CH 3 p.228
Deductions & Credits
Categories for determining tax deduction
availability/limitations:
1) “Above the line” deductions.
2) Itemized deductions (with various “floors”),
e.g., medical and charitable deductions (or, alternatively, the “standard
deduction”).
3) Miscellaneous deductions (for purposes of
the §67 two percent floor).
4) ALTMIN tax.
Deductions & Credits p.229
What is the availability of (1) business
and (2) investment deductions, including for losses from the activity:
See Code §§162, 212, 165; but, see Code §262.
Depreciation & amortization deductions
are also available: Code §§167 & 168. Presenting “timing” issues. See
Code § 263.
But, does a limit on these deductions apply
because of a possible personal element?
“Above the line” business expense deductions
p.228
§62(a) - deductions available towards
reaching adjusted gross income (AGI), including:
§62(a)(1) - trade/business expenses,
but not employee or investment expenses.
§62(a)(2) - certain employee trade or
business deductions as above-the-line items:
§162 deductions of performing artists;
§162 deductions that are reimbursed by
an employer.
Taxable Income Defined
§63
§63(a ) - Taxable income is gross
income
Less: deductions allowed
§63(b) Alternative: individuals who
do not itemize deductions: gross income less (1) standard deduction and (2)
deduction for personal exemptions
Impact of Miscellaneous Itemized Deduction
Status
1) 2% of AGI floor in §67.
2) Overall limit on
itemized deductions: Phase-out reduction specified in §68.
See §68(f) phaseout of
overall limitation.
& §68(g) re
termination (12-31-2009), but, subject to “sunset provision” (and restoration)?
3) Treatment as (alternative minimum
tax) ALTMIN items.
Do §67 and §68 constitute indirect
income tax rate increases?
CH 3-1 Deductibility of
Business Expenses p.229
1) §162 - deduction for ordinary and
necessary business expenses.
2) § 212 – individuals only:
§212(1) – expenses for the production or
collection of income
§212(2) – expenses for the management,
conservation or maintenance of property held for the production of income.
Deductibility Requirements
Welch vs. Helvering p.231
Welch paid debts of the former E.L.
Welch Company to improve his personal relationships with creditors of old Co.
Held: Payments by the taxpayer were not
ordinary (but were necessary?) business expenses (§162); but,
were these capital expenditures (extraordinary) for the development of
the “goodwill” of the business (and, therefore, not “personal”
expenses).
Gilliam v. Commr.
P.234 Business Expense?
Irrational/disoriented airline
passenger – on a business trip – arrested by Feds.
Acquitted by reason of temporary
insanity, but incurred legal fees to accomplish the acquittal. Does §262
preclude a business expense deduction?
Held: these expenses are not
ordinary to his (artist) trade or business.
Litigation Expenses – “Origin of Claim”
Doctrine
U.S. v. Gilmore (p. 236) & Code §212(2).
What deductibility of the husband’s expenses for attorney’s fees for his
successful resistance to wife’s community property claims in their divorce
proceeding?
The husband’s property consisted of interests
in three corps. holding auto dealerships.
“Origin of the claim” doctrine (here a
personal matter) applies to deny the income tax deduction.
Reasonable Allowance for Salaries -
§162(a)(1) p.237
Exacto Spring Corp. – reasonable
salary amount, to enable a business expense deduction?
Or, was the salary excessive
(therefore, in the closely held corp. context, a profits distribution)?
Dividend distribution?
Note here the analysis re percentage
of investment return to the shareholders.
7th Cir.: not
unreasonable compensation.
Note: “independent investor” test.
P.240
Additional compensation issues
What relevance of an absence of
dividend payments being made? P. 243
Is the repayment (pursuant to a
reimbursement agreement) of an excessive amount deductible?
§162(m) – re no deduction for
compensation in excess of $1 million – unless performance-based. P. 245. No
limit on other than executives (e.g., professionals). And, TARP recipients
(Supp).
Undercompensation issues – (1)
avoiding employment tax, and (2) shifting value in a family partnership.
Expenses Contrary to Public
Policy p.246
Tellier p.246 - legal
expenses incurred for (unsuccessful) criminal defense in a securities fraud
matter were deductible - arising from taxpayer’s business.
Should disallowance of a tax deduction
occur on public policy grounds in this situation? No.
This deduction enables a tax on “net
income.”
Public Policy Limitations
Tank Truck Rentals
p.248
Is the deductibility of fines
permitted for FIT purposes? No. See Code §162(f).
Sullivan p.249 - What
deductibility of the operating expenses of a “bookmaker” or a drug dealer?
See Code §280E. What about
deducting the cost of the drug dealer’s “inventory”?
Statutory Provisions and
Public Policy Issues p.249
Code §162(c) re illegal
bribes.
Code §162(f) re fines &
penalties. P.250.
Code §162(g) - 2/3rds of an antitrust
treble damage award.
Code §280E (p. 252) – no deductions re
activities in illegal drug trafficking. But, why enable a deduction for
inventory costs (and not other expenses)?
Loss deduction for theft is loser in
an illegal scheme? P. 251.
Public Policy and Lobbying
Expenses p.252
Code §162(e) provides for no deduction
for lobbying expenses incurred.
But, a deduction is available
for lobbying local political bodies.
No indirect deduction for lobbying
expenses by paying dues to a trade organization. Code §6033(e).
What relationship to one’s business is
required for deductibility?
Domestic Production
Deduction p.254
Deduction (under §199) to reduce tax
cost for domestic manufacturing activities.
Numerous prior invalid enactments
(under WTO/GATT) of export tax incentives.
Deduction is available for lesser of
9% of taxable income or qualified production costs. Effectively, a 3% tax rate
reduction.
What is qualified manufacturing
production?
Employee Business Expenses
p.255
An employee is
engaged in a trade or business & business expense is deductible.
The important issue is whether expense
is an “above the line” expense or an itemized deduction.
Reimbursed expenses are “above
the line” -§62(a)(2)(A). Substantiation is required.
Otherwise, an itemized deduction.
But not for performing artists -
§62(a)(2)(B).
Self-employed – “above the line”
expenses.
Deductions – Floor & Ceiling
p.255
§67 – two percent floor applicable to
“miscellaneous itemized deductions.”
These are primarily
investment interest expenses (not interest, taxes and charitable deductions
& medical expenses).
§68 – cap on certain itemized
deductions.
Some itemized deduction
reduced by 3% of excess AGI. Note phased-out repeal, but returning in 2013?
CH 3-2 Business &Investment vs. Personal
Expenses p.258
Fundamental issue: How distinguish
between business and personal when expenses are for consumption
purposes?
Include in gross income the value of
the personal satisfaction element (or preclude a deduction)?
Cf., allowing corporate officers to
fund large personal expenses disguised as business expenses? Equitable to the
“rank and file” workers who can not enjoy “business lunches,” etc .?
Pevsner v. Commr.
P.261
Employee of an upscale clothing store
was required to buy and wear high fashion clothing at work - “projecting the
image.”
She did not wear this clothing
after-hours.
A §162 business expense or a §262
personal cost?
Apply a subjective (personal
preference) or an objective test (general acceptability of this clothing)?
Held: Objective test is applicable (5th
Cir., reversing TC decision).
Other clothing situations
Policeman’s uniform?
Formal concert attire for a musician?
Golf attire for the professional
golfer (advertising a brand)?
Army fatigue uniform?
What about a “loan” of clothing from
the employer – as constituting gross income?
Assume all clothing to be inherently
personal? What effect of a presumption here?
Business Expense Deduction for Psychological
Assistance?
p.265 - Deduct the cost for advice for
one’s business activities – (1) management consultant; (2) when the advice is
to pray for success for the taxpayer’s business?
What if the advice is from a quacky
“business consultant”?
What if the assistance is from a
“personal trainer” or “personal coach” to increase one’s motivational level to
work hard as a law firm associate?
Child Care Costs as a Business
Expense p.266
Is the cost of child care to enable
one to go to work a deductible business expense? “But for” this cost the
parent would not be able to work – but this cost is still an inherently
personal expense. Cf., Gilmore (divorce).
Is this matter solved through tax
credits?
§21 – qualifying child care credit,
& phase-out.
§129 – exclusion from GI for
dependent care cost covered by the employer
§45F – employer tax credit
for child care facilities
Transportation Expenses
p.268 Cf., “travel expenses”
Transportation expenses are deductible
when traveling for business purposes. §162(a)(2).
Commuting is a nondeductible personal
cost.
Treatment of the cost for transporting
tools to work? Additional cost is deductible.
Commuting to a temporary
employment situation – Rev. Rul. 99-7, p. 270.
Further travel after reaching business
site?
Luxury water travel? §274(m) – limit
to twice the highest per diem allowable amount.
Food & Lodging Expenses
p.271
§162(a)(2) allows a deduction for
travel expenses incurred “while away from home in the pursuit of a trade or
business.”
Correll decision (p.271) – the “sleep
or rest” or “overnight” rule applies to enable eligibility to deduct food and
lodging costs.
What is “away from home”? What is the
“home” for this purpose? How far must one go to be “away from home”?
Hantzis case §162(a)(2)
summer law clerk p.272
Home in Boston but worked during
summer in NYC as summer clerk in a law firm.
Apartment cost in NYC incurred during
the week and the Boston-NYC transportation cost.
Tax Court says a deduction is
available; but, 1st Circuit says no deduction. Why?
§262 disallows a personal cost
deduction.
The temporary employment rule
necessitates a business location at the primary home.
What is a “home” for federal tax
purposes? P.278
Is (1) the personal residence, or (2)
the general location of business activities the situs from which to measure if
the taxpayer is “away from home” (for §162 purposes)?
What if no “tax home” exists?
See Henderson case –always “on the road”, p. 279.
The “two-earner” family scenario –
each spouse working at a different location.
Section 274 Limitations
p. 280
Foreign travel expense limitations -
§274(c); exception for less than one week.
Treatment of expenses to attend a
“foreign convention”? Deductible? §274(h)(1)&(3).
What is “foreign” for this purpose?
Caribbean countries? §274(h)(6) – part of North America if country has signed a
TIEA with US.
Travel as education? §274(m)(2).
Investment seminars - §212 &
§274(h)(7).
Luxury water transportation -
§274(m)(1).
Entertainment and Business Meals Moss
case p.281
Moss as a partner in a defense
litigation law firm. Partners met for lunch daily at Café Angelo and discussed
their cases at lunch.
Consider: a) Code §262 (no deduction
for personal expenses);
b) Code §119 (exclusion for meal
provided in kind on the premises); and,
c) Code §162(a) (ordinary and
necessary business expenses being deductible).
Code Limitations on the Deductibility of Meals
Code §274(k) - entertainment meal expenses –
can not be lavish or extravagant, and
the taxpayer or a taxpayer’s representative
must be present at the meal.
Code §274(n)(1) - only 50 percent
deductibility for meals;
Who bears this 50% limit burden? The
employee does if not reimbursed by employer.
Client Lunch p.285
Employer requires employee to take a
client to lunch. The client lunch is reimbursed by employer, but not for the
employee’s lunch.
Employer can deduct if the employee is
present at the client’s meal. §274(k)(1)(B). Assumes bona fide business
discussion satisfies the “associated with” test.
Expense Substantiation
Code §274(d) p.286
Documentation required: (1) time, (2)
place, (3) business purpose, (4) amount of the expense, and (5) the
relationship to any recipients of the entertainment.
Must have adequate contemporaneous
records. No estimates are permitted.
Cf., Merians case (& the Cohan
doctrine enabling low level estimates in § 212 expenses).
Certain per diem allowances are OK in
lieu of specific expense recordkeeping.
Entertainment Expenses
p. 286
Limitations on Code §162(a) deduction:
§274(a)(1)(B) entertainment facilities.
- including skyboxes - §274(l)(2)
§274(a)(3) club dues -
nondeductibility.
§274(a)(1)(A) activities.
(i) “directly related” requirement;
or
(ii) “associated with” requirement
&
“bona fide business discussion” of a
possible transaction must occur for deductibility.
Soliman case
p.289
Anesthesiologist with no office at a
hospital where he rendered services in the operating room.
He managed the business activities of
his practice from his home office (not meeting there with patients).
No home office expense deduction was
permitted.
Professional activities were conducted
at the hospital & the hospital was the principal place of business
for tax deduction purposes.
“Office in the Home” Deduction – Excess Loss?
Code §280A(a) disallows all §§162, 165, 167,
168 and 212 deductions for a home office or work area in a personal residence.
But, see Code §280A(c)(1) permitting a home
office deduction if exclusively used on a regular basis, such as
for meeting customers.
Deduction limited to gross income from
activity.
What if the office is the “principal office”
for a trade or business of the taxpayer? §280A(c)(1)(A).
Possible limit on §280A Deduction
§280A(c)(5) provides for limit on office in
the home deductions:
1) First deductions are those allocable to
statutory deductions (e.g., taxes and interest).
2) Additional deductions allocable to the
business use.
Possible carryover of unused deductions.
Possible limit on §280A Deduction
§280A(c)(5) provides for limit on office in
the home deductions:
1) First deductions are those allocable to
statutory deductions (e.g., taxes and interest).
2) Additional deductions allocable to the
business use.
Possible carryover of unused deductions.
Deductions limited to income from the
business activity.
Possible Deduction for a
Vacation Home p.293
Code §280A(a) provides rules limiting
deductions for costs of vacation homes:
1) Under 15 days rental use -
income and deductions both ignored; §280A(g). See the Tax Expenditure amount
re this item.
2) Over 14 days personal use -
limit on % of deductions for rental use; §280A(d)(1).
3) Rented more than 14 days, but less
than 14 day personal use, larger deductions.
Deduction limited for “Listed Property”
Limits on deductions for expenses for various
types of mixed use (business and personal) property under §280F:
1) Automobiles – except when weighing more
than 6,000 pounds: consider the Range Rover of the Hummer.
2) Cellphones.
CH 3-3 Business & Investment vs.
Capital p.294
Code §263 disallows a current
deduction for a “capital expenditure.” Note: Welch v. Helvering re extraordinary
costs – to be capitalized (not totally disallowed).
Tax policy choices re capital cost
recovery are:
1) Immediate deduction
2) Spread cost of item over the life
of the asset
3) Cost recovery upon final
disposition of asset.
Cf., consumption tax approach.
What Benefit Derived from Tax
Deferral? P.296-301
1) Equivalent to an interest free
loan from U.S. Treasury Dept.?
2) Equivalent to an income tax rate
reduction (or forgiveness)?
3) Exemption of income from
investment?
See present value tables (p.839),
e.g., obligation to pay $1 in ten years:
- Discount factors
- Future value
Conditions for Achieving this Income Tax
Benefit P.300
1) Income tax rates remain constant
(particularly no tax rate reduction in the future)
2) The current deduction is valuable
– i.e., it offsets taxpayer income at highest marginal tax rate.
3) The tax savings amount is actually
invested to produce a return at least equivalent to the original investment.
Capitalization Doctrine
p.301
What is the function of the “doctrine
of capitalization”? See IRC §263.
How identify the dividing line
between:
1) current expenses, and
2) capital expenditures
(requiring capitalization for tax purposes)?
Consider the non-relevance of
the capitalization doctrine in the consumption tax context.
Transaction Costs - Title Defense and
Protection Costs
Woodward v.
Commissioner,
p.302
Minority shareholders voted against an
extension of the corporation’s limited term charter.
Dissenters' rights cash-out valuation
proceeding. Appraisal proceeding to determine the fair value of the minority
owned shares.
Are these expenses for the minority
cash out proceeding to be capitalized? Yes, these costs incurred in
negotiating the purchase of the minority’s stock are capital costs.
Note: Broker’s fees for the
acquisition of listed stock are to be capitalized.
Cost of Producing Tangible Assets (&
Inventory)
Idaho Power Co.
case p.305
Self-created assets: Equipment used
for the construction of capital facilities. 10 year depreciation life for the
equipment used.
Is construction related
depreciation expense to be included in the tax basis of the constructed
asset? Cf., the income tax treatment of wage costs.
The result is the partial integration
of the asset (e.g., a segment of the construction equipment) into the construction
of another longer lived asset (e.g., the building with 40 year life).
Cf., a “turn key” lease construction
contract.
Code §263A p.306
Capitalization Provision
Capitalization is required – full
inclusion in (1) inventory costs and (2) the costs of other produced property.
What is “full inclusion”? Both (1)
direct costs and (2) indirect costs are to be included in the tax basis of the
produced property.
Compare the taxpayer’s objective: (1)
current deduction applied against ordinary income, and (2) increased capital
gain amount at the subsequent date of asset disposition.
Costs of Demolition
p.308
Land and building are acquired, with
the building to be immediately demolished.
Allocate some of the acquisition cost
to the basis of the acquired building and deduct this tax basis (as a loss)
when demolition then occurs?
Code §280B disallows the deduction and
requires an addition to tax basis for the land for any basis allocated to the
building.
Why? Was the entire purchase cost
really paid for the land?
Substantial Future Benefits
Indopco case p.309
Expenses incurred by a target
corporation (seller) in a friendly takeover.
Investment banker charged the seller
a valuation opinion fee of $2.2 million & also attorney’s fees.
The Tax Court and Third Circuit
treated these intangible expenditures as capital.
National Starch (Indopco) paid the
fee.
Expenses are to be capitalized, even
though no specific asset was created, since a “future benefit”
would be realized.
Here – really a dividend to
shareholders since a shareholders expense?
Indopco comparison – p.313 Hostile
Takeover Attempt
Assume amount was spent to defeat a hostile
takeover attempt. Note that Indopco was a “friendly takeover.”
Possibilities: (1) Success in
rejecting a hostile takeover – current deduction of these costs.
(2) No success in rejecting
hostile takeover – still deductibility for costs incurred by/for the target
(& target shareholders?)
Deductible cost for obtaining regular
advice to fight a hostile takeover attempt?
Indopco sequel – Rulings &
Regulations
Numerous IRS published rulings
(p.311-2) distinguishing the Indopco decision, including with respect to:
Employee training costs,
employment severance benefits, and advertising costs.
Subsequent Regs. § 1.263(a)-4 & 5
providing various exceptions from strict adherence to the Indopco “future
benefits” test for certain intangibles. What is the IRS authority to issue
these rulings & regulations?
Expenses for a New Business
Richmond TV p.314
Treatment of training expenses for
employees before the corp. “started to carry on a trade or business”? Richmond
case – not “carrying on” a trade or business.
Therefore, capitalize this
cost?
See Code §195 permitting amortization
of start-up expenses over 15 years. If no amortization permitted then frozen
cost until disposition.
Includes the expenditures incurred to
investigate or to create a business.
Treatment of Expenditures to Expand a
Business p.315-6
Central Texas S&L (5th
Cir) – expenditures to investigate and establish new bank branches - to be
treated as capital expenses.
Or, deduct immediately because merely
an expansion of an existing business, and this is what businesses do to
remain in business?
What about initiating new services
at the same location? E.g., credit cards or mortgage banking?
NCNB Corp. case – p. 316.
Nonrecurring Capital Outlays
p.317
Encyclopaedia Britannica - a “turnkey”
deal made for the preparation of an entire book for Britannica by
non-Britannica personnel.
Holding: Expenditures incurred to
create a book must be capitalized and then amortized.
Rejection of the argument that this
was part of a number of continuing projects and, therefore, that a “period
cost” concept was not necessary. Cf., advertising expense.
Cf., large oil co. where G&G
expenses are regularly incurred.
Deduction of Expenses of
Authors p.318
See Code §263A(h) providing a
deduction for “free lance” authors, photographers and artists for the costs
incurred in creating their products.
To qualify for the deduction the
person must be self-employed (or own most of the stock of a personal service
corporation).
What is a “qualified creative
expense”?
Can the artist deduct wages paid to
employees (e.g., researchers)?
Why provide this limited area
exception from the application of the doctrine of capitalization?
Deductible Repairs vs. Nondeductible
Improvements
Rev. Rul. 2001-4
p. 319
Aircraft “heavy maintenance” to
restore the equipment. Necessary to maintain an airworthiness certificate. Not
a material upgrade of the quality of the aircraft? Is the useful life of
the aircraft extended by this maintenance?
Reg. §1.162-4 deduction for the cost
of incidental repairs? Yes, in Situation 1, but not in Situation 2 (increased
value) & Situation 3 where material additions to aircraft.
Environmental Cleanup Costs
Capitalize? p.326
Rev. Rul. 94-38 – deduction for cleanup
of hazardous waste at manufacturing plant.
Rev. Rul. 98-25 cost of disposing of
leaking underground storage tanks as currently deductible. See §4081(a)(2)(B) -
LUST excise tax.
But, Rev. Rul. 2004-18 & Rev. Rul.
2005-42 – capitalization into inventory cost for environmental
remediation expenses at a manufacturing plant.
No deduction for cleanup when
purchasing contaminated property.
Job-seeking expenses
p.327
Rev. Rul. 75-120 - Expenses to seek
new employment in same trade or business are deductible.
But, expenses are not
deductible if seeking employment in a new trade or business.
What about the cost for seeking one’s first
job (e.g., after law school)? Not presently “in business” (but preparing to go
into business). At least permit amortization of some of this cost?
No deduction if seeking a job as a
political (or judicial) official – on public policy grounds?
Education Expenses
p. 329
Wassenar v. Commissioner - obtained an
LL.M. degree in taxation.
Deduction for expense for tuition,
etc., as an employee business expense? No.
Was he in a trade or business of
rendering services to employers? No.
IRS – he had not begun the practice of
law – an essential for this deduction. Not admitted to practice law before LLM
degree was pursued.
& Reg. §1.162-5(b)(3) – re new
trade or business.
Other Educational Expense
Issues p.335
Travel can not be treated as a deductible
educational cost. Code §274(m)(2).
No gross income from an employer’s
educational assistance program. Code §127.
To the individual - a deduction for
up to $4,000 for college tuition. Code §222. Education for business purpose
not required.
An AGI cap applies to the deduction,
with a “cliff” effect, rather than a phase-down.
Options to Deduct - Examples
p.335
§174 – an immediate deduction is
available for research and experimental expenditures. Alternatives: (1)
capitalize or (2) deduct over 5 years.
Why permit such a deduction? Who
benefits? Drug companies? Software companies?
§180 – deduction to farmers for
fertilizer used to improve land for planting crops.
CH 3-4 Recovery of Capital
Expenditures p.337
Depreciation deduction specified in Code
§§167 & 168 (re “accelerated cost recovery system” (ACRS)).
Basic objective: allocate the cost of a
depreciating item over its period of productivity (i.e., coordinate the cost
with the income production from the asset).
For federal income tax purposes how should
the cost (i.e., tax basis) for equipment, buildings, and intangibles (other
than financial instruments) be recovered (prior to their ultimate disposition)?
Factors Impacting Future Asset Value
Variations
1) Changes in the amount of
anticipated net receipts from asset utilization.
2) The applicable discount rate (when
increasing rate future values are less).
3) Timing of the anticipated receipts
(i.e., earlier or later).
4) The number of changes in future
receipts changes (increases or declines).
Rationale for the Tax Depreciation
Deduction
A depreciation deduction provides cost
recovery over the asset’s “useful life” (as prescribed in the Code). This
assumes a “useful life” is determinable for tax purposes.
An alternative to a depreciation system would
be to allow a tax deduction for the actual annual FMV decline (but the
property may not actually decline in fair market value in some years – it may
appreciate, and then?).
What Assets Are Depreciable?
P.337
Code §167(a) prescribes the statutory
allowance for depreciation:
1) property must be (1) “used in the trade
or business” (note §162), or (2) “held for the production of income” (note
§212), and
2) must be subject to “exhaustion, wear and
tear” (including obsolescence).
Raw land and corporate stock are not
depreciable assets for federal tax purposes (cf., economic value decline is
certainly possible).
Effect of the depreciation deduction on tax
basis
Depreciation reduces tax basis, but not if
disallowed as a tax deduction.
Personal use property does not cause a
reduction in tax basis. Should it? Inclusion if the use value is not included
in gross income?
Similar treatment if a Code §280F(a)
disallowance?
Code §1016(a)(2)(B) requires tax basis
reduction only if (excess) depreciation has reduced taxes. This constitutes a
“tax benefit” rule.
Code §168 - Depreciation
Deduction Issues p.338
Tangible property depreciation rules.
What amount is deductible? Consider:
1) Property class life classification -
§168(e).
2) Recovery period - §168(c).
3) Depreciation method (or rate) - §168(b);
straight line for real estate.
4) Applicable convention - §168(d) (1/2
year?).
Note: no salvage value is required -
§168(b)(4).
Methods for Accelerating the
Depreciation Deduction
1. Expensing of capital expenditures
(cf., the consumption tax approach).
2. Disregard salvage value.
3. Use shorter useful
lives than actual lives.
4. Use an accelerated
depreciation (or even straight line?) cost recovery structure.
Consider the benefits from a
depreciable tax basis derived from borrowed funds. E.g.: 90% debt; 50%
tax rate; & acc. depr., & Crane/Tufts.
Tangible personal property
depreciation computation
See Code §168(b)(3) concerning the
classification of property for establishing depreciation lives.
Code §168(b)(1)(A) requires the use of the
200% declining balance method (until switch-over to S.L. is preferable).
What is a “declining balance” method?
What is a “half-year convention”?
See Code/Regs volume - Rev. Proc. 87-57
(p.xv).
Example - $100,000 cost
See Rev. Proc. 87-57
Entire $100,000 cost is deductible. Seven
year class life; 5 year property. No §179. Depreciated under Code using the 200
percent declining balance method.
Year one depreciation is 20% x two
equals 40% x $100,000 equals $40,000; but the 1/2 year convention
produces $20,000 deduction. Year 2 - $32,000 ($80,000 balance x 40% (DDB)).
Also §168(k) 50% or 100% (2011) depreciation?
Real Property Depreciation
Computation
No depreciation is available for land (since
not a wasting asset). P.343
Residential real property or nonresidential
property depreciation:
- 27.5 years (residential), or,
- 39 years (nonresidential) recovery
periods. Code §168(c) & (e)(2).
Straight line depreciation. §168(b)(3).
A mid-month convention is applicable for the
year the asset is placed into service.
See Rev. Proc. 87-57.
Code §179 Deduction P.341
Special Limits P.L. 111-312
Immediate expensing for up to $500,000
of the cost of tangible business personal property (for 2010 and 2011);
$125,000 for 2012.
Reduction od deduction when investment
above $2.0 million (for 2010 & 2011); $500,000 for 2012.
Cost basis is reduced for this
depreciation expense.
Inflation adjustments after 2011;
§179(b)(6).
Limit specified of $25,000 for any
“sports utility vehicle” (e.g., Hummer). §179(b)(5). No limit if above 14,000
pounds weight!
Amortization of Intangibles
Newark Morning Ledger
P. 341 Allocation of part of the purchase
price for newspapers was allocated to the subscribers lists. How demonstrate
the useful lives? Apply a “mass asset” rule?
Treat as separate from goodwill?
Response: Code §197 - permitting (or requiring)
15 year amortization for intangibles (subject to certain exceptions).
Was Code §197 a “tax increase
provision”?
Simon vs. Commissioner
p.344
Depreciation deductions were claimed for
antique violin bows (use in business).
Under “ACRS” the taxpayers were permitted tax
depreciation of the bows.
“Recovery property” is defined to mean
tangible property of a character subject to depreciation. Actual life is not
important.
Dissent: no determinable useful life and no
actual loss in the value of the violin bow.
Query re Office Decorations
Office furnishings consists of:
1) antique furniture, and
2) Old masters paintings.
Is the cost for these items deductible
under Code §162 or depreciable under §167?
Code §280F Limitations
p.345 Cf. §179
Special limits apply to depreciation
for automobiles and certain tangible personal property used in business.
See §280F(a)(1)(A) limits for
automobiles; but, §280F(d)(5) defines “passenger automobile.” (+/- 6,000
pounds).
See §280F(b)(1) for further limits for
“listed property” when business use less than 50%.
See §280F(d)(4) for identification of
“listed property.”
CH 3-5
Depletion p.347
Do oil & gas deposits and hard mineral
deposits get exhausted, i.e. “depleted”?
Should cost recovery (of the tax basis) be
permitted for income tax purposes? A wasting asset?
How should this depletion be determined?
Note: Code §611 which permits a “reasonable allowance
for depletion.”
Depletion of Natural
Resources p.347
The total remaining tax basis must first be
established for those minerals expected to be extracted from the property.
Code §611 - cost depletion is
determined as (1) that proportion of the total tax basis which is attributable
to (2) the product extracted during the tax year. What happens when the cost
basis is completely recovered?
Percentage Depletion --
Deduct % of Revenue p.348
This deduction is based on a percentage of
the revenue from the minerals extracted (not cost).
The deduction cannot exceed a specified portion
of taxable income.
Not available for oil and gas, except for
small royalty owners and independent producers (and certain others). §613A.
The percentage depletion deduction continues after
tax basis has been reduced to zero.
Oil & Gas - IDCs & Exploration
Expenses p.349
Geological & geophysical (G&G)
costs to be capitalized?
Intangible drilling costs (IDCs) for
oil & gas wells are deductible. §263(c) & Reg. §1.612-4. Cf.,
exploration costs. But, §291(b) limit for corp.
Production: depletion and
depreciation (for equipment).
Potential recapture (as ordinary
income) when property is sold. §1254.
Treatment of abandonment/dry hole
costs?
Hard Minerals Exploration, etc.
Expenses p.349
§617 permits a current deduction of
hard mineral exploration expenses. Deducted expenses must be
“recaptured” when production commences.
What is a development expense?
Answer: The cost of preparing the mine site for production or extraction of the
hard mineral. See §616.
Further potential recapture (as
ordinary income) when property is sold. §1254.
Production & depletion allowance.
CH 3-6
Interest Expense p.350
What is “interest expense”? Rent for use of
money.
Deductibility for business interest?
Code §163(a). Cf., Code §162(a).
What is “business interest”? Cf.,
“investment interest.” Note §163(d). Purpose of this provision – to prevent
both a timing and character mismatch? No current income inclusion of the
accruing investment value & no deduction until recognition.
Cf., treatment of construction period
interest?
Code §263A(f). Remember the Idaho Power case.
State and Local Bond Interest Exemption
p.352
§103 provides exclusion for state and
local bond interest. Why? States’ rights concern?
What types of bonds are eligible for
exclusion?
What economic effect of this
exclusion?
Is the market efficient in
adjusting to this exclusion (e.g., is the tax-exempt interest rate 35% less
than rate on taxable bonds?)
Purpose of the §265(a)(2) prohibition
on interest expense deduction? Also, §264 re life insurance.
Cf., deduction for residence interest
expense.
No Deduction for Personal
Interest p.352
§163(h) – personal interest expense is
not (generally) deductible.
See the exceptions in §163(h)(2).
What about credit card interest, and
other debt, e.g., personal auto financing?
I.e., no moderation of the cost for
personal interest by the value of an income tax deduction.
Deduction for Home Mortgage Interest
p.353
Interest expense constitutes “rent”
for the use of borrowed money. Incentive to buy a home?
§163(a) - an interest expense deduction
is available; cf., §163(h)(1) providing that personal interest
(e.g., credit card debt interest) is not deductible.
But: No decrease in net wealth has
occurred - since no imputed income is included in gross income from the
(financed) property used for personal purposes.
“Qualified residence interest” defined
p.354
Code §163(h)(3).
1) Acquisition indebtedness - up to
a $1 million borrowing limit.
2) Home-equity indebtedness -
up to a $100,000 limit (limited to
equity value). No limit on the use of these funds.
What is a “qualified residence”? The
principal residence and one other home. §163(h)(4).
Tax subsidy to homeowners? A tax
expenditure?
Example One:
Home Equity Loan Limit
Purchased a home for 200x taking out a
mortgage for 160x (80%); subsequently borrowed 75x to finance a personal item.
A 2nd mortgage was provided, but primarily a “signature loan.”
The home equity loan limitation is 40x
(200x value less 160x existing debt).
Deduction for 40/75ths of this
interest expense. Deduction is not limited if “acquisition indebtedness.”
See §163(h)(4)(C) re
unenforceable debt.
Example Two:
Loan for Home Improvements
Purchased home for $200,000, taking
out a mortgage for $160,000 (80%); subsequently borrowed $75,000 to add home
improvements.
A 2nd mortgage was
provided, but primarily a signature loan. See §163(h)(4)(C).
Now, acquisition debt, and all the
interest expense is deductible (since below the maximum $1 million limitation
for acquisition debt). §163(h)(3)(B).
Interest Expense & Tax
Arbitrage p.356
How create a beneficial arbitrage
situation?
1) Borrow and deduct the interest
2) Exclude (or defer) income from the
asset purchased with borrowed funds.
See §§163(d) & 265(a)(2).
E.g., home mortgage interest
Knetch v. U.S.
“Sham” Treatment? p.360
Bought annuity bonds for $4 million,
paying interest at @2½%; and paid with $4 million nonrecourse notes. Interest
payable in advance and taxpayer paid first year’s $140,000 interest.
Taxpayer could borrow excess value
over debt and immediately borrowed most of the value and the prepaid interest
on this loan.
No real net value of bonds if
continued borrowing.
Held: Sham arrangement; no interest
expense deduction permitted. What statutory provision limits the §163
interest expense deduction?
Tax Avoidance Motive
Goldstein case, p. 363
Irish sweepstakes lottery winner:
Borrowed money at 4% and bought U.S.
Govt. obligations at 1.5%, and prepaid interest on the loan to claim a current
interest expense deduction.
Deduction for the prepaid interest was
not allowed because: no purpose of this arrangement other than to
receive an income tax deduction for the interest paid (to reduce current income
tax liability), enabling spread forward of income to average into lower tax
rates.
What is Interest Expense?
P.365
1) Definition: Rent for the use of
money?
What about late payment fees?
2) Distinguishing debt from equity:
p.366-7
In the corporate context - §385.
Distinguish dividends (15%) from interest (deductible, but 35% tax to interest
income recipient).
3) High-yield discount obligations –
part of “interest” are really a nondeductible dividend?
4) Equity “kicker” loans – p.368.
Debt or equity?
Inflation and the Interest Expense
Deduction p.369
How should the effect of inflation be
accounted for in the federal income tax system?
E.g., borrower: loan over extended
term can be paid with “cheaper dollars” if inflation dilutes the purchasing
power of the dollar.
What about tax losses for those
individuals who are “long” dollars (i.e., lenders)?
What are “TIPs”? Treasury Inflation
Protected Securities.
CH 3-7
Losses p.371
§165 provides for the deduction of certain
losses not covered by insurance (i.e., real economic losses). Cf., §§ 162
& 212.
Amount of the loss
deduction? §165(b) basis limit.
No deduction permitted for most personal
losses.
When do losses occur? P. 372 - need a
definitive/identifiable event to determine timing.
Cf., “worthless securities” vs. “paper
losses.”
Amount of the loss? Tax
basis - §165(b). P.373
Business/Investment vs. Personal
Losses p.375
No deduction for personal losses – other
than theft and casualty losses. IRC §165(c)(3).
What happens when a personal
residence is converted into a “rent house”? Example: Purchase at 100x;
declines to 70x at conversion to rental; sell for 50x.
What happens when the rent house
converted into the personal residence and sales loss is incurred?
What happens when portions are used
for (1) business and (2) personal purposes? Allocate the deduction
proportionately. P. 376 (airplane).
Gambling Losses
p.376 Remember Zarin?
No deduction available for gambling
losses - §165(d). A “separate basket” approach.
Limit on the
deduction of losses to the amount of gambling gains – during the tax
year.
How prove the gambling losses? E.g.,
when incurred at the racetrack? Or, the gambling tables at Las Vegas?
What about the tax treatment of “professional
gamblers”? E.g., Groetzinger (p. 377).
Expenses are deductible (including a
NOL deduction?), but not the net gambling
losses.
Hobby Losses – Deductible or Personal
Expense? p.378
§183 limits hobby loss deductions.
How determine that an adequate “profit
motive” exists to avoid §183 (and obtain § 165 deduction)?
Plunkett, p.379 –mud racing &
truck pulling.
Did he have an objective of making
a profit?
See Reg. §1.183-2(b) factors – at p.
380.
Here “not engaged in for profit” – an
amateur and not a pro? Cf., truck-pulling for profit.
Note: §183(d) presumption (3 of 5 as
gain years).
Deduction to extent of income? Which
deductions?
Casualty Losses
p.383
Section 165(c)(3) provides for a
deduction for certain personal losses: fire, storm, shipwreck, or other
casualty, or from theft.
Subject to a 10% floor & a $100
limit. What is the purpose of the 10% floor?
What is a casualty loss? A
sudden loss?
- jewelry loss?
- fast-eating termites?
Require an insurance claim? See §
165(h)(5)(E).
Amount of a Casualty Loss
p.386
Reg. §1.165-7(b) – the amount
of the deduction is limited to the lesser of the asset’s fair market
value or tax basis (where a depreciated asset).
Consider the appreciated property lost
in a casualty – deduction is limited to tax basis. §165(b).
No loss if an insurance recovery?
Possible casualty gain (with
insurance proceeds)?
Consider the Madoff scams – what
income tax effect? Theft loss & deduction available?
Protecting Against Abuses re
Realization p.388
Fender case – p.388. Sale by
trusts.
Sale of depreciated, unrated bonds to
a friendly (noncontrolled) bank and the repurchase of these bonds for the same
amount 42 days later (when seller then a bank controlled by buyer).
Sale made to generate losses to offset
realized gains.
Statutory limitation provisions not
applicable: §267 (related parties) & §1091 (wash loss rule).
But, here a tax “common law”
rule – no real economic loss and, therefore, no realized tax loss.
Code Limitations on Losses
p.391
1) §267 – disallowance of losses on
sales between certain related parties. Seller’s loss is permanently lost
(§267(d)), but tax basis protection on the upside is provided.
What about a sale through an
intermediary?
2) §1091 – wash sales rules – p.392.
Sale and purchase of substantially
identical securities within a 30 day period precludes loss deduction. But, a
tax basis adjustment is available so the loss is not lost forever.
No prohibition against the recognition
of gain, and the immediate buy back of the asset sold.
Tax Shelter Losses
p.393
Objective of a “tax shelter”
investment: generate tax losses (but not real economic losses) which can
offset other ordinary taxable income. Remember the Tufts case!
Investment vehicle as an LP or an LLC
– for limitation of liability and conduit income tax treatment.
What is an “abusive tax
shelter”? P.394
Note re “playing the audit
lottery.”
Tax Shelter Objectives
p.395
1) Income shifting (to low/no taxed
taxpayer)
2) Exemption of income, e.g.,
qualified plans
3) Deferral of income recognition or
acceleration of deductions
4) Conversion from ordinary income
into capital gain (tax rate arbitrage).
5) Leverage – debt is included in tax
basis - remember the Tufts case (nonrecourse debt).
What is a “negative tax rate”?
Frank Lyon Co. case
p.398
Lyon owned a building leased to Worthen
Bank.
(1) Sale and (3) leaseback and (3) a
purchase option held by lessee at the end of the certain terms at a set price
(not the then FMV).
Option prices (at various intervals)
equaled the then unpaid mortgage balance plus 6% return on Lyons 500x investment.
Only the building (not land) owned by
Lyon.
IRS says Lyon not the true owner, but
Sup. Ct. says Lyon is the owner. Correct result?
“At-Risk Limitation” Rule
§465 p.413
Loss deduction is available only to
the extent of the amount economically at investment risk.
“At risk” is only to the extent of:
(1) cash investment, (2) tax basis of contributed property, (3) personal
liability debt, and (4) other assets securing nonrecourse borrowings.
Deduction limitation rules, not
a tax basis rule (e.g., the Crane doctrine – basis includes debt - is
not impacted).
Passive Loss Limitation
§469 p.414
Passive activity losses in excess of
passive activity income are not deductible.
Passive activity: (1) taxpayer does
not “materially participate,” and (2) rentals.
“Material participation” where 500+
hours spent on the activity. Not a ltd. partner.
Special §469(i) $25,000 loss allowance
rule.
Passive activity income not
including portfolio income.
CH 3-8
Bad Debts p.418
§166(a) – a business bad debt
deduction is treated in full as an ordinary loss; a nonbusiness
bad debt is deductible as a short term capital loss (i.e., against
capital gains, plus $3,000).
How differentiate? See Generes case (p.418)
re the business or non-business debt choice – not lending to save job. Note
“facts & circumstances” analysis.
Cf., the business of money lending with the
bad debts being incurred as “business bad debts.”
Loans to Friends and Family
p.419
Loan or gift to a family member? How
document the loan – promissory note and a market rate interest and an actual
payment of interest by the debtor?
What about a loan “guarantee”? Cf.,
(1) trade or business guarantee, (2) transaction for profit, or (3)
personal/family situation guarantee.
Cf., Code §271 – no deduction for bad
loans made to political organizations (unless a bona fide sale to the
organization). Why?
CH 3-9 p.421
Personal Deductions
Standard deduction – §63(c) - as
indexed for inflation for (1) joint return ($11,900) for 2012, (2) head
of household ($8,700), (3) unmarried individuals ($5,950), and (4) married
filing separately ($5,950, & neither spouse can itemize). Rev Proc.
2011-52.
Objective of the standard deduction - tax
administration simplification (including removing some from income tax
liability) & tax rate adjustment.
The Personal Exemption
p.424
§151 provides for a personal exemption
- $3,800 for the year 2012 (after indexation). And, for spouse.
And, an exemption for each
“dependent.”
§152 defines “dependent” – children
and other relatives - & over ½ support provided.
How allocate exemption in a divorce
situation? What assumption for the custodial parent?
What is the usefulness of a “multiple
support agreement”? See §152(d)(3).
Child Tax Credit
p.425
§24 – provides a $1,000 credit for
each qualifying child under age 17.
Subject to a phase-out when “modified
adjusted gross income” is above a “threshold amount.”
A portion of the credit is refundable
– computation based on a $3,000 value for the year 2012. See Rev. Proc.
2011-52.
No credit unless name of child and ID
number included on the return. §24(e).
Subject to “sunset provision” as of
12-31-2011.
Earned Income Tax Credit
p. 427
A “refundable credit” – i.e., file a
tax return and get a rebate (even with no income tax liability).
§32 provides for allowance of the
credit – amount depends upon (1) the number of dependent children and (2)
income limitations/phaseouts.
Objective – reduce Social Security
taxes on the poor? A pro-work incentive? Cf., welfare payments.
Subject to phase-out. See Rev. Proc.
2011-52.
Credit for Elderly & Disabled
p.428
§22 – provides a credit for the
elderly and the disabled – up to 15% of the §22 amount.
This amount is $7,500 for a joint
return.
Subject to reduction for Social
Security and pension benefits which are excluded from gross income.
CH 3-10 Personal Itemized
Deductions p.430
Identifying these itemized deductions:
1) Taxes - §164
2) Charitable contributions - §170
3) Medical expenses - §213
Not related to business
or investment activities.
See the §68 limitation on itemized
deductions – reduced by 3% of excess of AGI over $100,000 (except phase-out in
2010, i.e., after 2009; §68(f)). This repeal sunsets after 12-31-2012.
Taxes - Deduction & Foreign Tax
Credit p.431
§164 – provides for a deduction for
certain taxes paid to state and local governments and to foreign governments.
Includes these taxes paid for (1)
business purposes, (2) investment property, and (3) personal purposes.
Including property taxes (on
the owner, not the renter), state income taxes, but not federal taxes
(§275), and not sales taxes; but, cf. §164(b)(5)(A) phased out in
2012? See later slide.
Is this a form of “revenue sharing”
with states?
Significant cost to U.S.? See Tax
Expenditure list.
State and Local Property and Income
Taxes
1) State and local (personal &
real) property taxes are deductible - even though related to personal
consumption items. Property taxes are based on ownership - but are not
imposed at the federal level. Is this local property tax equivalent to a
wealth tax (therefore not permitted for U.S. tax)?
2) State and local income taxes are
deductible (even non-business tax). Does Texas have an “income tax”? What
about the “margins” tax on certain businesses?
Problem:
Who Has the Deduction?
Parent pays real estate taxes incurred
by daughter. Who has the tax deduction for these taxes?
Taxes are only deductible by the
person upon whom they are legally imposed. Reg. §1.164-1(a).
Treat this payment of the daughter’s
real estate tax as (1) a gift to daughter (not included in her gross income,
§102), and, (2) for income tax deduction purposes, as if the real estate taxes
are actually paid by the daughter?
Problem: Year of Sale – Assume $1,200
Property Tax
Sale of residential real estate is made
1/4th through the tax year. Actual tax payment made in year 2.
Proportionately allocate the $1,200
real estate taxes to the seller and the buyer?
Seller deducts $300 (even though no
actual direct payment of taxes) for year 1. See Code §164(d)(2)(A).
How determine the amounts?
Buyer deducts the remaining $900 when
paid.
Actual calculation is made on a daily
basis.
State & Local Sales Taxes
Code §164(a) Deduction
Sales taxes are not deductible -
unless paid to purchase investment or business property.
If incurred on the purchase of
business property, sales taxes are then either:
(1) capitalized, or (2) a business
expense.
But consider the 2004
Jobs Tax Act: An election is available to deduct sales tax in lieu of astate
income tax deduction. Further extension from 2005 through 2011? §164(b)(5)(I).
How determine the amount? Provide
specific receipts or use the IRS tables (§164(b)(5)(H)) & document the big
ticket purchases (e.g., auto).
Problem: Texas Sales Tax on Auto Purchase
A $2,000 state sales tax is paid upon
a $40,000 automobile purchase.
First question: Is the automobile to
be used for personal or business purposes? If used for a business asset
acquisition, add the sales tax expense to the depreciable tax basis for the
automobile.
If only personal usage, possible
deduction of state sales tax in Texas (2004-2011?), since no state income tax
is (or can be) applicable?
U.S. Tax Treatment of Foreign Taxes Paid
p.433
Is a deduction or a credit
available? §27 credit.
§901 - a dollar for dollar credit
is available against the U.S. income tax liability of U.S. citizens and
residents for foreign tax paid.
Residue (if any) is taxed in the
United States.
The residence jurisdiction
recognizes the primary taxing rights in the source jurisdiction.
What if the foreign income tax
rate is higher? Possible territorial exemption? Continued
Limit on Credit Amount for Foreign Income Tax
Paid
A limitation is applicable if the foreign
income tax rate is higher than U.S. income tax rate.
Example: Foreign tax rate is 50%;
& income is 100x foreign and
100x U.S. source.
Options: 1) No limit
2) Limit on credit
Income 200 200
U.S. tax (35%) 70 70
Foreign tax credit 50
35
Net U.S tax 20
35
Charitable Contributions
Tax Issues p.435
Code §170 deduction issues
summarized:
1) Is the recipient
eligible to receive a tax deductible charitable contribution?
2) Is a percentage limitation
applicable to the tax deduction amount?
3) What is the type of donated
property and is any special percentage or other limitation
applicable to the tax deduction because of the type?
4) What is the specific type of
eligible charitable donee?
Mechanics of the Limit on Contributions
Deduction
Percentage
Limitations on this Deduction:
1) 50 percent of the
contribution base.
Public charities -
§170(b)(1)(B)
2) 30 percent or a lesser
percentage.
Appreciated property
(but 50% election?)
A “ceiling” rather than a “floor.”
Important Variables
in Making Deductible Charitable Contributions:
1) cash or other property?
2) is the donee a public or a private
charity?
Is
the charitable contribution tax deduction justified?
Is the charitable contribution really
a consumption item for federal income tax purposes?
Is the charitable contribution a
substitute for direct governmental support?
What other reasons exist for allowing
a charitable contributions federal income tax deduction?
E.g., to facilitate wealth redistribution?
E.g., to circumvent U.S.
Constitution concerns?
Is this deduction a “tax expenditure”
item?
What effect of any increased or any
decreased income tax rates on contribution behavior?
Defining a “charitable contribution”
“Quid pro quo” analysis – Are
charitable contributions made? Hernandez case, p.436
Payments were made to the Church of
Scientology to obtain services such as "auditing" and
"training,” based on the Scientology "doctrine of exchange.”
Held: An identifiable benefit
was received & no income tax deduction was available.
Correct result? Note subsequent
provisions: §§170(f)(8) & 6115.
Athletic “Booster Club”
p.444
Consider opportunity to purchase
scarce college football tickets (at certain state universities!).
See §170(l). What is the origin of
this provision? Cf., Codification vs. only a “Public Law” provision specifying
full deduction availability.
How value the “opportunity” to
purchase football tickets as made available to the donor by the donee
university?
What if the team has a losing record
and the sports “entertainment” value at the games is limited?
Services Contribution
p.446 cf., Haverly case
Contribution of services to
charity.
No deduction is available for the
value of the contributed services. Reg. §1.170A-1(g).
A deduction would produce a double tax
benefit since the value of the services is not included in donor’s gross income
(under §61(a)) .
Cf., the deduction rule for the
charitable contribution of certain appreciated property to certain
charities. P. 447.
But, §170(j) re travel expenses
deduction.
Appreciated Property Given to Charity - §170(e)
Alternative situations:
1) Gift of appreciated stock
to a public charity. Treatment of the appreciation?
2) Tangible personal property:
(used car?, p.451)
- for “the use of” the charity -
§170(e)(1)(B)(i).
- not “for the use of” the
charity
- self-created asset donated
to charity
3) Appreciated stock/other property to
a private charitable foundation. Note §170(e)(5).
4) If not long term capital
gain property.
Example: Self-created Asset Donated to
Charity
Painter donates his own self-created
painting to the charity auction. 20x tax basis & 300x FMV.
See Code §1221(a)(3). Not a
capital asset (since self-created). Sale would produce ordinary income.
Donor can deduct only to the extent of
the donor’s tax basis for the self-created asset. See Code
§170(e)(1)(A).
Cf., gift of one’s personal &
business papers to charity? See §1221(a)(3).
Art Work Not Self-created
Contributed to Charity
Art work created by the donor’s father
& donated to charity for auction (sale).
Inherited when property FMV was
$20,000.
$60,000 FMV when contributed, but
property is sold at auction for $40,000. Contributions deduction for $60,000 (or
$40,000 or $20,000)? Holding period? Gain to donor from the sale?
Note: the used automobile (&
boat) gift to charity gambit. See §170(f)(12) .
Charitable Gifts of
Partial Interests
Tangible personal property -
Remainder interest gift -
See Code §170(a)(3), restricting a current deduction.
Trusts, etc. - Code §170(f)
limitations re partial interest gifts -
1) Income interest to charity.
§170(f)(2)(B).
2) Remainder interests to charity -
CRATs & CRUTs. §170(f)(2)(A) & §664(d)).
3) Charity remainder in a residence
or farm. §170(f)(3)(B).
Substantiation of Charitable Gifts
p.447
What notice from the charity to the
donor?
How treat gifts to a charity to be
used as a charitable auction item?
Documentation required. E.g., §170(f)(12)
re cars and boats. Blue-book value? Basis limit?
Clothing - §170(f)(16).
Gifts of fractional interests, e.g.,
in a valuable painting. §170(o).
Conservation easements - §170(h).
Bargain Sale to Charity
Code §1011(b)
Example: Property fmv is 10x.
Tax basis is 4x; sale to charity
for 4x.
Charitable deduction under §170 is 6x.
Is gain also to be recognized on this
“sale”? In what amount? A proportionate tax basis allocation is
required: 4x sale less 1.6x basis (4x basis x 40% as sale portion = 1.6) = 2.4
net gain. Why?
Cf, the intrafamily bargain sale
tax basis allocation rule (basis offsets all proceeds). Why different?
Charitable, Tax-Exempt Organizations
Identified
Types of §§170(c)/501(c)(3) entities:
- publicly supported charity
- private charitable
foundation (§509)
small group of
contributors &
distributes its funds to
other charities.
- private “operating”
charitable foundation directly carries on charitable
activities (§4942(j)(3))
What enables tax-exempt, charitable
status? Cf., Bob Jones University case, p. 454.
Medical Expense
§213 Deduction p.455
Medical expense is a uniquely personal
cost, but the cost is (partially) deductible. Why?
Is the expense not a consumption item?
Consider the “tax expenditure” cost of
deduction.
Code §213(a) - provides a deduction
for medical expenses in excess of 7.5% of the taxpayer’s “adjusted gross
income.” 10% floor after 2012 (Patient Protection and Affordable Care Act,
2010) for persons above 65. §213(f).
(why ?, see next slide)
Why is a 7.5% floor imposed on the available
deduction?
No deduction is available unless an extraordinary
reduction of wealth has occurred (presumably above the 7.5% of AGI level).
Cf., §165(h)(2) 10% loss floor (& future 10% floor for §213).
Otherwise, the expense is equivalent
to an ordinary expenditure for living expenses.
Note: this deduction is (when
available) more valuable to higher bracket taxpayers (i.e., regressive effect
applies). Upside/down effect for the value of this deduction?
Defining the term
“medical care” P.456
Code §213(d)(1)(A).
Amounts paid for diagnosis, cure,
mitigation, treatment, or prevention of disease.
Not for some cosmetic surgery - note
the Code §213(d)(9) limitation. Is a “business expense” deduction available
as an alternative (since not treated as deductible for medical care)? No?
Or, is a depreciation deduction available?
Definition of Medical Care, continued
Stop smoking program expense as
deductible? yes, Rev. Rul. 99-28.
Birth control pills? “Quality of
life” drugs: Prozac? Viagra? Marijuana? (in California, where legal?)
Anti-baldness drugs? See Code §213(b) & (d)(3) re prescribed drugs.
Psychological counseling?
Additions to a residence -capital
improvements
See Rev. Rul. 87-106, p. 456
Are the following “medical expenses”
for deduction purposes:
An elevator in the home?
A swimming pool at home? P.458
A weight room & sauna?
A tennis court?
What if the expense produces an
increase in the value of the property?
Other expenses - medical expense
deductibility?
Transportation. Code §213(d)(1)(B).
Lodging. Code §213(d)(2).
not lavish: $50 per night
limit.
Travel from the cold north to a warm
weather environment in the winter (with a doctor’s prescription)?
Medical insurance premiums as
deductible/excludible?
Deduction for medical insurance
premiums.
Code §213(d)(1)(D), (6) &
(7).
Self-employed coverage costs -
§162(l).
Medicare contributions.
Code §213(d)(1)(D).
Long term care premiums.
Code §213(d)(1)(C) & (10).
Exclusion – next
slide
Gross income -
exclusion from GI items
Code §106 - an exclusion from gross
income is available for the value of employer provided health insurance.
Code §105(b) - an exclusion from gross
income is available for the value of free medical care or reimbursement.
Options for Funding a Health Care System
1) Cash grants to hospitals.
2) Medical research assistance.
3) Tax deductions for contributions to
hospitals and research organizations.
4) Deductions for medical expenses -
benefit for the wealthiest taxpayers and, therefore, a regressive impact in the
tax system?
5) Others? Health savings account
(HSA)?
i.e., before-tax dollars (cf,
§401(k) plan).