1

I.

Spring2012TaxOutline
Whatisincome?
a. 61definesincomeasincomefromanysource
derived.
i. VeryEXPANSIVEphrasing:Including,butnot
limitedtoenumeratedcategories.
ii. Eisnerv.Macomber(1920)heldthatincomewithin
themeaningofthe16thAmendmentwasgainfrom
labor,capital,orthecombinationofthetwo.
iii. GlenshawGlass(1955)overturnedEisnerandheld
essentiallythatincomeiswhatcongresssaysit
isverydeferentialtoCongressional
interpretation.
1. Anyaccessiontowealthclearlyrealized
overwhichthetaxpayerhasdominion.
2. Lostprofitsawardedinalawsuitclearlyare
taxedasifearnedinitiallysubjectto
incometax.
b. Wherearetaxcasesadjudicated?
i. U.S.TaxCourtHears95%oftaxdisputes.This
isaPREPAYMENTtribunalwhereyoucanlitigate
withthefederalgovernmentwithouthavingto
firstpaythetax.
ii. CourtofFederalClaimsANDUSDistrictCourts
BothareREFUNDtribunals.
iii. Treasurycanpassregulationsinterpretingthe
statute,whichtaxpayerscanchallenge.However,
iftreasurysinterpretationisreasonablethenit
willprevailbaseduponChevrondeference.
c. NonCashBenefitsGenerallywillbesubjecttotax
basedontheFMVofthenoncashbenefitreceived.
i. OldColonyTrust(1929)Ifacompanypaysincome
taxesonbehalfofanemployeethentheamountof
taxpaidmustalsobetreatedasincometothe
employee.
d. EXCEPTIONStoGeneralNonCashBenefitRule:
i. 119(a)MealsandLodgingFurnishedforthe
ConvenienceoftheEmployerExcludedfromGross
Income.
1. Mealsonlyexcludedifprovidedonthe
businesspremises.
a. TreasuryRegulation1.1191:TwoProng
Test:(1)Onbusinesspremises,and(2)

2
ForConvenienceofemployer[determined
byfactsNOTstatementsoftheparties].
i. Requiresthemealstobefurnished
forasubstantialnoncompensatory
businessreason.
1. Generallymealsfurnished
beforeorafterworkinghours
willNOTbeseenasforthe
convenienceoftheemployer.
a. ExamplesNoncompensatory
businessreasons:
b. Furnishedtotheemployee
duringworkinghoursto
haveemployeeavailable
foremergencycallduring
amealperiod.
c. Mealperiodsaresoshort
thatemployeecannot
reasonablybeexpectedto
leavethepremisesto
securehisownmeal.
d. Restaurantemployeeson
dutyduringmealperiods
meettheexception.
e. COMPENSATORYBUSINESS
REASONifgoalisto
raisemorale.
2. Lodgingonlyexcludedifemployeeis
REQUIREDtoacceptthelodgingasacondition
ofhisemployment.
a. TreasuryRegulation1.119threeprong
test:(1)Lodgingisfurnishedonthe
businesspremises,(2)lodgingisfor
theemployersconvenience,and(3)
employeeisrequiredtoacceptlodging
asaconditionofemployment.
ii. 132FringeBenefits[ExcludedfromGross
Income]
1. (b)NoadditionalCostServiceServiceis
providedbyemployerintheregularcourseof
businessANDcanbeprovidedtoemployee
withoutadditionalcosttoemployer,
includingforegonerevenue.

3
a. Cancoveremployee,spouse,and
dependentchildren.
b. Airtransportationallowstheparentof
employeetobeincludedaswell.
2. (c)QualifiedEmployeeDiscounts
a. ProductsDiscountcannotexceedgross
profit%forwhichitemissoldto
public.
b. ServicesDiscountcannotexceed20%.
i. Product/Servicediscountscancover
employee,spouse,anddependent
children.
iii. (f)QualifiedTransportationFringeCanexclude
parkingandtransportationpasses.
iv. (j)Noadditionalcostserviceandemployee
discountexceptionsONLYapplytohighly
compensatedemployeesifthepolicyalsonon
discriminatorilycoversnonhighlycompensated
employees.
1. (j)(4)Ifagymisoperatedbyemployeron
premisesforbenefitofemployeesthenthe
valueofthemembershipcanbeexcluded
fromtheemployeesgrossincome.
e. 106EmployerProvidedHealthInsuranceNot
includedintheemployeesgrossincome.
f. Imputedincometheeconomicvalueofservices
providedforoneselfortheuseofonesownproperty,
whichisNOTrecognizedastaxableincome(ex.
homemakerorlivinginanowneroccupiedhouse).
i. RevenueRuling7924:Ifservicesarepaidfor
otherthaninmoney,theFMVofthepropertyor
servicestakeninpaymentmustbeincludedin
income(i.e.,theuseofbarterratherthancash
willnotmakethethingreceivednotbetreatedas
income).
1. TreasuryRegulation1.612(d):Ifproperty
istransferredtoanemployeeinexchangefor
lessthanitsFMVthanthedifferencebetween
theFMVandtheamountpaidmustbeincluded
asincome.
a. Whenservicesareexchangedthetaxdue
willbebasedupontheFMVofthe
servicesreceivedevenifsaidservices
wereNOTofequalvalue.However,if

4
theFMVofonebutnottheotherwas
readilyascertainablethentheknown
valuemaybeusedasevidencethatthe
otherhadthesamevalue.
b. FMVtaxsystemdreamsupanarmslength
transactionbetweenunrelatedparties.
g. TreasureTroveRegulations:Ifyoufindsomethingof
value,ex.aBarryBondshomerunballyouwillbetaxed
ontheFMVoftheitemyoudiscover.
i. IfyoupaytaxontheFMVoftheiteminyear1
(ex.$200k)thensellitinyear4foraprofit
(ex.$800k)yourbasisintheballwillequal
theamountthatyoupaidtaxoninyear1($200k).
h. 102GiftsandInheritances:Grossincomedoesnot
includethevalueofpropertyacquiredbygift.
i. Gift=somethingofvaluetransferredwithout
consideration.
ii. 102(c)Anyamounttransferredfromanemployer
toorforthebenefitofanemployeeshallNOTbe
consideredagift.
iii. 274(b)Ifagiftcanbeexcludedfromincome
bytherecipientunder102thenanyvalueover
$25cannotbewrittenoffasabusinessexpense.
1. Thusagiftfromanemployertoanemployee,
whichcannotbeagiftforpurposesof
274(b)becauseitcannotbeexcludedunder
102(a)per102(c)isdeductibleforthe
employer.
iv. Duberstein(1960)Gaveabusinessassociatea
Cadillactothankhimforsalesleads,buthewas
undernocontractualobligationtoprovideany
compensation.
1. Stanton(1960)Atconclusionofemployment
hewasgivena$20,000severance/pensionthat
wasNOTlegallyowedtohim.
2. InBOTHcasesSCOTUSrefusedaperserule
thatbusinessrelatedtransferscanneverbe
agift,butheldthattheintentofthedonor
iskey:wasitmotivatedbydetachedand
disinterestedgenerosity?
3. NOTE:102(c)waspassedafterthe
DubersteinandStantoncasestocreatethe
persebanforemployertoemployee
transfers.

5
i. TransferofProperty
i. 1014(a)Steppedupbasisatdeath.
1. 1014(b)(6)IfownedasCPthentheentire
propertyvaluewillgetasteppedupbasis
withthedeathofeitherspouse.
2. 1014(e)Antifraudprovisionifacquiredby
deceasedpersoninthelastyearofhislife
anditgoesbacktotheonewhogaveitto
himthentherewillbenosteppedupbasisat
death.
3. CanactuallybeastepupORdownatdeath,
butusuallyonlyastepupbecausetaxpayers
willusuallyselllosspropertiespriorto
deathtoharvestthetaxloss.
a. Incentiveistoholdappreciated
propertyandtoselldepreciated
property.
ii. 1015(a)BasisofPropertyacquiredbyGift:
Basisshallbethesameasitwouldbeinthe
handsofthedonor,EXCEPTifthebasisisgreater
thantheFMVatthetimeofthegiftthenforthe
purposeofdetermininglossthebasiswillbethe
FMVatthetimeoftransfer.
1. HYPOS:Abuysstockfor$1,000andgivestoB
Whenworth$2,500.
a. Bsellsfor$3,500$2,500gainbased
onAs$1,000basis.
b. Bsellsfor$1,500$500gainbasedon
As$1,000basis.
c. Sellsstockfor$300$700lossbased
onAs$1,000basis;exceptionin1015
doesNOTapplytothissituation.
2. HYPO:Cpurchasesstockfor$2,000thengives
toDwhenworth$1,000.
a. $2,500sale$500gainbasedonCs
$2,000basis.
b. $500sale$500lossbasedonFMVat
timeoftransfer.
c. $1,500saleNOGAINORLOSS:Less
thanadjustedbasis[$2,000],butmore
thanFMVatthetimeoftransfer
[$1,000].

6
3. HYPO:$80,000forStogotocollege,most
taxfavoredwaytotransfertoS?Disin
topmarginaltaxrateandShasnoincome.
a. Stockwithbasisof$20,000andaFMVof
$80,000GivetoS,hewillpaytax
butatalowermarginaltaxrate.
b. Stockwithabasisof$120,000andaFMV
of$80,000Sellstocktorealizethe
lossthengiveS$80,000.
c. Stockwitha$20,000basis,FMVof
$80,000and$80,000cashKeepthe
appreciatedstockandgiveawaythe
cash.
d. Basisof$20,000andaFMVof$80,000,
alsootherstockwithabasisof
$120,000andaFMVof$80,000Sell
stock#2forthelossandletthegain
on#1ride.
e. IfneardeathholdonuntildeathsoS
canreceivestocktaxfreeduetothe
1014steppedupbasis.
iii. 1001Computationofgainorloss.
1. Gain=Amountrealizedadjustedbasis.
2. Loss=Adjustedbasisamountrealized.
a. Eitherwaythenumberwillalwaysbe
POSITIVE.
iv. 1012CostBasisofPropertyGenerallybasis
willbethecostofpropertyunlessotherwise
provided.
j. RecoveryofCapitalIncomeincludesreturnsfromthe
saleofonescapital,butNOTtherecoveryofthe
initialamountinvested(whichiswherebasiscomes
in).
i. 72:Annuities,Certainproceedsfromlife
insurancecontractsExclusionratiodivide
theamountinvestedbytheexpectedreturntoget
theexclusionratio.Thenuponeachreceiptof
paymenttheamountreceivedtimestheexclusion
ratiowillbetheamountreportedasincome.
1. Ex.Invest$25,000,expectreturnof
$100,000.Exclusionratiowillbe
(25,000/100,000)or25%.Ifeachpaymentis
for$10,000thenthetaxableamountwillbe
$7,500[excluding25%ofeachpayment].

7
2. Oncetheentireinvestmenthasbeenrecovered
(ex.$25,000)thentheexclusionratiowill
nolongerapplyandtheentirepaymentwill
besubjecttoincometax.
a. Ifannuitantdiespriortorecovering
entirebasisthentheunrecoveredamount
canbeexcludedintotalonthe
decedentsfinaltaxreturn.
b. Ifreturndependsonthelifeofthe
annuitantthanexpectedreturnsshallbe
calculatedusingactuarialtables.
ii. TreasuryRegulation1.616:Whenapartofa
propertyissoldthecostorbasisoftheentire
propertyshallbeequitablyapportionedamongst
theparts.Theamountrealizedforthesold
portionwillbecalculatedbasedupontheportion
ofthebasisallottedtothatspecificparcel.
1. InajaLand(1947)Ifdeterminingtheportion
ofthebasisforaparticularpropertyright
soldisimpracticableorimpossiblethenno
taxwillimmediatelybedue,butthebasisof
theentireparcelwillbereducedbythe
amountreceived.
iii. Basisisawayoftakingintoaccountones
initialinvestmentsothatuponasubsequentsale
taxisonlypaidonthegainorloss(i.e.,the
difference).
1. Thetaxpayerwantsthebasistobeashighas
possiblebecausethatisashieldfrom
potentialfuturetaxliability.
k. Timingoftaxiskeybecausetodeferthepaymentof
taxistosystematicallylowertheeffectivetaxrate
ontheincomethatiseventuallytaxed(assuming
constanttaxratesovertime).
l. 165Losses:Forindividualsdeductionsarelimited
tolossesincurredinatradeorbusiness,transactions
enteredforprofit,orarisingfromfire,storm,
shipwreck,orfromothercasualty.
i. Clark(1939)Taxpayeroverpaidtaxesinaprior
yearby$19,000duetobadadvicebyhisCPA.The
CPAsubsequentlypaidthemoneyovertotaxpayer
tomakeupforthemistake.Courtheldthatthe
recoverywasNOTtaxablebecauseitwasthe

8
recoveryforanearliernondeductibleloss,
taxpayerwasmerelymadewhole.
1. InorderforClarktoapplytheremustbea
conceptualnexusbetweenthelossandthe
moneyacquired.Normallyadeductioncould
offsetany$19,000ofincome,BUTsincehere
thereisnodeductiontherehastobea
specificnexusbetweenthelossandthe
subsequentgain.
a. InClarktheexclusionwouldonlyapply
forarecoverycomingfromthenegligent
taxadviser.Ifinstead,hehadfound
$19,000thatwouldnotbeshieldedand
wouldbesubjecttotaxdespitethe
uncompensatedloss.
2. ThecourtdistinguishedthiscasefromOld
ColonyTrustwhereanemployervoluntarily
paidthetaxesofitsCEO,whichwasfoundto
beadditionalincomepaidtotheCEO(thus
theamountpaidintaxeswasalsosubjectto
tax).
3. IFthepriorlosshadbeendeductibleAND
claimedthenuponrecoverythetaxpayerwould
havetoreporttheamountreceivedasincome
pertheTAXBENEFITRULE.
m. 172:NetOperatingLoss(NOL)DeductionCanbe
carriedback2yearsORforward20years.
i. 172(c)requiresNOLtobecalculatedbefore
factoringinanyNOLdeductionsbecauseotherwise
thetimerestrictionswouldhavenoimpact.
ii. ThisisCongressattempttosoftenthesometimes
harshresultsthattheannualsnapshotsweuse
forincometaxpurposesmayimposewhenthereis
unsteadyincomefromyeartoyear.
iii. Sanford&Brooks(1931)Taxpayerlostmoneyfor
threeyearsondredgingcontract.They
subsequentlysuedtheotherpartyforbreachof
warrantyandrecoveredtheamounttheypreviously
lost($176,000).Taxpayerarguesthejudgment
justmadethemwholesothereshouldbenotax
consequences.Courtrejectsargumentbasedon
annualaccountingperiods:nomatterwhathappened
in19161919,in1920theygained$176,000because

9
theUSusesannualasopposedtotransactional
accounting.
1. NOTE:Thiscase,whilestillgoodlaw,would
nothavenearlythesameharsheffectsnow
dueto172sNOLprovisions.
n. 1341:ClaimofRightIfaClaimofRightrecognized
inaprioryearmustbereturned(andthedeductionis
greaterthan$3,000)thenthetaxpayerisentitledto
deductthegreaterof(1)thetaxsavingsfromusing
thedeductionnormallyonthepresentreturn,OR(2)
theamountoftaxpaidintheprioryearwiththeclaim
ofrightincludedminuswhatwouldhavebeendue
withouttheclaimofright[i.e.,theoriginalamount
overpaid]
i. NorthAmericanOilConsolidated(1932)Receiver
appointedovertaxpayersbusinessin1916,in
1917DistrictCourtsidedwithNAOCandprofits
from1916intheamountof$172,000wereturned
over.Finalappealsofthedecisionwere
dismissedin1922.
1. SCOTUSheldthattaxpayerhadaClaimof
Rightwithoutrestrictionastoits
dispositiontothemoneyin1917soithad
tobereportedonthe1917taxreturn.If
subsequenteventsin1922(ex.losingthe
appeal)causeNAOCtoloseitsclaimthenin
1922itwouldbeentitledtoadeduction.
a. NOTE:Thegeneralruleisstilltrue,
buttheresultsthatmaycomefrom
differentmarginaltaxratesin
differentyearsaresoftenedvia1341.
2. ThisisNOTapropersituationforfilingan
amendedreturnbecausetherewasNOMISTAKE
baseduponthefactsthatwereknownatthe
timethereturnwasfiled.
ii. Lewis(1951)Employeereceiveda$22,000bonus
in1944andpaidtaxesonthatamount.In1946it
wasdeterminedthathewasonlysupposedto
receiveofthebonussohereturned$11,000.
Courtheldhewasentitledtoan$11,000deduction
in1946,buthewasNOTabletoamendhis1944
returnbecauseatthetimehisreturnwasaccurate
basedonhisClaimofRight.

10
o. 111:RecoveryofTaxBenefit:Anamountrecovered
thatwaspreviouslydeductedwillNOTbeincludedin
incomeduringthepresentyearifitdidNOTreducethe
taxpaidbythetaxpayerintheyearthatthededuction
wasoriginallyclaimed.
i. EXCLUSIONARYTAXBENEFITRULENoneedtoreport
incomeonanamountpreviouslydeductedifitdid
NOToriginallysavethetaxpayermoneyintheyear
itwasoriginallydeducted.
ii. INCLUSIONARYTAXBENEFITRULEIftheprior
deductiondidsavethetaxpayermoneyandthenis
subsequentlyrecovereditmustbeincludedin
incomefortheyearinwhichitisrecovered.
iii. 111(c)ifthedeductiondidNOTreducetax
liabilityintheyearthatitwastaken,BUTdid
createorenlargeaNOLitwillbetreatedasa
taxbenefitforpurposesof111.Thusthe
presentrecoverymustbeincludedinincome.
iv. TheTaxBenefitRulecanbeseenastheopposite
oftheClaimofRight.
1. ClaimorRightTaxfirstthendeduction
whenassumptionsprovewrong.
a. Sensitivetodifferentialratesover
timebyvirtueof1341.
2. TaxBenefitDeductfirstthenpaytaxwhen
assumptionsprovewrong.
a. Appliesregardlessofwhetherornot
differentialratesovertimewill
benefitordisadvantagethetaxpayer.
p. 104:CompensationforInjuriesorSicknessThe
amountofANYdamagesreceivedforpersonalinjuryor
sickness(whetherpaidinalumpsumorperiodic
payments)isexcludedfromincome.BUT,emotional
distressshallnotbetreatedasaphysical
injury/sicknessexcepttotheextentthattherecovery
isbeingusedtocoverACTUALmedicalbills.
i. LostProfitsTaxedinthesamemannerthe
originalprofitswouldhavebeentaxedincluded
inincome.
ii. DamagedPropertyTreatedasaforcedsale
(involuntaryconversion).Absentaspecialrule,
youwillbetreatedasifthepropertyhadbeen
soldvoluntarily.

11
1. 1033providesanexceptionifyoureinvest
theproceedsinsimilaruseproperties.
iii. IFmedicalexpensesaredeductedinoneyearthen
asubsequentjudgmentawardsmoneyforthose
expensesdespite104(a)(2)thejudgmentwill
betaxableundertheTaxBenefitRule.
iv. Emotionaldistressdamagesarespecifically
excludedunderthestatuteexcepttotheextent
theycoveractualmedicalcosts(i.e.,therapy
bills),unlesspreviouslydeductedbecausetheTax
BenefitRulewouldthenrequiretherecovery
includedinincome.
1. Ifsomeoneelsewasinjuredphysicallythen
itcouldbearguedthatthesoftemotional
distressdamagesareexcludablefromincome:
thestatuteisambiguousbasedonthe
languageonaccountofpersonalinjuryand
doesNOTexplicitlysayhispersonal
injury.
v. VictimofpersonalinjuriescanexcludeALL
recoveriesexceptpunitivedamagesfromincome.
ThuslostwageswillNOTbetaxableeventhough
thewageswouldbetaxedifearned.
1. Medicalexpensesincludedinrecoverywill
onlybeincludedinincomeifrequiredbythe
TaxBenefitRule.
a. NOTE:Deductionofmedicalexpenses
under213hasaverysignificantfloor
of7.5%ofAGI.
q. 104(a)(2)sallowancetobepaidinlumpsumsor
periodicpaymentsincentivizespeopletocreate
structuredsettlementsbecausetheinterestcomponent
ofthesettlementwillbeexcludedfromincome,butif
alumpsumwaspaidouttheninvestedtheinvestment
proceedswouldbeincludedasincome.
r. 108Specificexclusionsfromthegeneralruleunder
61(a)(12)forincomefromthedischargeof
indebtedness.
i. NOTE:GenerallyspeakingloanproceedsareNOT
incomeandloanpaymentsareNOTdeductible.
ii. CoDIncome=CancellationofDebtIncome.
iii. KirbyLumberCompanyissued$1Mworthofbonds
andboughtthembackfor$800k.Courtfoundthat
companyhadCoDIncomeintheamountof$200k.

12
iv. 108(b)whileCoDincomecanbeexcludedinsome
cases(See108(a))itwillbeusedtooffset
othertaxattributesunderthebasictheorythat
ifthetaxpayerendsupprosperousthentheCoD
incomeshouldproperlybetaxeddespite108(a)s
generalreliefprovisions.
1. Catchallprovisionisreductionofbasis
ofotherpropertyownedbythetaxpayer,
which1017willrequirethatportionofthe
taxonasubsequentsaletobepaidasincome
taxinsteadoftheusualcapitalgainstax
rates.
v. Amongotherthings108(a)eliminatesCoDincome
whendebtisdischargedinbankruptcy;property
mortgageworkoutagreementswillhaveNOCoD
income,butwilladjustthebasis;renegotiation
ofapurchasepricebyasolventdebtorwillbe
seenasapurchasepricereduction(andaffect
basis)buttherewillbeNOCoDincome.
vi. ZarinTaxpayerdisputedadebtheowedtoa
casinobecauseheclaimeditwasunenforceable.
The$3.5Mdebtwassubsequentlysettledfor$500k.
Thecourtheldthatsincethedebtwasindispute
theamountofdebtwasproperlyfixedbythe
settlementsotherewasnoCoDincomerealized.
1. ContestedLiabilityDoctrineIfthedebt
isdisputedingoodfaith,asubsequent
settlementwillbeseenasthetruedebtfor
taxpurposes.
a. I.e.,itreallywasa$500,000debt
thatwaspaidinfull.
s. 103Incomefromstateandlocalbondsareexcluded
fromgrossincome.
i. Intheory,themarketwillsimplydiscountfor
thisadvantagebyofferinglowerinterestrates;
however,theremaystillbesomeadvantagefortax
payersinthehighermarginaltaxbrackets
dependingonthediscountrateappliedbymarket
forces.
ii. Theexemptionisprovidedbystatute,butthereis
noConstitutionalbarriertotaxingproceedsfrom
state/localbondsperSouthCarolinav.Baker.

13

II.

t. 121Gainfromthesaleofaprincipalresidencecan
beexcludedupto$250,000($500,000ifmarried)ifthe
taxpayerlivedtherefor2ofthelast5years.
i. 1012Basisrulesforcapitalassets.
Whenisitincome?
a. Eisner(1920)dealtwithConstitutionalrealization
requirements,whichhavesubsequentlybeenoverturned.
However,realizationisstillimportantbecauseof
statutoryrequirementssetbyCongressintheInternal
RevenueCode.
i. Delayedrealizationdrivesdowntheeffectiverate
oftaxationovertimeduetothetimevalueof
money.
ii. Also,incentivizespeopletoholdappreciated
assetstoavoidrealizationandtosell
depreciatedassetstorealizethelossfortax
purposes.
1. 1091Designedtopreventpeoplefrom
sellingdepreciatedassetstorealizethe
lossthenimmediatelybuyingthemback.If
donewithin60daysofthesalethededuction
forthelosswillnotbeallowed.
a. Designedtocombatstrategicbehaviorby
taxpayerswhohavesolecontrolover
whencapitalassetswillbesubjectto
tax.
iii. Realizationv.Recognition1001(c)
1. RealizationReferencestheunderlying
transaction(sold,purchase,exchange,etc.)
2. RecognitionTherealizationmustbe
reportedonyourtaxreturns.
3. Usuallythetwogohandinhandwhere
realizedgainsorlosseswillalsobe
recognized;however,Congresscanpassnon
recognitionrulesthatallowcertain
realizationstonothavetobe
recognized/reportedononestaxreturn.
a. Nonrecognitionrulesareusuallyused
todeferratherthaneliminatetax
burdens.
b. Oftentimestaxlawyersworktohelpclientstocomeas
closeaspossibletosellinganasset(i.e.,to
monetizeit)withouttriggeringarealizationeventand
theaccompanyingtaxconsequences.

14
i. Goalinmanycasesistoeither1)mimicasaleby
changingeconomiccircumstanceswithoutfacingtax
consequences,or2)totriggerasalefortax
purposes,butNOTchangetheunderlyingeconomic
circumstances.
ii. TakingoutaloanagainstanassetisNOTa
realizationevent.
iii. ZeroCostCollar:Sellacalloption,buyaput
option,andborrowagainsttheasset.
1. Ex.ADBEstockworth$100M:Sellacall
optionfor$110M,buyaputoptionfor$90M
THENborrowagainstthesecureeconomic
position[$90M$110M].
c. 1001Determinationofamountrealizedshalltake
intoaccounttheamountofmoneyANDtheFMVofany
propertyreceived.
d. CottageSavings(1991)Taxpayerwantedtotriggera
salefortaxpurposes,butavoidoneforaccounting
purposes.
i. Taxpayerunsuccessfullytriedtoargueagainstthe
regulationsadoptedbytheIRS,whichisanuphill
battleinlightofChevrondeference.However,
whileSCOTUSdeferredtotheIRSregulationsit
didNOTdefertotheIRSlitigationpositions
interpretingtheregulations.
ii. SCOTUSholdsthatwhenthereisachangeinlegal
entitlementsevenwhentheassetsexchangedare
essentiallythesameeconomicallythereisa
realizationevent.THUSitisEXCEPTIONALLYEASY
totriggerarealizationevent.
1. NOTE:108Excludestherenegotiationof
mortgagesfromCoDincomebecauseotherwise
itcouldbeseenasarealizationeventdue
tothechangedlegalrights/circumstances.
e. 1031LikeKindExchangesofRealProperty
i. Exchangedpropertieswillalmostneverhavethe
samevaluesoonepartyoftenhastokickin
somethingextra(oftencash)toevenoutthe
transactioncalledaboot.Per1031(b)the
bootistaxedbaseduponitsFMVnodeferralon
thebootbecausenonrecognitionislimitedto
qualifiedproperty.
1. IfNObootisreceivedthennogainhastobe
recognized,BUTifbootisreceivedthangain

15
mustberecognizedbutonlytotheextentof
thebootsFMV.
ii. HYPO:DickCheneyownsaBuildingwithaFMVof
$100andabasisof$60;SnookieownsaRanchwith
aFMVof$90andabasisof$75.
1. SnookiewillhavetotransfertheRanchAND
$10,DickCheneywilltransfertheBuilding
(bothpartingwith$100).
a. Snookiefitsneatlywithin1031(a)
Likekindpropertygivenupsolelyfor
likekindproperty.[Sherealizesagain
of$15($100FMVofbuilding$10boot
=$90$75basisinranch=$15);
however,$0isrecognizedper1031(a).
i. Basisinranchwillbe$85($75
transferredbasis+$10boot).
ii. Goalof1031istopreservethe
$15ofbuiltingainthatshehad
beforethetransactionmerelya
deferralprovision.
b. DickCheneyisgettingBootof$10AND
theRanch.Realizationof$40($100
purchaseprice$60basis=$40).
i. Recognitionunder1031(b)willbe
$10,mustrecognizegain,BUTonly
totheextentofbootreceived.
ii. BasisintheRanchwillbe$60($60
transferredbasis+$10recognized
THEN$10bootreceived=$60).
iii. Goalistopreservehis$30of
builtingain($40ofgain
originally,buthealready
recognized$10ofit).Ranch:FMV
$90$60basis=$30builtin
gain.
1. NOTE:DONOTSKIPTHESTEPof
transferredbasisplusgain
recognizedminustheamountof
bootreceivedbecauseinsome
casesthenumberswillbe
differentsoitmakesa
differenceCANNOTassumeit
willmerelybeawash.

16
2. Keythingstocheck:(1)Howmuchgainhave
yourecognized?[ItwillNEVERbemorethan
theamountrealized.],and(2)Theamountof
gainrecognizedwillbethelesserofthe
amountofbootreceivedORtheamount
realized.
a. THUSifnogainisrealizedbutthereis
abootthebootwillNOTbesubjectto
tax.
3. IntherealworldthesewillNOTbeexchanges
butratherasalefollowedbyareinvestment
oftheproceedsinanewproperty.Bootwill
beanyproceedsNOTreinvestedintothe
secondproperty.
iii. Intangiblelegalrightssuchasnegativeeasements
canbeseenaslikekindwhenexchangedforreal
propertysolongastheintangiblelegalrightis
seenasaninterestinrealpropertyunderthe
substantivestatelawtheIRSdeferstostate
lawinthisregard.
iv. Stricttimingrequirementsmustbemettotake
advantageof1031snonrecognitionprovisions
failuretomeetprovisionswillsubject
transactiontothegeneralrequirementsof1001.
f. MethodsofAccounting
i. CashMethodIncomeistakenintoaccountwhenit
isreceived.Deductionsaretakenintoaccount
whenpaid.
1. Becauseitisbaseduponreceipt/paymentit
issubjecttostrategicmanipulationto
minimizetaxliabilities.
2. TreasuryRegulation1.4511and2income
mustberecognizedupontheFIRSTofrealor
constructivereceipt.
a. Constructivereceiptoccurswhenthe
moneyismadeavailabletothetaxpayer
totakeatanytimeofhischoosing.
b. Amend(1949)TaxCourtfoundNO
constructivereceiptwhentaxpayerwas
NOTentitledtoimmediatepaymentunder
thecontracteventhoughhecouldhave
negotiatedforimmediatepaymentwhen
thecontractwasformed.Thelegal
rightsarethekeyissue.

17
c. Pulsifer(1975)Lottoproceedswere
placedinatrustaccountforminors,
butwasaccessibleupontheapplication
oftheirparent/guardian.Courtfound
constructivereceipt.
d. Alternativeapproach:ECONOMICBENEFIT
DOCTRINEMoneyiscurrentlytaxable
oncetheabsoluterighttoincomeinthe
formofafinancialbenefitisderived
fromtheabsoluterighttoincomeinthe
formofafundthathasbeen
irrevocablysetasideforhimintrust
beyondthereachofthepayors
creditors.
i. Thereceiptoftheabsoluteright
tofuturepaymentsisseenas
presentincome.
ii. Planningaroundtheeconomic
benefitdoctrinerequiresthepayor
tomakecommitmentsthatareas
secureaspossibleforthepayee,
BUTNOTsosecureastotriggerthe
doctrine.
3. ***Usethiscashmethodfortheexam***
ii. AccrualMethodIncomeistakenintoaccountwhen
earnedevenifNOTreceivedyet.Deductionsare
takenintoaccountwhentheexpenseisincurred.
g. NonQualifiedDeferredCompensation
i. Minor(1985)EconomicbenefitdoctrinedoesNOT
applywhenemployeeisNOTthebeneficiaryofthe
trustratherthecorporationisandwill
subsequentlyremitpaymenttotheemployee.Key
differencebecauseuponreceiptbythe
corporation,theemployeesclaimtothemoney
willhavetocompetewiththosefromthefirms
othercreditors.
1. IFthetrustpaidtheemployeedirectlythen
theEconomicBenefitDoctrinewouldapplyand
theemployeewouldbesubjecttopresenttax.
2. HYPOS:
a. PlayernamedasbeneficiaryofTrust
worth$600,000SubjecttoPRESENT
tax.Taxedupon$600,000immediately,

18
whichwillgivehimabasisof$600,000
intheannuitycontract.
b. Playernamedasbeneficiaryoftrust
worth$600,000ANDwillreceive$400,000
ofinterestinfiveyearsPlayer
taxedimmediatelyonthe$600,000value
ofthetrustANDtaxedontheportions
ofthe$400,000ininterestincomeasit
isearnedbythetrust(eventhoughthe
playerwillNOTgetanypayoutsinyears
14).
c. Corporationisthebeneficiaryofthe
trustworth$600,000withanexpected
interestaccrualof$400,000over5
yearsNopresenttaxationbecausethe
playerwillstandshouldertoshoulder
withothercreditorsandthushasonlya
merepromisetopay.
d. CorporationANDownerguaranteetopay
player$1MinfiveyearsNopresent
taxation:twomerepromisestopay.
h. QualifiedDeferredCompensation:
i. 401(k)andIRA:Deductioninitially,taxfree
growth,andtaxabledistributions.
ii. RothIRA:Noinitialdeduction,taxfreegrowth,
andtaxfreedistributions.
iii. Ifratesstayconstantfromyeartoyearthe
regularandRothIRAsshouldtheoreticallyproduce
identicalresultsintermsoftheamountofmoney
availableuponwithdrawalforconsumption.
iv. WheninvestmentsareinEITHERtypeofIRAaccount
thenyoudonthavetocarewhetheritspinsoff
ordinaryv.capitalincome.
1. Canoptforbetterreturnbecauseimmediate
taxconsequencesthatnormallywouldhaveto
beconsideredcanbedisregarded.
2. Ifyouareinvestingbothinsideandoutside
ofanIRAinvestinthetaxpreferred
assets(ex.municipalbonds)outsideofthe
IRAtogetthemaximumtaxadvantageofboth.
3. AllincomefromanIRAwillbetaxedas
ordinaryincomeupondistributionno
distinctionismadebetweencapitaland
ordinaryincomeupondistribution.

19
i. ConsumptionTax:I=C+S(I=Income,C=Consumption,
andS=Savings).AlgebraicallythenC=IS,which
representsdeductionsforcontributionstoaqualifying
accountresultingintaxingthatwhichisNOTsaved
(i.e.,consumption).
i. Thisisanalternativetoatransactionbased
consumptiontax(i.e.,salestax).The
consumptiontaxallowsprogressiveratestobe
appliedunlikesalestaxes,whichareapplied
evenlyacrosstheboard.
ii. Adoptingthisapproachwouldalsoreflecta
commitmenttoNOTtaxinginvestmentincome.
j. 83:PropertyTransferredinConnectionwith
PerformanceofServicesWhenpropertyistransferred
toaserviceproviderforlessthanitsFMVthe
differencewillbetaxableIFitisEITHER1)
transferrableOR2)NOTsubjecttoasubstantialrisk
offorfeiture(whicheverhappensfirst).
i. Propertyissubjecttoasubstantialriskof
forfeitureifitisconditionedontheperformance
ofsubstantialfutureservices.
ii. 83(b)Uponreceiptthetaxpayercanoptfor
immediatetaxationbasedontheFMVamountpaid
fortheproperty.
1. HYPO:Employeegranted$200,000worthofLLC
unitsthatwillNOTvestfor5years.Should
hemakea83(b)election?
a. Under83(a)Notaxesonunitsuntil
theyvestthustaxNOTdueuntilyear5.
IFFMVinyear5was$2.2Mtherewill
thenbeordinaryincomeof$2.2Minyear
5[$770,000taxbill@35%]
b. Under83(b)Year1$200kofordinary
income[$70,000@35%].Inyear5when
thevestingoccurstherearenodirect
taxconsequences,BUTuponsaleifFMV
was$2.2M$200kbasisso$2Mofgain
taxedascapitalgains[$300,000tax
bill@15%]
c. Thus83(a)hasatotaltaxof$770,000
v.83(b)hasatotaltaxof$370,000.
iii. Whendoyouwanttomakea83(b)election?
1. LowFMVinitially.

20
2. Ifyouexpectpropertyreceivedtoappreciate
substantially.
3. Ifyouarefairlycertainthatyouwill
satisfythevestingrequirements.
iv. Under83(b)ifthepropertyisforfeitedbefore
itvests,buttaxwaspreviouslypaiduponreceipt
(ex.$200k)therewillbeNOdeductionforthe
amountofincomethatwasinitiallyreceivedbut
subsequentlyforfeited.
v. 83(h)Employergetstodeducttheamountthat
theemployeeincludesinhisordinaryincomefor
theyearthattheemployeereportssaidincome.
vi. Cramer(1995)83(e)(3)statesthat83doesNOT
applytoOPTIONSwithoutareadilyascertainable
FMV.
1. TreasuryRegulation1.837(b)(2):No
readilyascertainableFMVunlessamongother
thingstheoptionisexercisableimmediately
bytheoptioneeANDitisNOTsubjecttoa
condition/restrictionthatwillaffectits
FMV.
2. NOTE:83sNonascertainableFMV
restrictionONLYappliestoOPTIONSitdoes
NOTapplytostock.
k. (1)IncentiveStockOptions(ISO)mustcomplywiththe
rulesof421422,whichareveryrestrictivesoitis
rarelyused.Ifconditionsaremetthenonlythe
exerciseoftheoptionwillbeataxableeventwith
gainstaxedaslongtermcapitalgains.
i. (2)NonQualifiedStockOptionsaremuchmore
commonandconsistofanyoptionsthatdoNOTmeet
theISOrequirements.
ii. PerIRSregulationsnonqualifiedoptionsdoNOT
havereadilyascertainablefairmarketvaluesso
theyareNOTtaxableupongrant.However,the
exerciseisataxableeventandtheSTOCKwillbe
the83property.
1. Thenonascertainablefairmarketvalue
restrictionwillNOTapplytothestock.
iii. NonQualifiedStockOptions:FMVexerciseprice
=ordinaryincome.[Ex.Price$10,FMV=$70
$60/shareofordinaryincome,Basiswillbe$70
($10paidplus$60taxed)].Uponsalecapital
gains/losseswillbebasedoffthe$70basis.

21
iv. (3)EquityStockItself:RestrictedStock
subjecttoasubstantialriskofforfeiture
opportunitytoconsiderfilinga83(b)election
nocarveoutexclusioneveniftheFMVisNOT
readilyascertainable.
l. 6662:ImpositionofAccuracyRelatedPenaltyIf
sectionappliesthen20%ofunderstatementcanbe
tackedonasapenalty.
i. (b)Negligenceordisregardofrules/regulations
orsubstantialunderstatementofincometax.
1. (d)Understatementiftaxpaidisunderstated
bythegreaterof10%oftaxdueOR$5,000.
ii. ImportantforTaxLawyerstoexpresstoclients
variouslevelsofuncertainties.
1. ReasonableBasis(1530%)
2. SubstantialAuthority(3050%)
3. Morelikelythannot(50%+)
4. Shouldprevail(70%+)
iii. 6662(d)(2)(B)Iftaxpayerhassubstantial
authorityforpositionthentheunderpayment
penaltycanbeavoided.
1. Alsocanavoidpenaltyifrelevantfactsare
attachedtothereturnandthetaxpayerhasa
reasonablebasisforthepositiontaken.
2. BUTifyouuseataxshelteryouhaveto
reasonablybelievethatyouweremorelikely
thannotfollowingthepropertreatment.
a. Taxshelteranyplanorarrangement
whereasignificantpurposeisthe
avoidanceoffederalincometaxes.
i. Writtenbroadlyenoughthatalmost
anyactivity(ex.buyingtaxexempt
bondsorahousetodeduct
interest)canbeseenashavinga
purposeofavoidance,butin
practiceitamountstoakindof
prosecutorialdiscretion.Unlikely
tobeusedinmostcases.
iv. 6664(c)Nopenaltyunder6662iftaxpayercan
showareasonablecauseforapositionoractedin
goodfaithwithrespecttosuchposition.
1. Majorfactorhereisprofessionaladvicefrom
ataxadvisor.

22
m. 1041:TransferofPropertyBetweenSpousesIncident
toDivorceNogainorlossshallberecognizedand
therewillbeatransferredbasis.
i. Davis(1962)Htransferredappreciatedstockto
Waspartofadivorcesettlement.SCOTUSholds
thatWhadlegalrightsbyvirtueofthemarriage
andextinguishedthoseclaims.Thusthiswasthe
useofappreciatedpropertytosatisfyadebtso
taxabletoH(akintoselling$10,000worthof
stockwitha$1,000basisthenpayingthe$10,000
toathirdparty$9,000ofgainsubjectto
tax).
1. NOTE:DaviswasdecidedBEFORE1041.
2. 1041hasNOapplicationtosamesex
couples.ThusDaviswouldbethestarting
point.
ii. Ratherthanattempttovaluelegalobligations,
theFMVoftheobligationwillbepresumedequal
tothevalueofthepropertytransferredsinceit
isanarmslengthtransaction.Technicallythe
amountrealizediswhatheisgettingNOTwhathe
isgivingup(however,theamountgivenupis
beingusedtogetatthevalueofwhatis
received).
iii. Under1041thereisatransferredbasisinthe
property(evenifitisalossproperty).Thus
taxpayersshouldallelsebeingequaltransferthe
propertythattheyhavethelowestbasisinorder
topassthebuckintermsoftaxliabilityto
therecipient.
n. FaridEsSultaneh(1947)Appreciatedstocktransferred
toWaspartofaprenup.1041doesNOTapply.
CourtheldthepropertywasacquiredbypurchaseNOTby
giftwiththepurchasepricebeingthewaiveroflegal
claimsintheeventofdivorce.
i. ThusinitiallyHshouldhavebeensubjecttotax
basedontheFMVattimeoftransferbasis.
THENWshouldhavebeensubjecttotaxatthetime
ofsalebasedonSalepricebasis(FMVattime
oftransfer).
1. Courtdoesnot,butshouldhaveaddressedWs
basisinherlegalrightstodetermineher
initialtaxliability.Thestartingpoint
shouldprobablybe$0sincethelegalrights

23
soldwerenotpurchased,butitcouldbe
arguedthatcertaincostsshouldbefactored
in(ex.costofgymmemberships,wedding
relatedexpenses,etc.).
2. NOTE:The$800,000FMVofthelegalclaim
(basedontheassumptionthatitequalsthe
FMVofthetransferredstock)ONLYreveals
theFMV,BUTthatisNOTthebasis.
o. 71:AlimonyandSeparateMaintenancePayments
i. Alimonyisdeductiblebythepayor(abovethe
line)andtaxableforthepayee.
1. Onlycashpaymentsareconsideredtobe
alimony.
ii. ChildsupportisNEITHERdeductiblebythepayor
NORtaxableforthepayee.
1. DiezArguelle(1984)Backchildsupport
cannotbedeductedunder166asanon
businessbaddebtbecausethetaxpayerhasno
basisintheproperty.Thecourt
specificallyrejectedtheargumentthatmoney
spenttocareforkidscreatedabasis.
III. PersonalDeductionsandtheAlternativeMinimumTax
a. Personaldeductionsisshorthandfordeductionsthat
areunrelatedtothecostofproducingincome.
i. Mostpersonaldeductionsareitemizedorbelow
thelinedeductions,whichmeanstheyaretakenin
lieuofthestandarddeductionandsubtractedfrom
AGItodeterminetaxableincome.
1. Abovethelinedeductionsareavailableeven
ifyoutakethestandarddeduction,butwith
belowthelinedeductionsyoumustmakea
choicebetweentheitemizeddeductionsorthe
standarddeduction.
2. About70%oftaxpayerstakethestandard
deduction.
ii. GrossIncome(61)MINUSAbovetheLine
Deductions(62(a))EQUALSAdjustedGross
Income(62)MINUSBelowthelineDeductions
(i.e.,EITHERthestandarddeduction(63(c))OR
Itemizeddeductions(63(d)))ANDDeductionsfor
PersonalExemptions(151)EQUALSTaxableIncome
(63).[PAGE353]
iii. Typicallytaxpayerswillonlyelecttoitemize
theirdeductionsiftheaggregateamountofthose

24
deductionsexceedstheamountofthestandard
deduction.
1. Thestandarddeductionalongwithpersonal
exemptionscreatesaneffectivezero
bracketamountfortaxpayers.
iv. 262Nodeductionsforpersonal/familyexpenses
UNLESSexpresslyprovidedinthischapter.
v. EXCEPTIONS(Belowthelinedeductions)[MostCommon
Ones]
1. CasualtyLosses165(c)(3)Estimated
costof$300M/year.
2. MedicalExpenses213Estimatedcostof
$8.9B/year.
3. CharitableContributions170Estimated
costof$36.2B/year.
4. HomeMortgageInterest163(h)Estimated
costof$82.6B/year.
5. StateandLocalTaxes164Estimated
costof$62.4B/year.
vi. Employeescandeductbusinessexpensesunder
162(a),BUTitisbelowthelineANDsubjectto
a2%floorimposedby67[first2%isnon
deductibleevenafterflooriscleared:i.e.,ona
$100,000incomeif$2,001inexpensesthenonly$1
canbededucted.]
vii. Deductionswillhaveagreaterimpactonthosein
highertaxbracketssoitisadifferential
subsidybaseduponmarginaltaxrate.
b. Casualtylossdeductionsunder165(c)arelimitedto
(1)lossesintradeorbusiness,(2)lossesassociated
withtransactionsenteredintoforprofit,(3)unless
itarisesfromfire,storm,shipwreck,othercasualty,
orfromtheft.
i. Issuebecomeswhatisothercasualty?
ii. Dyer(1961)Taxpayerclaimedadeductionunder
165(c)foravasedestroyedbyhercatwhenthe
cathadafit.Taxcourtrejectedthisposition
basedonejusdemgenerisbecauseothercasualty
shouldbesomethingsimilartofire,storm,or
shipwrecks,andcatfitsdoNOTfitthatbill.
iii. 165(h)imposesa$100minimumclaimper
casualty,andallclaimsintheaggregatemust
exceed10%ofAGItobedeductibleinorderto
avoiddeminimisclaims.

25
c. 213allowsdeductionsformedicalexpensesabovea
floorof7.5%ofAGI.
i. 213(d)definesmedicalcareasforthe
diagnosis,cure,mitigation,treatment,or
preventionofdisease,orforthepurposeof
affectinganystructureorfunctionofthebody.
1. Tangentiallyrelevanttomedicalissuesare
NOTdeductible.
a. Ex.hiringagardenerbecausetaxpayer
hasallergies.
b. Ex.playinggolfbecausepsychiatrist
toldtaxpayertorelax.
2. IRSputsoutapublication(509),which
summarizesthelawofdeductiblemedical
expenses.
ii. 213(d)(9)Excludescosmeticsurgeryunlessitis
necessarytoameliorateadeformityarisingfrom
acongenitalabnormality,apersonalinjury
resultingfromanaccidentortrauma,or
disfiguringdisease.
iii. HYPO:Year1:AGI:$100,000,QualifyingMedical
Expensesof$20,000.Floor(7.5%)or$7,500
Deduct$12,500.
1. Year2:Recoveryof$20,000paidtax
consequences?Atmost$12,500willbetaxed
asincomepertheTaxBenefitRule[Could
havenoneofittaxedifprovidedbyanother
sectionEx.ifitcameinanontaxable
personalinjuryrecovery].
d. 170CharitableContributions.
i. 170(c)definescharitablecontributions.
1. Cashthendeductionwillbeequaltothe
amountofcashdonated.
2. PropertydeductionwillequaltheFMVof
theproperty.
a. HUGEloopholebecauseitallows
taxpayerstoavoidtaxesonitemswith
lowbasis.Avoidsrecognitionofthe
builtingain.
i. NOTE:Ifyouhavelossproperty
(ex.ADBEstockwitha$40,000
basisandaFMVof$6,000)itwould
loseitsbuiltinlossifyou
donateittocharity.Thusbetter

26
courseistosellthestock,
recognizetheloss,andthendonate
thecash.
ii. Limitationimposedby170(e)(1)
(A):Ifyousoldthepropertythat
youaredonatinganditwouldgive
risetosomethingOTHERTHANlong
termcapitalgains(akashortterm
capitalgainsorordinaryincome)
THENyoucanonlydeductyourbasis
intheproperty.
1. Takehomeadviceisdonate
capitalassetsthatyouhave
heldformorethanayearso
theywillgetthelongterm
capitalgainstreatment.
2. 170(e)(1)(B):Donating
tangiblepersonalpropertythe
gainthatwouldhavebeenlong
termcapitalgainifthe
propertywassoldatitsFMV
willbereducedtothebasis
UNLESStheuseoftheproperty
bytheorganizationisrelated
toitscharitablepurpose
[primarilyservestomakesure
thatartworkisdonatedto
museums].
ii. Sincecharitabledeductionsareanitemized
deductiontheyonlyconferbenefitsonitemizers.
iii. ServicesthattaxpayersdonateareNOTtax
deductible.
iv. Ifyougetanythingbackforyourcontributionyou
needtodeducttheFMVoftheitemyoureceive
back.
1. Ex.$100donation,$7shirtonly$93will
bedeductible.
v. 170(c)(2)(D)NOdeductionforcontributionsif
theorganizationengagesinpoliticalactivities
thatareprohibitedunder501(c)(3).
e. Lary(1986)Taxpayerdonatedbloodthenattemptedto
claimacharitabledeductionfortheFMVoftheblood.
Unclearifthiswasaservice(nondeductible)or
property,butifpropertyitMAYbedeductible.

27
i. 170(e)Ifasalewillgiverisetoordinary
incomeorshorttermcapitalgainthenyoucan
onlydeductyourbasisintheproperty.
1. Unclearifthisiscapitalassetunder
1221,butevenIFacapitalassetthe
holdingperiodislessthanoneyear(based
onscientificevidenceaboutblood)soit
wouldbesubjecttoshorttermcapitalgains
taxes.
a. Thusonlydeductibleuptoitsbasis,
buttaxpayerhasnobasisintheblood
soNOdeduction.
2. NeverreachedthequestionofIFtheblood
wasproperty.
f. 170(l)Only80%ofregulardeductionwillbe
allowedifdonatingtoauniversityandbyreasonof
thedonationthedonorwillhavetheopportunityto
purchaseseatsatathleticevents.
g. 163(h)Deductionforhomemortgageinterest,whichis
aspecificcarveoutfromthegeneralrulethat
personalinterestisNOTdeductible.
i. 163(h)(3)Definesqualifiedresidenceinterest
asAcquisitionIndebtednessANDHomeEquity
Indebtedness.
1. 163(h)(3)(B)(ii)Theaggregateamount
treatedasAcquisitionIndebtednessshallNOT
exceed$1M.
a. Marriagepenaltyissuebecauseif
marriedandfilingseparatelythelimit
isloweredto$500k,BUTsinglepeople
geta$1Mlimit,and2singlepeople
livingtogethercouldaggregatea$2M
exception.
2. 163(h)(3)(c)HomeEquityIndebtednesscan
addonanadditional$100k.
ii. 163(h)(C)HomeEquityIndebtednesscanbeany
indebtednesssecuredbyaprincipalresidence,BUT
cannotexceedthetaxpayersequityinthehouse.
1. Nolimitsonhowthefundsareused.
iii. 163(h)(4)QualifiedResidenceisaprincipal
residenceANDoneotherresidenceofthetaxpayer.
h. 164Deductibilityofstateandlocaltaxes(SALT).
Itappliesto(1)realpropertytaxes,(2)personal
propertytaxes,and(3)state/localincometaxes.

28
i. Thisexcludessalestax,BUTunder164(b)(5)
salestaxescanbedeductedinlieuofstate/local
incometaxesattheelectionofthetaxpayer.
1. 165(b)(5)(H):Tablesareprovidedwherea
taxpayerwithxincomeinystatecantakez
deductionwithouthavingtoproduceany
receipts.
ii. 164isaregressivesubsidythatencourages
statestoadoptmoreprogressivetaxsystemsthan
theyotherwisemightadopt.
i. ALTERNATIVEMINIMUMTAX(AMT)Basiceffectisa
paralleltaxsystemin5557withadifferentrate
structureandadifferentbase(flatterratestructure
of26%or28%,andalargeexemptionamount,BUTamuch
broaderbasepostexemption).
i. Exemptionamountissetbydefaulttobe$45,000
andeveryyearCongresspassesapatch,which
changesthatthresholdin55(d)(1)(A);however,
thelawiswrittenwithoutautomaticadjustments
forinflationsothechangerequiresan
affirmativeactbyCongress.
ii. AMTrulesapplytoEVERYONEwhomustcalculateAMT
taxliabilityANDregulartaxliabilitythenpay
thehigherofthetwo.
1. ThusitapplieswhentheAMTtaxishigher
thantheregularincometax.
2. IfsomeoneissubjecttotheAMTthencutting
theirregulartaxeswithoutcuttingAMTtaxes
willbeuselessbecausetheywillbesubject
totheHIGHERofthetwo.
iii. Klassan(1999)Taxpayerwith10kidsandanAGI
of$83,056challengedAMTtaxliabilityNOT
mechanically,BUTonthegroundsthatCongress
onlyintendedtohitwealthyindividualswiththe
AMT.
1. 10thCircuitheldthatthestatuteiscrystal
clearandtheAMTapplies.
2. ReasonstaxpayerfacedmoreAMTthanregular
taxliability.
a. NOpersonalexemptionsundertheAMT.
b. NOSALTexemptions.
c. Medicalexpensefloorraisedfrom7.5%
ofAGIto10%.

29

IV.

i. NOTE:Charitablecontributionand
homemortgageinterestdeductions
areunaffectedundertheAMT.
AllowancesforMixedBusinessandPersonalOutlays
a. Conflictbetween162(a),whichgenerallyallows
deductionsforordinary/necessarybusinessexpensesAND
262,whichgenerallyprohibitsdeductionsfor
personalliving/familyexpenses.
i. Createsalinedrawingprobleminplaceswhere
thesetwoprovisionsintersect.
b. 62(a)(2)(A)IfanEMPLOYEEbearsabusinessexpense
thatisreimbursedbytheemployerthanitis
deductibleabovetheline(inpracticeitismerely
ignoredbecausetherewouldbeincomeofxfollowedby
acorrespondingdeductionofxforanetgainof0).
i. Nonreimbursedemployeebusinessexpensesare
belowthelinedeductions.
1. 67Individualmiscellaneousitemized
deductions,whichconsistprimarilyof
unreimbursedemployeebusinessexpenses,has
a2%floor.
a. Ex.$100,000AGIthenfirst$2,000is
NOTdeductible.
2. Miscellaneousbusinessexpensesunder67(b)
areNOTdeductibleundertheAMTper56(b)
(1)(A)(i).
c. HomeOfficeDeduction:280A(a)Generallythereis
nobusinessdeductionifitisadwellingunitandthe
taxpayerusesitasaresidence.
i. 280A(c)doesallowadeductionifthespaceis
EXCLUSIVELYusedonaregularbasisasthe
principalplaceofbusinessforanytradeor
businessofthetaxpayer.
ii. Popov(2001)Concertviolinistwholivedina
onebedroomapartmentwithhusbandanddaughter
claimedthelivingroomwasherhomeofficethat
sheusedtopracticehermusic.
1. Onlydeductibleifitisherprincipalplace
ofbusinessper280A(c)thecourtused
theSolimanTest:
a. (1)RelativeImportanceNoonefactor
isdeterminative,butSCOTUSgivesgreat
weighttowheregoods/servicesare
delivered.

30
i. Courtheldthattheservice
deliverymodeldidNOTworkwellin
thecontextofmusicsofoundthis
tobeinconclusive(betweenconcert
hallsforperformancesandthe
apartmentforpractice).
b. AmountofTimeTaxpayerspentFARmore
timepracticingthanperforming.
i. Thusthecourtfoundthededuction
tobeproper.
iii. TheServicetakesthepositionthat280A(a)s
generalruletakesprecedenceover280A(c)when
indoubt.
1. Essentiallyitarguesthat280A(c)isa
minorexceptiontothegeneralrule.
d. CHILDCAREDEDUCTIONSSmith(1940)Taxpayerargues
thatchildcareexpensesshouldbedeductiblebecause
butforthemthewifewouldNOTbeabletoworkthus
itwasacostofproducingincome.Thecourtrejected
theargumentbecauseitknowsnoboundsandwouldturn
EVERYTHINGintoabusinessexpense.
i. ItheldthatchildcarewasaPERSONALexpense,
whichisalongstandingpositioninAmericantax
law.
ii. Thiscasearosepre21and129.
e. 21ChildCareTaxCredit:3520%ofexpensesspent
onchildcare(the%dropsasonesAGIgoesup).
i. 21(b)(2)(A)Theexpensehastobeemployment
relatedinthatitallowsthetaxpayertowork.
ii. 21(a)(2)20%ratekicksinatanAGIof
$45,000.
iii. 21(c)Employmentrelatedexpensesthatcanbe
multipliedbythe%shallNOTexceed$3,000for1
kidOR$6,000for2ormorekids.
iv. ThisisanonrefundabletaxcreditsoNOT
helpfulforthosewith0taxliability.
1. CreditscomeAFTERtaxliabilityis
calculatedthentheyserveasadollarfor
dollarreductionintaxliability.
v. Youcannottakeboth21and129haveto
chooseoneortheother.
f. 129DependentCareExclusionMaximumof$5,000of
incomecanbesetasidefromotherwisetaxablesalary

31
andnotbetaxedprovidedthatitisspenton
qualifyingdependentcarerelatedexpenses.
g. 24ChildTaxCredit$1,000valueforakid,but
ithasvariousphaseoutsasAGIgoesup.
h. BUSINESSTRAVELEXPENSES162(a)(2)Deductionfor
travelingexpenses,whichareNOTlavishwhileaway
fromhomeinthepursuitofatradeorbusiness.
i. FlushlanguageMustbefor1yearorless.
ii. Flowers(1945)TaxpayerlivesinJackson,
MississippiandhisofficeisinMobile,Alabama.
SCOTUScreateda3parttesttodetermineifthe
travelexpensesweredeductibleunder162(a)(2):
(1)Expensesarereasonableandnecessary,(2)
incurredwhileawayfromhome,AND(3)inthe
pursuitofatradeorbusiness.
1. CourtheldthesewereNOTbusinessexpenses.
2. CasehascometobeseenasaCOMMUTING
EXPENSEScasewhichisNOTdeductibleeither
because(3)itisnotincurredinthepursuit
ofatradeorbusinessOR(2)wasNOT
incurredwhileawayfromhome.
iii. TheServiceseeshomeastheprincipalplaceof
businessratherthanonespersonalresidence.
1. Thusonewhoworksoutofoneoffice(ex.LA)
andthentravelstoanotheroffice(ex.
Boston)willbeawayfromhomeandableto
deducthistravelexpensesunder162(a)(2).
iv. Hantzis(1981)LawstudentfromBostontooka
summerjobinNYC.Shedeductedhertraveland
lodgingexpensesto/inNYCunder162(a)(2).The
1stCircuitrejectedthedeductionsbecauseit
heldthatthetaxpayershome(akaprincipalplace
ofbusiness)wasinNYCthusthoseexpenseswere
NOTdeductibleANDhertripstoBostonwerefor
PERSONALreasonssothatalsowasNOTdeductible.
1. Temporaryawayfromhomeexpensescanbe
deductedeventhoughthingslikerent/food
wouldtypicallybeanondeductiblepersonal
expense,BUTonehastobeawayfromhistax
homeinpursuitofatradeorbusiness.
a. Ex.Lawprofessorsteachingata
differentschoolawayfromtheirtax
homeoverthesummer.

32
b. Theconnectionhastobetothe
taxpayerstradeorbusiness(i.e.,asa
lawprofessor),BUTdoesNOTneedtobe
fortheconvenienceofthehome
employer.
c. Temporaryemploymentexpensescanbe
repetitiveaslongaseachis
temporary.Twoparttest:(1)
subjectiveintentofthetaxpayeris
toreturntothepermanenthomewithin
theyear,and(2)objectiveithasnot
beenmorethanayear.
i. CLOTHINGEXPENSES:Pevsner(1980)Taxpayerworkedata
YSLboutiqueandhadtobuyYSLclothestowearto
work.Thetaxpayerdeductedtheclothesasabusiness
expenseandtheIRSchallengedthatposition.Inorder
tobedeductibleclothingmustbe:
i. (1)ofatypespecificallyrequiredasa
conditionofemployment,
ii. (2)NOTadaptabletogeneralusageasordinary
clothing,AND
iii. (3)NOTsowornbythetaxpayer.
iv. ThecourtheldtheclotheswereNOTadeductible
expensebecause#2isobjectiveandtheclothes
wereadaptableeventhoughthetaxpayeronlyused
themforwork.
v. Uniformsingeneralaredeductiblebecausethey
passtheobjectivetestunder#2,butthisrarely
comesupbecauseofthe2%floorimposedby67.
j. Gilmore(1963)Hattemptstodeductlegalbillsfrom
hisdivorceproceedingwherehewasresistingWsclaim
ofownershipinhis3GMdealerships.
i. Hclaimedthedeductionunder212(2)asan
ordinaryandnecessaryexpenseforthe
management,conservation,ormaintenanceof
propertyheldforproductionofincome.
1. NOTE:Thisprovisionissimilarto162
deductiblebusinessexpenses,butitismore
laxinthattheactivitydoesNOThaveto
risetothelevelofatradeorbusiness.
ii. SCOTUSrejectedthedeductionstatingthatthe
ORIGINoftheCLAIMmustbebusinessbasedin
orderforthedeductiontoapply.

33

V.

1. Inthiscasetheoriginwaspersonaleven
thoughitultimatelywouldhaveimpactedthe
incomeproducingproperty.
iii. NOTE:Eventhoughtheunderlyinglitigationcannot
bededucted(i.e.,thedivorcelitigation
expenses).ThetaxlitigationexpensesCANBE
DEDUCTEDunder212(3),whichallowsforthe
deductionofexpensesinconnectionwiththe
determination,collection,orrefundofanytax.
BusinessExpenses,Appreciation/Amortization,andTax
Shelters
a. Depreciationisbasedontheideathatthereshouldbe
anoffsetagainstrevenuesforthecostofwasting
assetsthatareusedfortheproductionofthose
revenues,buthasalifeextendingbeyondthecurrent
taxyear.
i. Deductionsfordeprecation,orcostrecovery,
resultsfortaxpurposesinareductioninthe
basisofanasset.
ii. Specificsaboutdepreciationdeductionsarelaid
outin167168.
iii. Priorto1981youneededtoknow:(1)Usefullife
ofitem,(2)Salvagevalue[coulddeductamount
paidsalvagevalue],and(3)Allocation
methodology.
1. 1981TaxReformBillAcceleratedCost
RecoverySystem(ACRS)definedusefullives
forcategoriesofassets,ignoredsalvage
values,andallowedacceleratedallocation
methodsthatfrontloadeddeductions.
b. Whatarethetaximplicationsofthesaleofproperty?
i. AmountrealizedANDAdjustedbasisper1001.
1. AdjustedBasisHYPO1:Blackacrepurchased
for$100,000cash.
a. 1012costbasisis$100,000.
2. AdjustedBasisHYPO2:Blackacrepurchased
for$100,000usingaRECOURSEloan.
a. 1012costbasisis$100,000.
3. AdjustedBasisHYPO3:Blackacrepurchased
for$100,000usingaNONRECOURSEloan.
a. 1012costbasisis$100,000perCrane
andTufts.

34
c. Amountrealizedisthestuffcomingtothepersonwho
isselling.ItdoesNOThavetobecash.Ifcouldbe
forexample:
i. Cash
ii. Property
iii. AssumptionofRecourseLiability
d. Crane(1947)whensellingpropertythevalueofany
NonRecoursedebtassumedbythebuyerneedstobe
factoredintotheamountrealizedbytheseller.
i. Whenbuyingthepropertytheadjustedbasiswill
betheamountpaidfortheproperty,which
includestheproceedsfromloans(recourseornot)
thatareusedtopaytheseller.
ii. Tufts(1983)CranesfactorNonRecourseDebt
assumptionsintoamountrealizedruleapplieseven
ifthetaxpayerhasnoequityintheproperty.
1. WithNonRecoursedebtthereCANNOTbeCoD
income,BUTthesaleofpropertywill
recognizethedebtaspartoftheamount
realized.
2. WithRecourseloansifpropertyisusedto
satisfyadebtthen1)iftheFMVofthe
propertyislessthenthedebttherewillbe
CoDincome,and2)gain/losswillhavetobe
recognizedonthepropertysoldtosatisfy
thedebt.
e. TAXSHELTERSTaxpayersboughtpropertiestotake
advantageofACRSdepreciationdeductionstooffset
ordinaryincome,whichallowedthemto1)defertaxes
and2)convertordinaryincomeintocapitalincome.
i. The1986TaxReformActtookawaymuchofthe
benefitsoftaxshelters:
1. 465AtRiskRules:Onlycantakelosses
oninvestmenttotheextentthatyouhavean
investmentatrisk.
a. Ex.$100kdownandaNONRECOURSEloan
thencanonlytakedepreciation
deductionsupto$100k.
b. Atrisk=cash,property,proceedsfrom
anyrecourseloan,ORNonRecourseloans
fromabank.
2. 469Passiveinvestorscanonlydeduct
passivelossesagainstpassiveincome.Thus
cannotbeusedtoshieldordinaryincome.

35
VI.

AssignmentofIncome,theMarriagePenalty/Bonus,andthe
EITC
a. Lucasv.Earl(1930)Taxpayerhadacontractwithhis
wifetosplithisincome50/50.Purposeofthe
contractwastogettwostartsatthebottomforthe
progressivemarginaltaxrates.SCOTUSheldthatHas
theearnershouldbetaxedonalltheincomeandhe
couldNOTassignoftheliabilitytoWbycontract.
i. Holdingappliedtocommonlaw,noncommunity
propertystates.
b. Poev.Seaborn(1930)SamefactsasEarlexceptthat
the50/50splitcameviastateCommunitypropertylaw
NOTaprivatecontract.SCOTUSheldthateventhough
onlyHwasworkingtheywereallowed2startsfromthe
bottomoftheratestructurebecauseeachwasentitled
bylawtoashareofthecommunitysincome.
i. HoldingappliedtoCommunityPropertyStates.
c. In1948Congressrespondedbychangingtheruleso
everyonecangetthebenefitofPoev.Seabornby
creatingthemarriedfilingjointlystatus.
d. Thiscreatedasinglespenaltybecauseasingletax
payeronlygetsonestartfromthebottom,butthesame
taxpayerwillgettwostartsfromthebottomoncehe
getsmarried.
e. Marriagebonus=singlespenaltyandvicaverse.
f. In1969,Congresscreatedamodifiedratestructure
thatreducedbutdidNOTtotallyeliminatethesingles
penalty.
i. Italsocreatedamarriagepenaltyforsome
earners.
ii. GoalwasfundamentalCOUPLEEQUALITYsocouples
earningequalamountswouldfacethesametax
liability.
1. Disparateincomeearningcouplesusuallyget
aBonus,viatwostartsfromthebottom.
2. Coupleswithfairlyevensplitearningpower
usuallyhaveaPenaltybecauseinthehigher
bracketsthebreakpointsformarriedcouples
arelessthan2xthatforsingles.
a. Onlythe10%and15%taxbracketshave
theexactsamebreakpointof2xthe
singlerate.
iii. Threefundamentalandirreconcilablevalues:

36
1. Coupleequalityequalearningcouples
shouldhavethesametaxliability.
2. Marginalrateprogressivity.
3. Maritalstatusneutrality.
g. Gaypeoplemarriedunderstatelawaresinglefortax
purposespertheDefenseofMarriageAct(DOMA).
i. BusheraIRSChiefCounselMemoheldthatPoev.
Seabornonlyappliedformarriagesotaxhastobe
paidentirelybytheearnerandcannotbesplit
betweenacouple.
ii. 2010ChiefCounselmemoheldthatPoev.Seaborn
appliessogaycoupleswhohaveequalrightsto
incomeunderstateCPlawget2startsfromthe
bottomandmusteachreportofthecommunity
income.
1. NOTE:thiswilltriggeranautomaticaudit
whenonlyofW2incomeisreportedona
taxreturn.
h. EarnedIncomeTaxCredit(EITC)istheprincipalincome
transferprogramforlowincomehouseholdsintheUS
today.
i. Thisisawagesubsidy,whichcreatesanegative
marginaltaxrateviaarefundablecredit.The
moreonemakesthemoretheywillgetbackupto
apoint.
ii. Oncethethresholdpointiscrossed(variesbased
onmaritalstatusandnumberofkids)thecredit
willbephasedout,whichisthesameassaying
taxliabilityisgoingup.
iii. Dependingonthespecificfacts(ex.incomeand
numberofkids)theEITCcanconfereithera
marriagepenaltyorbonus.
VII. CapitalGainsandLosses
a. Capitalgainisgainfromthesaleofacapitalasset.
b. 1221definescapitalassetsaspropertyheldbythe
taxpayer.
i. Specificexemptionsincludeamongstotherthings:
inventory,realpropertyusedinatradeor
business,andcopyrights,whichthetaxpayer
producedvialabor[ex.wrotethebook].
c. 1(h)themaximumstatutoryrateforcapitalgainsis
15%,whichisappliedtotheNETCAPITALGAIN.

37
i. NetCapitalGain=[NetofLongTermCapitalGains
overLongTermCapitalLosses][NetofShort
TermCapitalGainsShortTermCapitalLosses].
1. Longtermcomesfromthesaleofcapital
assetsthatwereheldforoneyearorover.
2. Shorttermcomesfromthesaleofcapital
assetsthatwereheldforlessthanoneyear.
d. Netcapitallossescanonlyoffsetupto$3,000of
ordinaryincomeperyear,butexcesslossesthatare
NOTusedcanbecarriedforwardtosubsequenttax
years.
e. Ifatransactionischaracterizedasthesaleofa
capitalassetthenitwillbesubjecttothefavorable
capitalgainstaxrateANDthebasisoftheproperty
canbedeductedfromthesaleprice.
f. Womackv.Commissioner(2007)Courtheldthatbasedon
thesubstituteforordinaryincomedoctrinewhena
partyreceivesalumpsumpaymentasasubstitutefor
whatwouldhaveotherwisebeenreceivedatafuture
time,asordinaryincomethenthelumpsumwillbe
taxableasordinaryincomeaswell.
i. Thusthecourtheldthattherighttoreceive
lotterywinningswasNOTacapitalassetwithin
themeaningof1221becausetheproceedsare
taxedasordinaryincome.