories, which all tangible property was placed. a.Real Property = 18 yrs. b.Tangible personal property = 3-5 yrs. ACRS-write off in a much more rapid rate. The 1986 Tax Reform Act: Real & tangible property after Dec. 31, 1986 "non-residential real property" is depr. not less than 27.5 yrs. Property other than non-residential & residential rental property is classified as 3,5,7,10,15,20 yrs. D. Depreciation Methods-current code uses both straightline and accelerated depr. 1.Strightline depr.- (cost of asset-salvage)/recovery period. 2.Accelerated Depr.-permits larger depr. deductions in the early yrs. of recovery period (Front- loaded). a.Declining Balance Method-Fixed rate greater than SL rate is used and is applied not to the total cost of property each yr. as SL, but to the cost less the depr. deductions claimed for prior yrs. (1)Double Declining Balance/200% (2)Sum of the Years Digits (SOYD) 5/15,4/15,3/15 etc... Num=Remaining useful life Den=SOYD E. Conventions-When the depr. can be claimed. Reg. 1.46- 3(c)(1) defines "placed in service" to mean "placed in a condition or state of readiness and available for the specifically assigned function. F. Expending Tangible Personal Property-179; deduct currently the cost of acquisition of depr. business assets, subject to limitations. Can also deduct depr. under 168-179 provides for "additional" first year depr. XVI. CHAPTER 18 - LOSSES AND BAD DEBTS A. Losses-165-authorizes a deduction for any uncompensated loss sustained during the year. 165(c) restricts losses to trade/business losses or losses in profit seeking transactions or casualty, theft losses. 1.When is a loss sustained? 1.165-1(b)-a loss "must be evidenced by closed and completed transaction, fixed by identifiable events." a.Loss by securities-165(g)(2)-when they become "worthless" which is a factual matter. b.Losses-Amount of the Deduction; 165(b)- limited under this section to the adjusted basis. c.Disallowed Losses-loss which are allowed under 165 maybe disallowed under other provisions of code, i.e,. 267(a)(1), disallowing losses on "related party" sales or exchanges. 1009 on "wash sales" of securities, 1092 tax straddles. B. Bad Debt-166; allows a deduction for debts that become worthless with in taxable year. No distinction b/w corporate & individual TP. However, a distinction b/w business and nonbusiness bad debts. 1.Bad Debt: Bona Fide Debt Req-166 doses not apply unless a debit-credit relationship exist. A gift is not a debt. In close relationships, a gift, not a loan, was intended. 2.Bad Debt: "Worthlessness"- The debt must be a "bad" debt for deduction to be allowed, i.e., forgiveness, or cancellation will constitute a gift rather than evidence of worthlessness. Therefore, non-deductible. Reg.1.166-2(a)(b) states all evidence must be reviewed in determining worthlessness. Furthermore, 6511(d) provides 7 year statute of limitations for claims under 166. 3.Bad Debt: Business or Nonbusiness Debts-166(d). a.Business Debts are deductible in year become worthless. Also applies to partial worthlessness. No distinction between individual and corporations. b.Nonbusiness Debts are deductible only upon wholly worthlessness and are treated as short term capital losses. 166(d)(1). 4.Bad Debts: Amount Deductible-the amount of a bad debt deduction is the adj. basis. 166(b). Regs provide that no deduction unless included as income, i.e., cash basis TP. Different with cash method TP. 1.166-1(e) performing services without compensation, TP net worth is unchanged, if no income = no loss. If income was recognized with accrual method, TP gets deduction. 5.Bad Debt: Guarantee-Losses from loan guarantees are treated as losses from bad debts, and are considered business or nonbusiness according to TP's trade or business. 1.116(9). XVII. CHAPTER 19 - TRAVEL EXPENSES A. Travel Expenses 162: B. Commuting Expenses: The choice of where one lives is generally personal. Commuting costs are therefore appropriately viewed as personal in nature and nondeductible under 262. See Tres. Reg. 1.162-1(b)(5). Ex: TP works in tow different location for the same employer. Expenses incurred b/w two locations is deductible, but the expense to and from and not. C. Other Transportation Expenses: If expenses are both personal and business related, i.e., fly to meeting and spend remaining time renting a car and fishing. The courts have held that where your primary purpose for the travel is business, you will be entitled to deduct the transportation costs which are business related. It is likely that your entire airfare in not deductible if primarily personal in nature. D. Expenses for Meals and Lodging While in Travel Status: 162(a)(2) permits the entire amount of meal and lodging expenses to be deducted when TP is "away from home." "HOME": The IRS and the courts do not agree upon the meaning of home. IRS=principal place of business. Courts=place emphasis on the business necessity of incurring travel expenses. Temporary assignments: IRS, TP will be considered to be in travel status, "away from home", can deduct travel exp. including meals and lodging in TP satisfies all of the following: 1.TP has used the claimed abode while performing work in the vicinity thereof immediately prior to the current job and the TP continues to maintain bona fide work contacts in that area during the alleged temp. employment; 2.TP's living expenses at the claimed abode are duplicated b/c work requires the TP to be away from the abode; and 3.Whether TP has a family member/s currently residing at the claimed abode, or continues to currently use the claimed abode frequently for purposes of the TP's lodging. *Gen. rule, assignment away from home of one year or less = temp. assignment; assign. of over one year consid. indefinite and not subject to the rules of temp. employment. E. Deduction of Travel Expenses of Spouse: Deduction only if it can be established that there was a bona fide business reason. Tres. Reg. 1.162-2(c). The expenses must be "ordinary and necessary" in connection with the business of the TP. F. Business-related Meals: The 1986 Tax Reform Act imposes stiffer substantiation requirements for the deduction of meal expenses, 274(a), requires the TP to be present at a meal for which an expense deduction is sought, 274(k), and reduced the meal expense deduction from 100% to 80%. 274(n). G. Limitations of Foreign Travel: Generally, travel outside of US is subject to the same standards as domestic travel. However, deductions for travel to seminars, conventions are limited by 274(h)(1). H. Substantiation Requirements: In addition to 162 & 212, TPs seeking deduction for travel expenses must meet the substantiation requirements of 274(d) (Chapter 20). XVIII. CHAPTER 20 - ENTERTAINMENT AND BUSINESS MEALS A. Business entertainment and meals 274 - The Tax Reform Act of 1986, reduces to 80 % the amount of allowable deductions for business meals... and business entertainment expenses [274(n)]. This reduction rule reflects the fact that all meals and entertainment inherently involve an element of personal living expenses, but still allows an 80% deduction where such expenses also have an identifiable business relationship. B. Entertainment Activities 274(a) - 274(a)(1) disallows any deduction for an activity "of a type generally considered to constitute entertainment, amusement, or recreation" unless the TP satisfies; 1."Directly related to" the active conduct of his trade or business (TP reasonably anticipate income or business benefit from expense); or 2."Associated with" the active conduct of the trade or business and directly preceded or followed by a substantial and bona fide business discussion. Note: "Substantial distractions" such as nightclubs, theaters, sporting event and cocktail parties are considered not "directly related" to business of TP. Note: Deductibility of 80%. 3.Entertainment Facilities - i.e., gold clubs, social clubs. 274 denies any deductions for entertainment facilities, except for qualifying dues or fees to facilities. Dues and fees for clubs are nondeductible unless the facility is used "primarily" for business purposes, i.e., 50%. 4.Substantiation Requirements 274(d) - TP is required to substantiate either by "adequate records" or "by sufficient evidence corroborating his own statement" the following: a.The amount of the expense; b.The time and place it was incurred; c.The business purpose for the expense; and d.The business relationship to the TP of the persons entertained. XIX. CHAPTER 21 - MOVING, CHILD CARE, LEGAL, CLOTHING EXPENSES A. Moving Expenses 217, 82 - 217 applies to the self- employed as well as employees; it applies to those changing jobs with the same employer, but to persons entering the work force for the first time., employees beginning work for a new employer, and to self-employed entering a new trade or business or moving to a new location. Reg. 1.217-2(a)(3)(i). 1."In connection with the commencement of work"-the move must bear "a reasonable proximity both in time and place to the new principal place of work. Prior employment arrangement is not required. Proximity is within one year. 2.Minimum Distance-new principal place of work is at least 35 miles farther from his former residence, or 35 miles from his residence. 3.Minimum Period-TP must be a full-time employee in the general location of the new principal place of work for at least 39 weeks during the 12-month period immediately following the move. Note: For 217 purposes, employment at the new principal place of work must be permanent or indefinite, rather than temporary, as under 162(a)(2). B. Child Care 21 - 21 applies only if there are "employment-related expenses" and one or more "qualifying individuals." The credit is not refundable, if the credit exceeds the tax liability, the excess credit is not allowed. Ex: mother sent son to boarding school. Ct held it was employment-related because she did not think she could work without such child care (Objective test). C. Legal Expenses - S.Ct. has applied the "origin-of-the- claim" test. 1."Origin-of-the-claim" Test: If the origin of the claim litigated lies in a personal, as opposed to a business or profit-seeking transaction, the expenses are nondeductible. D. Clothing and Uniforms - IRS has agreed that in some circumstances the business related nature of the TP's clothing may warrant a deduction. The test is if "required to wear distinctive types of uniforms while at work...which are not suitable for ordinary wear." XX. CHAPTER 22 - EDUCATION EXPENSES A. Deductible Education Expenses: Deduction for educational expenses if; 1.maintain or improve skills required in employment or trade or business, or 2.meet the express requirements of employer, or law, necessary to retain employment relationship, status, or rate of compensation. Reg. 1.162-5(a). B. Non-Deductible Educational Expenses: an expense is nondeductible if it either; 1.meets the minimum educational requirements for qualification in the TP's employment or trade or business, or 2.qualifies the TP for a new trade or business. Reg. 1.162-5(b)(2). a.The Skill-Maintenance or Employer-Requirement Tests: An TP may deduct educational expenses that maintain or improve skills required in employment or trade or business. This includes "refresher courses or courses dealing with current developments as well as academic or vocational courses." (1)TP must be "carrying on a trade or business" at the time the educational expense in question is incurred. (2)"Abandoned or withdrawn" from trade or business; RR 68-591 a suspension of employment for a year or less will be considered temporary, however, court looks to circumstances and may be up to 2 years. b."Express requirement of employer, law, status, rate of comp.: The employer requirement test applies only to "express requirements." (1)"Bona fide" business purpose. C. The Minimum-Educational-Requirements and New-Trade-or- Business Test: TP may not deduct educational expenses required to meet the minimum educational requirements for qualification in his employment or trade or business. Reg. 1.162-5(b)(2). 1.TP is also prohibited from deducting educational expenses "part of a program of study... which will lead to qualifying a new trade or business. 2.A mere "change of duties" is not equivalent to a new trade or business if the new duties involve "the same general type of work." a."Common sense approach" - determine if new trade or bus. or title. A comparison is made b/w the types of tasks and activities which the TP was qualified to perform before the acquisition of a particular title or degree, and those which he is qualified to perform afterwards. i.e., public accountants and CPA are different trades/business, also fixed wing pilots and helicopter pilots. D.Travel Expenses: IRS disallows deductions for travel that can be claimed only on the ground that the travel itself is "educational", but permits deductions for travel that is a necessary adjunct to engaging in an activity that gives rise to a business deduction relating to education. XXI. CHAPTER 23 - HOBBY LOSSES A. Hobby Losses 183: Losses incurred in carrying on personal hobbies clearly should not be deductible. Losses incurred in carrying on a trade, business or other profit-seeking activities are. 183 limits those deductions. 183 applies to an "activity not engaged in for profit" and each activity must be tested separately. 183(b) sets forth the following factors: 1.The manner in which the TP carries on the activity; 2.The expertise of the TP or his advisors; 3.The time and effort expended by the TP in carrying on the activity; 4.The expectation that assets used in the activity may appreciate in value; 5.The success of the TP in carrying on other similar or dissimilar activities; 6.The TP's history of income or losses with respect to the activity; 7.The amount of occasional profits, if any, which are earned, 8.The financial status of the TP; and 9.The elements of personal pleasure or recreation. 183 applies to individual, "S corporations", estates and trusts and partnerships. Corporations are excluded because no inference is to be drawn that corporate activity is not a business engaged in for profit. B. Deductions allowable under 183: If TP is engaged in an activity in which deductions are not allowed under 162, 212, then 183 allows deductions per 183(b). XXII. CHAPTER 24 - HOME OFFICE, VACATION HOME AND OTHER DUAL USE PROPERTY Expenses connected with a residence are not deductible. A residence is a dwelling unit which is used for more than 14 days a year for personal purposes. Exception: If a dwelling unit is used for less than 10% of the actual rental days then it is not considered a residence. If the unit is a residence the deductions are limited and 280A applies. If it is not a residence then 183 applies. If it is not a residence and profit oriented venture, then all allocable deductions are permitted. Analysis: 1. Has the home been rented for less than 15 days: Yes, then no deductions, and no GI; No, then 2. Has the TP lived in the unit for more than 14 days or 10 % of the actual rental time? Yes, then the it is a residence, and 280 applies; No, then 183 applies, deductions will be allowed up to the amount of loss unless; 3. Is the rental a profit or rented activity: Yes, then all deductions are permitted. Remember 212, which limits passive activities up. A. Home Office Deductions 280: The TP can deduct his expenses associated with the portion of the house which he exclusively uses for carrying on his trade or business. However, the TP cannot write off more income than the residence generates. B. Vacation Homes: The deductions for depreciation, utilities, upkeep, etc... will be apportioned between the personal use and the rental use. However, the TP cannot write off more income than the residence generates. Note, if the residence is actually rented for less than 15 days a year, then no deductions are allowed under 280A, however the rental income does not constitute GI. C. Dual Use Property 1.Computers and "Listed Property": 280F(d)(4)(A), limits deductions to the business use percentage for the TP year exceeds 50%, the TP is required to use the alternative depreciation system of 168(g), and is thus limited to straight line depreciation on the property. 2.Automobiles: Unless TP uses a passenger automobile more than 50% of the time in his trade or business, he may not use the accelerated depreciation percentages (ACRS) provided by 168. The SL method over a 5 year period and a maximum depr. of $4,000 for the first year and up to $6,000 for subsequent years. XXIII. CHAPTER 25 - INTEREST DEDUCTION A. Interest 163: The amount one has contracted to pay for the use of borrowed money, and as the compensation paid for the use of money. Interest expense incurred in a trade or business would be deductible under 162 even if 163 did not exist. B. Deduction of Personal Interest: The 1986 Tax Reform Act is phasing out the personal interest deductions and by 1991, no deduction will be allowed. However, "qualified residence interest" is exempted. C. "Qualified Residence Interest": Is interest paid or accrued during the tax year on certain "acquisition indebtedness: and "home equity indebtedness" secured by the TP's principal residence and on one other residence. 1.Acquisition Indebtedness: is indebtedness (not in excess of $1,000,000) incurred in "acquiring, constructing, or substantially improving any qualified residence of the TP. 2.Home Equity Indebtedness: is indebtedness (other than acquisition indebtedness) secured by a qualified residence, e.g., a second mortgage. D. Investment Interest 163(d)(4)(A): Investment interest is the interest "paid or accrued on indebtedness incurred or continued to purchase or carry property held for investment. 1986 Tax Act, limited the investment interest for any taxable year could not be deducted in an amount greater than the TP's net investment income. Net investment income is the excess of investment income over investment expenses. XXIV. CHAPTER 29 - CHARITABLE DEDUCTIONS 170 Although personal in nature, gifts to charities can be tax deductible. Congress seeks to encourage private support for a range of activities which "aid in the accomplishment of social goals." TP contributing to a charity makes the government a partner is supporting the charitable enterprise. A. Requirements for Charitable Deductions 170: To be deductible a charitable transfer must; 1.be made to a qualified recipient; 2.constitute a transfer of money or property made with on expectation of a return benefit; 3.actually be paid to the recipient; 4.not exceed certain percentage limitations. B. Qualified Recipient 170(c):To qualify as a organization, it must be organized and operated exclusively for religious, charitable, or other specified purposes; its net earnings cannot inure to the benefit of any private shareholder or individual (e.g., U.S., states and political subdivisions, religious, charitable, scientific, literary or educational organizations). C. Contribution or Gift 1.Gift: Duberstein Standard; a gift in the statutory sense proceeds from a "detached and disinterested generosity, out of affection, respect, admiration, charity or like impulses. 2.Contribution: a voluntary transfer of money or property that is made with no expectation of procuring a financial benefit commensurate with the amount of the transfer. D. Actual Payment Required 170(a)(1): allows a deduction for a contribution "payment made within the taxable year." 1.170A-1(a), irrespective of the method of accounting employed or of the date on which the contribution is pledged. 1.170A-1(b), contribution is made at the time delivery is effected, i.e., check, the date of mailing. E. Limitations on Charitable Deductions 170(b): The contribution in any one year is limited to 50% of AGI. 170(d)(1)(A), a charitable contributions which may not be deducted because of the percentage limitation may be carried over for a five year period. if the TP dies before he uses it up, the deduction is lost. F. Contribution of Services 1.170A-1(g): Example; musician plays for church. Services=$1000, musician takes a $1000 deduction. IRS says no deduction. G. Contribution of Appreciated Property: The amount of the contribution is based upon the fair market value of the property. Cash had a FMV equal to face. Property, such as stock, land, clothing has a FMV equal to what it could be sold for. Exception: (1) If the property is subject to short term gain, then the amount of the deduction is limited to the TP's basis, 170(e); (2) If the tangible personal property donated is unrelated to the function of the organization, then the deduction is limited to basis. 170(e)(1)(B). XXV. CHAPTER 30 - LIMITATIONS ON DEDUCTIONS 267, 265 A. Losses Between Related Taxpayers 267 General Rule: A sale or indirect sale of an asset for a loss to a related family member, or a controlled corporation, is not deductible. Family includes; siblings, children, spouse, ancestors, and lineal descendants. Note: The TP's in-laws are not considered family member. But, if the asset is transferred for the benefit of a community marriage, then 1/2 of the loss is disallowed. B. Wash Sales 1091 General Rule: 1.If stock is sold at a loss, and 2.Identical stock is repurchased within 30 days (either before or after) of the disposition, then 3.The loss on the original disposition is disallowed. Note: this provision applies only to securities or stocks. Thus, precious metals sold in this fashion will result in a deductible loss. XXVI. CHAPTER 33 - CHARACTERIZATION (CAPITAL GAINS AND LOSSES) A. Introduction: Long term capital gain is assessed at 28% on the entire gain short term capital gain is added to ordinary income. Requirements of a Capital Gain or Loss A capital gain or loss requires: 1.A transaction involving a capital asset; 2.A sale or exchange of that capital asset; 3.A determination of how long the TP held that capital asset. Net Long Term or Short Term Gains or Losses 4.First net all long term gains and losses. 5.Then net all short term gains and losses. 6.Then net the two, of one is a loss and the other is a gain. Excess Loss 1211(b) Capital losses are deducted from ordinary income up to $3000. If there is an excess loss it will be carried over to offset next year's capital gains. If the person dies before he uses up his carry over the excess is lost; and his estate cannot use it up. B. The Meaning of Capital Assets 1221 A question of fact. If the asset is disposed in the course of the TP's ordinary business, then it is not a capital asset. C. Sale or Exchange 1222 When the PR disposes of specific dollar requests with appreciated property, the estate will have a gain. Collection of a debt is not a sale or exchange, but rather ordinary income. However, sale of the debt thus entitling someone else to collect it is an exchange to capital gain/loss purposes. Property received by inheritance is treated as a long term asset to the beneficiary. D. Holding Period 1223 General Rule: For long term gains the holding period in 1987 must be more than 6 months. After 1987 it must be for 1 year. Commencement: The date of purchase is not counted, but the date of sale is. Purchased on 4/1/87 can be sold on 10/2/87. Sale of Stock: For computing loss, the holding period ends on the "trade date" year, even though it may not be "settled" until the following year. For purposes of computing a gain the TP can chose either the trade date or the settlement date as the end of the holding period.(e.g., purchase of a home; holding period ends when the home is closes). XXVII. CHAPTER 36 - ASSIGNMENT OF INCOME A. Introduction: Before the 1986 Code, the tax brackets ranged from 50% to 12%. This resulted in much income shifting. The 1987 code changed the tax bracket ranges to 28% to 15%. Thus, today, there is not as much as an incentive to shift income. B. Income From Services 1.General Rule The TP cannot assign his income, nor his contractual right to income. Thus if the TP earns the income, he will be taxed on it. Lucas v. Earl, 281 US 111 (1930). Professional Service corporations, P.S. P.S.'s permit assignment of income. The professional (Doctor, Dentist) will assign their contracts to the corporation. As a result, the corporation is taxed not the professional. It is questionable whether an athlete could assign his income to a P.S. 2.Absolving Right to Income A person can absolve his right to receive income, so long as it is done before it is earned and before there is a contractual right created. However, if a person maintains control of the absolved income, (like designating a worthy cause to donate it to) then he would have to pay tax on that income, for it would be an assignment. Waiver of Executrix Fee: If the executor is the sole heir, then advise her not to accept the fee for she will have to pay tax on the fee. If she refuses the fee the entire estate will pass to her income tax free. The waiver can be made within 6 months or by simply not accepting the fee. If there is more than one heir, then this may not be advisable. C. Income From Property 1.General Rule: A person who owns property (tree) is taxed on the Property (ripe fruit) from it. Thus, if you have a tree with "ripe fruit" on it and you pick some of the fruit and give it away, you are subject to income tax on the value of that fruit. a.Bonds & Coupons: This was the situation in Helvering v. Horst. Horst had clipped the coupons from his bonds and given them to his son. Even though Horst did not receive the interest, he still had to pay tax on it, because he retained control of the bond. If Horst had transferred the bond and coupons together, he would have been taxed only on the accrued interest on the date of the transfer. b.Stocks & Dividends: There are four important dates with respect to the issuance of dividends: (1) The declaration date; (2) The record date; and (3) The payment date. For tax purposes the TP will be taxed on the record date. This is because no enforceable right has accrued to any shareholder until this time. Thus, if the stock is transferred after the record date but before the payment date, the transferor is taxed on the dividend. XXVIII. CHAPTER 37 - THE KIDDIE TAX 1 A. General Rule: 1 wa to tax the "net unearned income" of a child under 14 at the top tax rate of his or her parents. The net unearned income is still taxed to the child, not to the parents, but it is taxed to the child as if it were additional parental taxable income. B. Earned Income: consists of personal services income. 911(d)(2). C. Unearned Income: includes not only the income attributable to property transfers form parents, but from other relatives, friends or strangers as well. D. Limitations 1.1 applies only to children under 14, income- shifting remains viable for everyone else. 2.First $1000 of unearned income of a child under 14 to be taxed at the child's rate. 3.1 does not apply unless the child has at least one living parent. Summary: 1 applies only to a child under 14, with at least one living parent, and with unearned income over $1,000. XXIX. CHAPTER 39 - TAX CONSEQUENCES OF DIVORCE XXX. CHAPTER 41 - LIKE KIND EXCHANGES 1031 A. Introduction: Tax is not paid on "realized gain," but rather tax is paid on "recognized gain." B. Scope: 1031 only applies to: 1.To exchanges of property of like kind which is; a.Held for productive use in the trade or business, or b.Held for investment; 2.It doesn't apply to exchanges of stocks, bonds, etc...see 1031(a)(2). C. Application: 1031 Does not "Recognize" "Realized" Gain. Hypo: Gary Sealey Land: FMV=$100,000Land: FMV=$100,000 Basis=$5,000Basis=$15,000 Transaction: Gary and Sealey swap parcels and in addition, Sealey pay Gary $10,000. This cash is called "boot." Sealey's land + cash = $100,000 Less: Basis= (5,000) Gain "Realized" $95,000 Tax consequences of the exchange: Under 1031, to the extent Gary does not receive "boot," he does not have to recognize his gain on the exchange of his land with Sealey. Tax consequences of "boot": Gary must pay tax on the "boot" he receives as a result of the exchange, or on the realized gain, which ever is less. If there is any depreciation recapture, Gary must pay it to the extent he receives boot. D. NEW BASIS 1.General Rule: New Basis = (TP's basis in the property he exchanged) - (boot received, if any) + (Gain Realized). In almost every case, the TP's new basis will be the same as his old basis. Gary's basis = $10,000. 2.Boot Paid: Any boot which is paid is added to that TP's old basis. Thus, Sealey's new basis =$25,000. XXXI. CHAPTER 42 - INVOLUNTARY CONVERSION 1033 A. Scope: 1033 applies to: 1.Property which has been "involuntary converted, and 2.Replaced within 2 years by "similar or related in service." 3.Then, no gain on the conversion is "recognized." B. Application Hypo: Basis $100,000 Condemned @ $300,000 Realized Gain $200,000 Tax consequences: Gain is "recognized" to the extent that the amount realized upon such conversion exceeds the cost of the replacement property. Above, Gary realized $300,000 for the condemnation. if he repurchases a house for $280,000 he recognizes a gain of $20,000. C. NEW BASIS 1.Buying Up: The new basis in the new property will be the old basis plus the additional money paid over the amount realized for the conversion. Thus, if Gary pays $320,000 for the new house, his basis will be $120,000. 2.Buying Down: (Cost of the new property) - (Gain not recognized). Almost always, the new property will have the same basis as the converted property. D. PROPERTY "SIMILARLY RELATED IN SERVICE" EFFECT OF CONDEMNATION OF REAL PROPERTY 1033 (G) 1.Scope: 1033(g) applies only to Real Property: a.Held for productive use in trade or business, or b.Held for investment; c.Which has been condemned. 2.General Rule: The rule of requiring the new property to be similarly related in service has been relaxed under 1033(g). Thus, a farmer does not have to recognize gain if he replaces his condemned farm with an apartment complex. Note, the replacement time is 3 years, 1033(g)(4). XXXII. CHAPTER 43 - SALE OF A PRINCIPLE RESIDENCE 1034 A. General Rule: Gain of the sale of the TP residence is mandatorily deferred, i.e., not recognized if; 1.TP sells his "principle" residence; and 2.Repurchases a "new" residence; 3.Within 2 years before after the sale of the old residence. 4.At a cost equal to or in excess of the sale of price of the old residence. Note: To the extent the cost of the new residence is less than the sale price of the old, the TP has recognized gain. B. Basis in the New Residence 1034(e) 1.Buy Down: The basis of the old residence is carried over. 2.Buy Up: The basis is the basis of the old residence plus the additional money paid to repurchase, over and above the sale price of the old residence. (Cost of new property) - (gain not recognized) C. Sale of Residence for Individuals over 55 121 1.General Rule: a.If the TP is 55 or over; and b.Sells his principle residence, (must live in it at least 3 of the previous 5 years); then c.The TP can exclude all of his gain up to $125,000 from his gross income. d.This a one time exclusion (per individual, and per marital community). 2.Married Couples, and the Tainted Spouse Dilemma a.If the TP's spouse has used her 121 exclusion, then the TP cannot use his exclusion, unless he gets divorced. If the TP is single, and then marries a person who has used their exclusion, then he cannot use his. This is known as a tainted spouse. XXXIII. CHAPTER 44 - INSTALLMENT SALES 453 A. General Rule: Gain will be taxed as the income is received, 453(c). A formula will determine the ratio of LTG in each installment. The formula is; (K price of sale) - (Adj. basis) = LTG (long term gain) LTG x install = taxable income. Sales price (LTG) + (K price) x (Installment) = LTG for that installment. Note: This formula is also applied to the down payment. 1.Election Out: The TP can elect not to have 453 apply, to pay tax in the year of the sale. Note, this election must be made in the year of the sale. 2.Installment Sale Defined: Is a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs. 453(b). B. Non-Real Property 453(i) 1.Recapture: General rule; If property is sold on he installment method, all depreciation recapture is included in income in the year of sale, no matter how much actual cash is received. 453(i). 2.Gain in Excess of Recapture: Taxed as it is received. C. Real Property 1.Recapture; General Rule: Any sale or real property subject to depreciation recapture on the installment method triggers all recapture in the year of sale. 453(i). 2.Gain in Excess of Recapture: Taxed as it is received. D. Trouble Areas with Installment Sales 1.Sale of Property between Related Parties 453(g): If the sale of depreciable property, even though on the installment method, is to a related TP, then all the gain will be taxed as ordinary income in the year of sale. Related persons include a corporation in which the seller (and family) owns more than 50% of the value of the outstanding stock. 2.Demand Notes 453(f)(4): Demand notes are treated like cash, in the year of receipt-at least up to its fair market value. 3.Disposition of the Installment Contract 453B a.General Rule: Any disposition of the installment obligation triggers the remaining gain in the year of the disposition. b.Exception: (1)A transfer to a former spouse, if incident to a divorce is not a disposition, and hence not taxable. (2)Death, IK's received by inheritance are not taxable. XXXIV. CASES CHAPTER 19 - TRAVEL EXPENSES UNITED STATES v. CORRELL Respondent was a traveling salesman for a wholesale grocery company. He left home early in the morning, had breakfast and lunch on the road, and returned home in time for dinner. The respondent deducted the cost of his morning and noon meals and "traveling expenses" incurred in the pursuit of his business "while away from home" under 162(a)(2). IRS; held that the daily trips did not require sleep nor rest, disallowed the deductions and held they were "personal living" expenses under 262. District Court: respondent prevailed. Court of Appeals: affirmed, holding the IRS "sleep or rest "rule is not a valid regulation under the present statute. S.Ct.: the statute speaks of "meals and lodging" as a unit, suggesting that Congress contemplated a deduction for the cost of meals only where the travel in question involves lodging as well. Therefore, the S.Ct reversed the Court of Appeals. COMMISSIONER v. FLOWERS TP was a lawyer for the railroad which required him to work in Mobile and Jackson. The railroad did not reimburse the TP for traveling expenses to Mobile since TP selected to live in Jackson. Subsequently, the TP deducted $900 in his 1939 income tax return and $1,620 in his 1940 return as traveling expenses incurred in making trips from Jackson to Mobile and as expenditures for meals and hotel accommodations while in Mobile. The IRS disallowed the deductions which was sustained by the Tax Court. The fifth Circuit, Court of Appeals reversed. S.Ct.; reverses the Court of Appeals. The court held that the relation of the expenditures were not incurred in the pursuit of the business of the taxpayer's employer. The expenses were as unnecessary and inappropriate to the development of the railroad's business. HANTZIS v. COMMISSIONER TP was a full time law student at Harvard. During her second year of law school she sought unsuccessfully to obtain employment for the summer in Boston. TP subsequently found employment in New York. TP maintained her place of residence in Boston with her husband. TP deducted the costs of travel, meals, lodging in New York in her income tax return for 1975. IRS; disallowed the deduction b/c NY was her place of employment and the cost of traveling to and living in NY was therefore not "incurred...while away from home." Further more the expenses were not incurred "in the pursuit of a trade or business." TC; rejected the IRS position and held the expenses to be deductible, b/c her employment was "temporary" and the expenses in NY were "necessitated" by her employment there. S.Ct.; "while away from home," we do not believe this requirement was satisfied in this case. TP trade or business did not require that she maintain a home in Boston as well as one in NY. REVENUE RULING 75-432 IRS defines "home" in 162(a)(2) as the place away from which traveling expenses must be incurred to be deductible is, as a general rule, the place at which the TP conducts the trade or business. If TP has two or more separate location, the "tax home" for purposes of 162 is located at the principal place of business during the taxable year. "Overnight Rule" or the "Sleep or Rest Rule"; an employee whose duties require that employee to leave the principal post of duty during all or part of actual working hours is considered to be in travel status. An employee may deduct the expenses for meals and lodging on business trip away from the principal post of duty only when the trip lasts longer than an ordinary day's work, the employee cannot reasonably be expected to make the trip without being released from duty for sufficient time to obtain sleep or rest while away from the principal post of duty, and the release from duty is with the employer's tacit or express acquiescence, or is required by gov. regulations. Summary: When expenses are incurred for meals and lodging by an employee "while away from home" in the course of business duties, they are deductible as traveling expenses under 162(a)(2), subject to the substantiation requirement of 274. CHAPTER 22 - EDUCATION EXPENSES Takahashi v. Commissioner Petitioners were employed as science teachers by LA school district. The CA Educational Code required a teacher to complete a minimum of two semester units in a course of study dealing with multicultural societies to receive promotions and salary increases. Petitioners spent 10 days in Hawaii with their son. The petitioner spent 9/10 day at the seminar lasting from 1 to 6 hours per day. Petitioner incurred expenses $2373. Under 1.162-5(a); education expenses are deductible as ordinary and necessary business expenses if the education; (1) maintains or improves skill required by the individual in employment or other trade or business, or (2) meets the express requirements of the TP's employer. I= Whether petitioners are entitled to deduct expenses incurred at a seminar in Hawaii as eduction expenses under 162(a)? R= The seminar attended satisfied the 3.3 CA Education Code and made petitioner eligible for promotions and salary increases. Petitioner's participation in this seminar in no way affected the retention of their current employment relationship, status or rate of compensation. TC= the context of petitioners' professional duties a science teacher, the Hawaiian Cultural Transition course does not fall within the category of a "refresher," "current developments," or "academic or vocational" course required y the regs. Therefore, TC held for the IRS. Wassenaar v. Commissioner Petitioner was a law student at Wayne State University, where he was on law review. During the summer petitioner worked for a law firm. Following his graduation the petitioner was not employed but he prepared the bar. In Sept 1972 petitioner began a LLM in tax and incurred $2781 in expenses. In the Petitioners 1973 tax return he deducted the expenses at NYU as an employee business expense. I= whether the petitioner may deduct as an ordinary and necessary expense incurred in his trade or business the expense for tuition, books, meals, lodging while incurred in pursuit of LLM. Petitioner claims these expenses enhanced his skills. IRS claims the expense where in preparatory to the practice of law, and in the alternative they were incurred while "away form home". R= Petitioner was not admitted to bar until May of 1973 and was not authorized to practice law, thus the expenses incurred was not maintaining or improving the skills of that profession. TC= held that the petitioner's expenses in LLM are not deductible as an ordinary and necessary business expense of being an attorney at the time such expenses were incurred and since he was not maintaining or improving the skills of such trade or business. (personal expenses). I= whether the petitioner's expense are deductible under 212? TC= to be deductible under 212, an expenses must meet the ordinary and necessary test. "Ordinary and necessary test" = must be reasonable in amount and must bear a reasonable and proximate relation to the purpose for the expenditure. Expenditure not allowable as deductions under 212 are "expenses of taking special courses or training. Therefore, the expenses incurred and not deductible under 162 nor 212. Furner v. Commissioner Petitioner, a junior high teacher enrolled in a full time graduate program and she claimed deductions for her expenses. Her employer does not grant leaves of absence and she resigned in June 1960. TC= held that (1) that petitioner was not engaged in carrying on a trade or business of teaching during the time she was attending school and (2) that she took the graduate work primarily for the purpose of obtaining a new position or advancement in position or for meeting the minimum qualifications of certain schools for a teacher of social studies. Therefore, the expenses were not deductible. I= whether the petitioner was carrying on a trade or business of teaching while a graduate student under these circumstances. S.Ct.= reversed the TC and the expenses were deductible. RR 68-591 The IRS will follow the Furner decision in cases where the requirements of 162 are satisfied, and where the facts are the same. Where a TP, in order to undertake education or training to maintain or improve skills required in his employment or other trade or business, temporarily ceases to engage actively in employment or other trade or business. Ordinarily a suspension for a period of a year or less, after which the TP resumes the same employment or trade or business, will be considered temporary. However, the IRS does not agree with Furner under which an expense could be considered incurred while carrying on a trade or business with in the meaning of 162 merely because (1) the study might be a "normal incident" of carrying on a trade or business and (2) the TP intends to resume the trade or business at some indefinite future date. Sharon v. Commissioner The petitioner attended graduate school at Columbia University School of Law. Petitioner expended $210 in gaining admission to practice law in New York. Petitioner was admitted to the bar in Dec. 1964. Petitioner was employed as an attorney until 1967. At this time petitioner accepted a job with the IRS in CA. Petitioner was admitted to the CA bar incurring expenses. In 1969, Petitioner incurred expenses in order to be admitted to practice before the U.S. District Court in CA. In 1970, petitioner incurred expenses in connection with his admission to the U.S. Supreme Court. Petitioner claimed a deduction for "Dues and Professional Expenses" in 1969 Court= Amortization of License to Practice in NY, the court held that the costs of his education were personal and nondeductible. However the $25 fee for license was a capital expenditure. I= whether the deduction for expenses incurred in admission to CA bar? Court= held that the bar review course helped to qualify the petitioner for a new trade or business so costs were personal expenses. "Commonsense Approach"= if the education qualifies the TP to perform different tasks and activities than he could perform prior to the education, then the education qualifies him for a new trade or business. Randall: might be deduction in future. Bar review course = no deduction; educational expense/personal License fees = deductible; capital expendure. CHAPTER 23 - HOBBY LOSSES Dreicer v. Commissioner Plaintiff. a world traveler wrote a series of books about his dining experiences during his travels. Both books failed and subsequently he claimed deductible losses in 1972, 1973 for travel and business expenses. Commissioner disallowed the deductions on the ground that the losses arose from activities not pursued for profit, and the TC agreed. Under 183, the court held he had not entertained a bona fide expectation of profit for writing and lecturing. Appealed to Court of Appeals which reversed because of the legal standard applied in determining plaintiff activities were engaged in for profit. C of A held that the standard was whether the TP engaged in the activity with the objective of making a profit. TC intention was that a "bona fide" expectation of profit = actual and honest profit objective. TC held that plaintiff's activities were not calculated to earn a profit because he sustained large losses, no realistic possibility he could ever earn sufficient income to offset such losses and he was able to continue due to the resources available to him. Randall: "Bona fide objective test" Remuzzi v. Commissioner Petitioner entered into an agreement with a hired hand such that the hired hand was to take care of the farm and pay off a $15,000 loan in exchange for rent. Hired hand was unable to perform and subsequently the petitioner obtained a default judgment in the amount of $13,800. Petitioner was unable to collect. Petitioner hired help and kept separate records of the farm expenses which he deducted. Commissioner determined that their farm losses were incurred n an activity not entered into for profit and disallowed the deductions. I=Whether petitioners operated the farm for profit, by a standard of a "bona fide objective" of making a profit when entering into. TC=held that under 1.183-2(b)(8); "substantial income from sources other than the activity (particularly if the losses from the activity generate substantial tax benefits may indicate that the activity is not engaged in for profit. Under 1.183-2(b)(1), provides a look to see if TP carries on an activity engaged in for profit. TC held not engaged in for profit because no estimate for repairing the property, did not monitor its profitability or reduce its expenses. a. History of losses: Petitioner large and consistent losses indicate the farm was not engaged in for profit. (e.g., horse racing) b. Business Experience: not evidence supporting that petitioners or farm hand had experience. c. Time and Effort Expended: Petitioner or his family did not spend a lot of time or effort nor did the hired help to justify a profit endeavor. d. Expectation: no evidence presented that petitioners purchased expecting profit rather it was for personal reasons. e. personal pleasure or Recreation: personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit. This factor indicated petitioners did not engage in farm for profit, thus, personal reasons. Therefore, after considering these factors, the petitioners failed to show they operated the farm for profit. I=Whether the $13,000 was a business bad debt. TC held that petitioner have failed to prove farm was an activity engaged in for profit, thus, not meeting the definition fora loss related to trade or business. CHAPTER 24 - DUAL USE PROPERTY Weissman v. Commissioner The TP was a associate professor in philosophy. The majority of his work was done at home. The school provided an office but was limited in space and was also shared by other professors. I=Wheterh the TC correctly concluded that the College was Prof. Weissman's principal place of business. Test=TP's principal place of business depends on the nature of his business activities, the attributes of the space in which such activities can be conducted, and the practicl necessity of using a home office to carry out such activities. Therefore, TP place of business was at home due to the time spent there, limited space at school etc... I=Whether it was for the convience of his employer? C of A; held that TP met this standard of "convience of the employert test". Therefore the TC is reversed. CHAPTER 29 - CHARITABLE DEDUCTIONS RR 67-246 I = Whether payments in connection with admission to or other participation in fun-rasing activities for charity such as charity balls, bazaars, banquets, shows, and athletic events. R = General Rule; where a transaction is a payment in the form of a purchase of an item of value, the presumption arises that no gift has been made for chart. contr. purposes, the presumption is the purchase price. Therefore, where the payment is in the form a admissions or other privileges or benefits in connection with fund- rasing affairs, the presumption is not gifts. The burden is on the TP that is was a gift. To prove gift; (1) payment claimed as a fift represents the excess of the total amount paid over the value of the consideration received; (2) evidence that the payment in excess of the value received was made with the intention of making a gift. The organization should keep adequate records showing the respective amounts, purchase price & gift clearly shown on ticket. Randall: If you get value back less than FMV, then deduction. RR 78-38 General Rule: when a deductible payment is made with borrowed money, the deduction is not postponed until the year in which the borrowed money is repaid. Such expenses must be deducted in the year they are paid and not when the loans are repaid. Therefore, RR 71-216 a contribution to a qualified charity by a charge to the TP's bank credit card, is entitled to a charitable contribution deduction in the year the charge was made and the deduction may not be postponed until the TP pays the ndbtedness resulting from charge. CHAPTER 30 - LIMITATION ON DEDUCTIONS McWilliams v. Commissioner Plaintiff, husband and wife, ordered his borker to sell certain stock for the account of one of the two and to buy the same number of shares of the same stock for the other, at as nearly the same price as possible. IRS= disallowed these deductions on the authority of 24(b) (267(a)(1)), which prohibits deductions for losses from "sales or exchanges of property, directly or indirectly between members of a family," and between certain other closely related individuals and corporations. Randall: Indirect transfer of stock, 267. Miller v. Commissioner The natural sons of Charles and Miriam Miller received property and stocks by will. A dispute arose between the brother resulting in an arbitration hearing which required petitioner to sell to Marvin three parcels of real estate and his stock in the corporation. Petitioner claimed on his tax return long-term capital loss of $4999, and three ordinary losses totaling $2,987, resulting form the sale of stock to his brother. I=Whether the deductions for losses sustained from the sales of stock and real property by the petitioner to his brother are deductible under 267. Petitioner claims that intent to 267 has an exception for "family hostility". IRS= not "family hostitity" provision in 267 TC=held that no deduction for losses sustained from sales or exchanges of property, directly or indirectly, between brothers are allowable, irrespective of the existence of hostility between them.