Ebook Concepts in federal taxation (2012 edition): Part 2

(BQ) Part 2 book Concepts in federal taxation has contents: Acquisitions of property, property dispositions, nonrecognition transactions, choice of business entity—other considerations, choice of business entity—operations and distributions,...and other contents.

P A R T IV Property Transactions CHAPTER Acquisitions of Property p 9-3 CHAPTER 10 Cost Recovery on Property: Depreciation, Depletion, and Amortization p 10-1 Monkey Business Images, 2009/Used under license from Shutterstock.com CHAPTER 11 Property Dispositions p 11-1 CHAPTER 12 Nonrecognition Transactions p 12-1 Virtually all persons or objects in this country may have tax problems Every day the economy generates thousands of sales, loans, gifts, purchases, leases wills and the like, which suggests the possibility of tax problems for somebody Our economy is tax relevant in almost every detail —Potter Stewart This page intentionally left blank CHAPTER Acquisitions of Property LEARNING OBJECTIVES Distinguish and define different types and classes of property Discuss the tax aspects of various ways to purchase the assets of a business Provide an overview of the property investment cycle from acquisition through disposition, and discuss the tax problems encountered throughout the cycle Describe the rules for determining the initial basis of gift property, inherited property, and personal use property converted to business use property Explain the calculation of a property’s adjusted basis Explain the tax problems associated with determining the initial basis of securities Distinguish a realized from a recognized gain or loss on a disposition of property Explain how to determine the initial basis of purchased property CONCEPT REVIEW GENERAL CONCEPTS Arm’s-length transaction A transaction in which all parties have bargained in good faith and for their individual benefit, not for the benefit of the transaction group p 2-4 Related party Family members and corporations that are owned by family members are considered related parties, as are certain other relationships between entities in which the power to control the substance of a transaction is evidenced through majority ownership p 2-4 ACCOUNTING CONCEPTS Accounting method A taxpayer must adopt an accounting method that clearly reflects income p 2-9 Annual accounting period All entities must report the results of their operations on an annual basis (the tax year) Each tax year stands on its own, apart from other tax years p 2-9 Conduit entity An entity whose tax attributes flow through to its owners for tax purposes p 2-6 Entity All items of income, deduction, and so on are traced to the tax unit responsible for the item p 2-6 Substance-over-form doctrine Transactions are to be taxed according to their true intention rather than some form that may have been contrived p 2-11 INCOME CONCEPTS All-inclusive income All income received is taxable unless a specific provision in the tax law either excludes the income from taxation or defers its recognition to a future tax year p 2-12 Capital recovery No income is realized until the taxpayer receives more than the amount invested to produce the income The amount invested in an asset represents the maximum amount recoverable p 2-20 Legislative grace Any tax relief provided is the result of a specific act of Congress that must be strictly applied and interpreted All income received is taxable unless a specific provision in the tax law excludes the income from taxation Deductions must be approached with the philosophy that nothing is deductible unless a provision in the tax law allows the deduction p 2-12 Realization No income or loss is recognized until it has been realized A realization involves a change in the form and/or the substance of a taxpayer’s property rights that results from an arm’s-length transaction p 2-14 DEDUCTION CONCEPTS Basis The amount of unrecovered investment in an asset As amounts are expended and/or recovered relative to an asset over time, the basis is adjusted in consideration of such changes The adjusted basis of an asset is the original basis, plus or minus the changes in the amount of unrecovered investment pp 2-13, 2-21 Business purpose To be deductible, an expenditure or a loss must have a business or other economic purpose that exceeds any tax avoidance motive The primary motive for the transaction must be to make a profit p 2-18 9-4 Part IV Property Transactions Introduction CHAPTER discussed the general criteria for deducting expenses Expenses incurred in a trade or business, for the production of income, and certain personal expenditures are deductible when they are paid or incurred However, expenditures incurred in these activities that provide benefits that extend significantly beyond the end of the tax year cannot be deducted as a current expense These expenditures, which provide long-lived benefits, are called capital expenditures Thus, capital expenditures result in assets that provide economic or personal benefits that extend significantly beyond the end of the accounting period in which the expenditure is made The term property is used in taxation to refer to long-lived assets that are owned by a taxpayer Throughout the remaining chapters, the terms property and asset are used interchangeably to mean anything owned or possessed by a taxpayer The capital recovery concept provides the foundation for the tax accounting for property According to this concept, the amount invested in an asset is recovered tax-free before the taxpayer realizes any taxable income from the property investment The two basic methods of recovering the capital invested in an asset are by deducting a portion of the cost of the asset against income during the life of the asset (e.g., through depreciation deductions) and by offsetting the invested amount against any amounts realized from the disposition of the asset at the end of its period of use The amount of investment in an asset is the asset’s basis An asset’s basis establishes the initial amount of capital investment that can be recovered tax-free as a capital recovery It is used to determine the amount of any annual deductions allowed for depreciation, and it represents the amount of unrecovered capital for determining gain or loss upon the disposition of the asset Therefore, determining the correct basis of property is essential to properly account for the tax effects of investments in property The next four chapters discuss the tax aspects related to the acquisition, use, and disposition of property This chapter begins with a discussion of the different classes of property and their characteristics An overview of the property investment cycle is discussed next; it provides the framework for the study of Chapters through Chapter 12 The remainder of the chapter deals with problems involved in determining the initial basis of property when it is acquired Classes of Property For tax purposes, property is classified by both its use and its type The use of property determines whether deductions are allowed for current-year expenditures (i.e., repairs, maintenance) relating to the property and for capital recovery deductions for depreciation, depletion, or amortization To take any deductions relating to property, the property must have a business purpose: It must be used in a trade or business or held for the production of income This is the general requirement for deductibility of expenses discussed in Chapter Deductions for expenditures on property that is held for purely personal use are not generally allowed Only those specifically allowed expenditures (discussed in Chapter 8) on personal use property, such as property taxes and home mortgage interest, are deductible In addition, only casualty and theft losses on personal use property are deductible Thus, proper classification of the use of an asset is essential in determining the effect of the property on taxable income LO1 Distinguish and define different types and classes of property E x a m p l e Ellen, a physician, purchases a television for her patients to watch while they wait for their appointments What is the proper classification of the television for Ellen? D i s c u s s i o n : Because the television is used in relation to Ellen’s business, it is classified as property used in a trade or business She may deduct any annual expenditures made relative to the television as ordinary and necessary business expenses In addition, Ellen may deduct the appropriate amount of depreciation on the television during its tax life E x a m p l e When Ellen purchased the television in example 1, she purchased another tel- evision that she put in her family room at home What is the proper classification of the second television set? D i s c u s s i o n : The second television is used for personal purposes and therefore is a personal use asset Ellen is not allowed any deductions for expenditures made relative to the second television, nor is she allowed to depreciate the television because it is a personal use asset CHAPTER Acquisitions of Property As these examples illustrate, the use of the property, not the type of property, is the key factor in determining deductibility That is, any property can be used in any of the three basic categories: trade or business, production of income, or personal use In addition, a single property may be used in more than one category Such property is referred to as a mixed-use property (also called mixed-use asset) Proper accounting for mixed-use property requires a reasonable allocation of costs among the uses of the property E x a m p l e Don purchases a duplex for $80,000 He lives in unit and rents out the other How should Don account for the duplex? D i s c u s s i o n : The duplex is mixed-use property The unit Don lives in is a personal use asset and must be accounted for separately from the unit that is rented Don is allowed an itemized deduction only for the interest and property taxes from the personal use unit However, on the rental unit, he can deduct all ordinary and necessary expenses of maintaining the unit For example, if Don pays the utility bill of both units, only the portion that is reasonably allocable to the rental unit is deductible In addition, Don may take the allowed depreciation deductions on the rental unit but is not allowed any depreciation deduction on the personal unit The type of property also affects the deductions allowed during the period the property is used All property may be classified as tangible property or intangible property Tangible property is any property that has a physical existence That is, tangible property has form, shape, and substance Land, buildings, machinery, equipment, automobiles, and furniture are all examples of tangible property Intangible property lacks any physical characteristics and exists only because of economic rights the property possesses Stocks, bonds, copyrights, trademarks, goodwill, and patents are examples of intangible property Tangible property is broken down further for tax purposes into real property and personal property Real property consists of land and any structures permanently attached to land A building and its structural components, such as the air-conditioning system, electrical wiring, and an elevator, are considered real property Real property is often referred to as real estate or realty, and the terms are used interchangeably Personal property is any tangible property that is not real property Machinery, equipment, livestock, automobiles, computers, and paintings are all examples of personal property Personal property is often referred to as personalty, and the terms are used interchangeably Personal property is a type of property that is different from personal use property, which is a use of property The type of property should not be confused with its use In contrast with the use of property, the type of property does not change from taxpayer to taxpayer That is, land is always real property, and a computer is always personal property, regardless of the use of the property The type of property determines such things as the amount of allowable depreciation on it Personal property generally has a shorter useful life than real property, and the amount and timing of the depreciation deductions on the two properties are adjusted for the difference in useful lives The allowable depreciation methods for different types of property are discussed in Chapter 10 Property type is also important in determining the tax effects of property dispositions As will be discussed in Chapter 11, depreciable real property and depreciable personal property are subject to special rules that reclassify income from capital gain income to ordinary income at disposition The type of property determines the amount of the gain that is reclassified Table 9–1 provides a summary of the different types of property Generating income involves the acquisition and use of property to produce that income That is, businesses acquire factories, equipment, supplies, and so on to produce products that are sold to generate income Similarly, investors purchase stocks and bonds to produce dividend and interest income as well as appreciation in the value of the security Individuals acquire homes, furniture, clothing, and automobiles that they use in their personal activities Acquisition of property begins a property investment cycle that has income tax effects throughout the period in which the taxpayer uses the property The property investment cycle and the tax accounting related to it are illustrated in Figure 9–1 In the top panel of Figure 9–1, the investment process begins with acquisition The Property Investment Cycle 9-5 9-6 Part IV Property Transactions TABLE 9–1 SUMMARY OF PROPERTY TYPES Type of Property Property Characteristics Personal property (Personalty) Real property (Real estate) (Realty) Intangible property Personal use property Property that has a physical existence and is not real estate or permanently attached to real estate Personal property has form, shape, and substance Land and any structures that are permanently attached to land Real property has form, shape, and substance Property that lacks a physical existence; the rights to the property exist only on paper Intangible property does not have form, shape, or physical substance Any property that is used by the taxpayer for purely personal purposes Personal use property can be personal property, real property, or intangible property Examples Machinery, equipment, automobiles, trucks, computers, furniture, fixtures, telephone systems, works of art, livestock, video equipment Land and land improvements such as landscaping, shrubbery, sidewalks, parking lots, and fences; buildings, barns, sheds Patents, copyrights, trademarks, goodwill, covenants not to compete, stocks, bonds, and other securities Personal residence, clothing, furniture, home computer, lawnmower, personal automobile FIGURE 9–1 PROPERTY INVESTMENT CYCLE Period of Use Property acquisition + – Initial basis Additional capital expenditures Recoveries of investment + Amount realized Minus Adjusted basis Property disposition Adjusted basis = Realized gain Recognized gain Character of gain Effect on taxable income Realized loss Recognized loss Character of loss Effect on taxable income Equals – LO2 Provide an overview of the property investment cycle from acquisition through disposition, and discuss the tax problems encountered throughout the cycle of the property The most common method of acquiring property is by purchase However, property may also be acquired through other means, such as by gift or inheritance The initial basis of the property must be determined at acquisition The initial basis of an asset is generally the cost of acquiring the asset and placing it into service When assets are acquired by means other than purchase, special rules determine the initial basis to assign to the asset for tax purposes The cost of acquiring an asset by purchase and the special rules for other methods of acquisition are discussed later in this chapter CHAPTER Acquisitions of Property EXHIBIT 9–1 COMPUTATION OF ADJUSTED BASIS Initial basis Increases in basis from n Additional investments l Capital invested l Costs of protecting ownership l Special property tax assessments for local benefits n Reinvestment of income l Income taxed to owners of conduit entities Decreases in basis from n Annual tax deductions resulting in a reduction of tax liability l Depreciation, depletion, and amortization l Losses from conduit entities n Dispositions of all or part of interest in an asset l Casualty loss l Sale or gift of part of an asset n Capital recovery resulting from excluded income l Nontaxable dividends l Easements Equals: Adjusted basis $ XXX XXX XXX (XXX) (XXX) (XXX) $ XXX* * Adjusted basis cannot be less than zero ADJUSTED BASIS Under the capital recovery concept, a taxpayer is allowed to recover the amount of capital invested in an asset tax-free Thus, basis sets the limit on the maximum amount that can be recovered tax-free As an asset is used to generate income, it may be necessary to adjust the initial basis to account for additional capital investments in the asset or for recoveries of capital investment.1 As Figure 9–1 illustrates, these adjustments result in an amount that is referred to as the adjusted basis Adjusted basis is equal to the initial basis, plus or minus the cumulative effects of the adjustments Adjusted basis roughly corresponds to the bookvalue concept studied in financial accounting At any point in time, the remaining capital investment to be recovered is represented by an asset’s adjusted basis An asset’s adjusted basis may never be less than zero (a negative number) For investments such as publicly traded corporate stocks, few, if any, adjustments to the initial basis are needed But for other types of assets, such as depreciable assets used in a business, the adjusted basis calculation is made at least annually and on the date of an asset’s disposition Exhibit 9–1 presents a general format for computing an asset’s adjusted basis Increases in Basis As Exhibit 9–1 indicates, there are two broad categories of increases in basis An asset’s basis is increased by expenditures that are an additional investment in the asset Additional investments are expenditures made on behalf of the asset that cannot be deducted as a current period expense and must be capitalized as part of its basis.2 Additional investments would include improvements to an asset that enlarge an asset (adding a room onto a building) or extend its useful life (putting a new roof on a building) In addition, any costs of defending the ownership of the property and special assessments for such local benefits as widening the street in front of a building are capitalized as part of the cost of the property Basis is also increased by items that constitute taxable income but are not withdrawn from the asset for personal or other use The taxable income of a conduit entity that is 9-7 LO3 Explain the calculation of a property’s adjusted basis 9-8 Part IV Property Transactions allocated to the owner of the entity is added to the basis of the investment in the entity, because the owner is taxed on the income yet does not necessarily receive income.3,4 This category of basis addition includes the bargain element that is recognized as income in a bargain purchase of property E x a m p l e Sterling is an employee of Shelf Road Development Company The company recently subdivided some property and offered lots for sale at a price of $50,000 each Shelf sells Sterling a lot for $20,000 The difference between the $50,000 fair market value and the $20,000 purchase price—$30,000—is taxable income to Sterling because the transaction is a bargain purchase The purchase price is an attempt to compensate Sterling How does Sterling’s recognition of this income affect his basis in the property? D i s c u s s i o n : The bargain purchase difference, $30,000, is added to Sterling’s purchase price of $20,000 to reflect the income recognition that results from the bargain purchase Therefore, Sterling will have to recognize the income from the bargain purchase, $30,000, only once The property’s basis becomes $50,000, which may reduce his capital gain when he sells the property Decreases in Basis Decreases in basis are grouped into three broad categories The first group results from annual expense deductions that are allowed when the asset is used to earn income The deduction of an expense is a capital recovery of an investment in an asset The capital recovery results from reducing the taxable income for the year in which the deduction is claimed In addition, any losses from a conduit entity that are allocated to the owner of the entity are subtracted from the basis of the investment, because the owner is entitled to the allowable loss deduction on the investment Basis is also reduced as a result of disposing of part of the asset For example, a gift of half of a taxpayer’s interest in an asset reduces the taxpayer’s basis by half If property is subject to a casualty, the asset’s basis is reduced by the amount of loss deducted Special income items also reduce basis For example, a payment received from a utility company for an easement for power lines does not constitute a realization, because the form or substance of the taxpayer’s property rights does not change; such a payment is excluded from income For tax purposes, the payment is treated as a capital recovery and a reduction in the basis of the land Similarly, a shareholder who receives a nontaxable dividend from a corporation treats the payment as a recovery of the stock’s basis If the shareholder receives nontaxable dividends that ultimately reduce the stock’s basis to zero, any additional nontaxable dividends mean the shareholder must recognize gain (from the ‘‘sale’’ of the asset) E x a m p l e In July of the current year, Cynthia buys 500 shares of Watkins common stock at $35 per share ($17,500 total cost) On December 31, Watkins pays a $4 per share cash distribution Watkins reports that $3 per share is taxable as a dividend and $1 per share is a nontaxable dividend What is Cynthia’s adjusted basis in the Watkins stock? D i s c u s s i o n : Cynthia’s adjusted basis in the Watkins stock after she receives the dividend is $34 per share Cynthia must reduce her $17,500 initial basis by the $500 nontaxable dividend that is excluded from gross income ($1 Â 500) Thus, Cynthia’s adjusted basis on December 31 for the 500 shares is $17,000 The $3 per share taxable dividend is reported as gross income and does not affect the basis of the stock E x a m p l e James buys an office building in 2006 He pays $30,000 for the land and $170,000 for the building Shortly after he acquires the property, the city imposes a $20,000 special property tax assessment to pave streets and install sidewalks In addition, James pays $25,000 to remodel two rooms in the building to make them suitable for his use When a dispute arises with a neighbor concerning property lines, James pays his attorney $2,000 to protect his interest in the land Total depreciation deducted from 2006 through 2011 is $35,000 A fire in 2011 results in an $8,000 uninsured casualty loss to the building, which James deducts as a loss on his tax return During 2011, he pays mortgage interest of $9,000, real estate taxes of $3,000, and maintenance service fees of $4,000 on the building What is James’s adjusted basis in the property on December 31, 2011? CHAPTER Acquisitions of Property D i s c u s s i o n : James’s adjusted basis in the building is $152,000 and in the land is $52,000, computed as follows: Expenditure Building Land Initial basis Remodel offices Special tax assessment for local benefits Attorney’s fee to defend title Depreciation deducted Casualty loss from fire Mortgage interest Real estate taxes Maintenance service fees Adjusted basis $170,000 25,000 $30,000 Current Expenses 20,000 2,000 (35,000) (8,000) $ (9,000) (3,000) (4,000) $152,000 $52,000 The expenditures must be identified as adjustments to the basis of the land or the basis of the building or as current expenses The $2,000 legal fee to defend title to the land increases the land’s basis The $20,000 in special tax assessments for local benefits is considered to attach to the basis of the land and also increases the land’s basis The $25,000 spent to remodel the building for James’s use is added to its basis The $35,000 deduction for depreciation and the $8,000 casualty loss deduction are capital recoveries that reduce the basis of the building The $9,000 mortgage interest, the $3,000 in real estate taxes, and the $4,000 in maintenance service fees are current expenses They not affect the basis of the building or the land The recovery of capital investment may occur at several different times Assets that have definite useful lives may be recovered over the period of use through depreciation, depletion, or amortization deductions To allocate the depreciation deduction to the correct accounting period, you must use tax accounting rules to correctly measure the basis subject to depreciation If the basis of an asset is undervalued, depreciation deductions may be permanently lost In addition, an asset’s basis must be reduced by the larger of the depreciation allowable, based on tax accounting methods for computing depreciation, or the amount of depreciation actually deducted on the taxpayer’s returns.5 Therefore, claiming smaller deductions than those to which the taxpayer is entitled can result in lost basis and unused deductions On the other hand, a taxpayer who claims inflated depreciation deductions may be subject to penalties Thus, proper determination of the basis in business assets is crucial to computing annual deductions for depreciation, depletion, and amortization The example that follows highlights the importance of properly reporting depreciation deductions Do not be concerned with depreciation methods until Chapter 10 E x a m p l e Kalil Corporation uses a machine in its business that cost $10,000 Using tax depreciation methods, Kalil is entitled to total allowable depreciation on the machine of $9,000 However, because of clerical errors, Kalil actually deducted a total of $6,000 in allowed depreciation on its tax returns Kalil sells the machine on July for $5,000 What are the tax effects to Kalil of the clerical errors? D i s c u s s i o n : Kalil Corporation must report a gain of $4,000 from the sale of the asset [$5,000 À ($10,000 À $9,000 allowable depreciation)] The tax law requires Kalil to reduce its basis in the machine by the larger of the depreciation that it actually deducted or the amount it should have deducted based on tax depreciation methods As a result, Kalil has lost the benefit of $3,000 in depreciation to which it was entitled under the capital recovery concept ($9,000 allowable À $6,000 deducted) Kalil Corporation might be able to salvage some of the lost basis by filing amended tax returns to correct the error BASIS IN CONDUIT ENTITIES Partnerships and S corporations are conduit entities As a result, the income and deductions of these entities are passed through and included in the gross income of the owners of the entity Ownership of an interest in a conduit entity creates an interesting tax accounting 9-9 9-10 Part IV Property Transactions EXHIBIT 9–2 CONDUIT ENTITY BASIS COMPUTATION Initial basis in stock (cost) or basis of investment at the beginning of the current year Increases in basis: l Additional capital invested during the year l Taxable and nontaxable income allocated to the owner for the current year l Liability adjustment – A partner’s share of any increase in liabilities related to the partnership Decreases in basis: l Cash received from the entity l Property received from the entity: – If a partnership, subtract the partnership’s basis for the property – If an S corporation, subtract the fair market value of the property l Deductions, losses, and nondeductible expenses allocated to the owner for the current year l Liability adjustment – A partner’s share of any decrease in liabilities related to the partnership Equals: Adjusted basis in the conduit entity $X,XXX XXX (XXX) $X,XXX problem Effectively, owners must determine the adjusted basis of their investment using an equity accounting method Using the equity accounting method, the investor increases and decreases the basis of the investment for items that change the amount that may be excluded from income under the capital recovery concept These adjustments are fully explained in Chapter 14; Exhibit 9–2 presents the effect of these adjustments on adjusted basis The taxpayer’s adjusted basis for the investment in the conduit entity can be zero, but it may not be a negative number, as explained in Chapter 14 E x a m p l e Tina owns a 25% interest in Quality Conduit Entity At the beginning of the current year, Tina’s adjusted basis for her investment is $75,000 For the current year, Quality reports the following pass-through tax information: Ordinary income Capital losses Nondeductible expenses Charitable contributions $100,000 10,000 5,000 1,600 During the year, Quality distributes $15,000 in cash to Tina What is Tina’s basis in Quality Conduit Entity at the end of the current year? D i s c u s s i o n : At the end of the year, Tina’s basis in Quality is $80,850 The adjusted basis is computed as follows: Adjusted basis at beginning of year Add: Share of current income Deduct: Share of deductions and losses Capital losses Nondeductible expenses Charitable contributions Deduct: Cash received Adjusted basis at end of year $ 75,000 25,000 (2,500) (1,250) (400) (15,000) $ 80,850 This page intentionally left blank INDEX Page numbers followed by t refer to Tables and Exhibits and those followed by f refer to Figures A Abandoned spouse, 8:8 Ability-to-pay concept, 1:5, 2:2–3 Accelerated Cost Recovery System (ACRS), 10:4 Accountable reimbursement plans, 6:21 Accounting concepts, 2:6–12 Accounting methods, 2:9–10, 5:5 accrual, 3:34–35 business entity, 13:32–35 cash, 3:32–34 depletion, 10:25–27 effect of, 3:32–37 exceptions to all methods, 3:36 hybrid, 3:35 Accounting periods, business entity, 13:30–32 Accrual basis of accounting, 2:9 Accrual method of accounting, 3:34–35 exceptions to, 3:34–35 timing of deductions, 5:31–34 Acquiescence, as sources of tax law, 16:10 Acquisition debt, 8:14 Actions on decisions (AOD), tax law, 16:11 Active income, passive activity loss rules, 7:14 Active investor, 5:10 Active participation exception, passive activity, 7:15–16, 15:7 Active trade or business income limit, Section 179, 10:8–9 Active trader, 5:11 Activity loss, 7:2 Actual cost method, for auto expense, 6:7 Additional first year depreciation, Section 179, 10:9–10 Add-on minimum tax, 15:27 Adjusted basis, 2:21, 9:7–9, 10:4 computation of, 9:7f decrease, 9:8 increase, 9:7 Adjusted gross income (AGI), 1:25–27 deductions for, 1:25–26 deductions from, 1:26–27, 8:8–20 individual deductions for, 6:20–33 personal and dependency exemptions, 1:27 Adjusted net capital gain, 11:11 Administrative appeals, IRS, 1:24 Administrative convenience concept, 2:3–4 Ad valorem tax, 1:14 Age and service requirements, pension plans, 15:4 Age test, dependency requirement, 8:3 Alimony deductions for, 1:25 income from, 3:18 All-events test, 5:31 All-inclusive income concept, 2:12 Alternate valuation date, 9:21 Alternative Depreciation System (ADS), 10:22–24 Alternative minimum tax (AMT), 15:27–36 adjustments, 15:29–32, 15:30t computation, 15:28–36, 15:29f credits, 15:34 credits against regular tax, 15:34–35 exemptions, 15:34, 15:34t preferences, 15:33, 15:33t tax planning and, 15:35–36 Alternative minimum taxable income (AMTI), 15:28 American Federal Tax Reports (A.F.T.R.), 16:15 American Institute of Certified Public Accountants (AICPA), 1:33 American Opportunity Tax Credit (AOTC), 8:20, 8:28–30 Amortization, 10:27 Amount realized, 9:11, 11:4–5 Annual accounting period concept, 2:9–12 Annual deduction limit, Section 179, 10:6–8 Annual investment limit, Section 179, 10:8 Annual loss, 1:19, 7:2–4 treatment, 7:3t Annuity(ies), 3:10–11, 3:11f, 3:12t ordinary, future value, 15:3t Annuity exclusion ratio, 3:11–13 Appellate courts, as sources of tax law, 16:12 Arm’s length transaction concept, 2:4–5 Assessed value of property, 1:14 Assessment for local benefits, 6:19 Asset(s) capital, 11:8 classification of, 11:4f constructed, 9:17–18 intangible, 10:27–29 purchase of, 9:12–18 Asset Depreciation Range (ADR), 10:4 Assignment-of-income doctrine, 2:8–9, 3:8 At-risk rules, 7:7–9, 7:7t Audit and appeal process, IRS, 1:23–24 Automobile expenses, business purpose, 6:5–8 Average tax rate, 1:7–8 Awards, income derived from, 3:15 B Bad debts business expenses, 6:12–14 deductions, 6:14t Bargain purchases basis of, 9:14 income from, 3:24 Basic alternative minimum tax (AMT) computation, 15:28–36, 15:29f Basis, 2:20, 5:5 adjusted, 9:7–8 bargain purchase, 9:14 depreciable, 10:12 gift, 9:18–19 initial, 9:12 in securities, 9:24–27 special sale price, 9:20 split rule for loss property, 9:19–20 summary of rules, 9:28t wash sale stock, 9:26 Below-market-rate loans, 3:20 Beneficiary, 2:6 The Bluebook: A Uniform System of Citation, 1:16 Boot, effect of, 12:11–14 Bureau of National Affairs, 16:16–17 Business casualty and theft losses, 7:19–22 Business entity accounting methods, 13:32–35 accounting periods, 13:30–32 choice of, 13:3–44, 14:1–44 compensation plans, 15:2–23 distribution, 14:21–30 formation, 13:23–29 liquidating distributions, 14:28t nonliquidating distributions, 14:28t operating items, 14:20t operations, 14:2–21 organizational costs, 13:29–30 tax factors, summary, 13:34t transfers to, 13:23–24 Business expenses, 6:1–53 automobile, 6:5–8 bad debts, 6:12–14 compensation of employees, 6:11–12 education, 6:10–11 employee, treatment of, 6:23f gifts, 6:9–10 insurance, 6:17 legal fees, 6:20 INDEX I-1 I-2 INDEX meals and entertainment, 6:3–5 qualified production activities deduction, 6:15–20, 6:16t, 6:17t reimbursed employee, 6:21–24 substantiation requirements for, 6:10 taxes, 6:18–20 travel, 6:8–9 Business purpose concept, 2:18–20 Business purpose tax year, 13:32 Business-related travel, 6:6t C Cafeteria plan, 4:13 Capital assets, 2:13, 11:8 Capital expenditures, 2:20 deductibility test, 5:18–19 Capital gains, 2:13, 3:24–32, 11:7–18 conduit entities, 3:31–32 corporations, 14:10–11 definition, 1:18 exclusion on qualified small business stock, 11:13–15 long-term vs short-term classification, 11:8–9 netting procedure, 3:25–27, 11:9–15, 11:10f planning strategies, 11:15–17 sole proprietorship, 14:2 tax treatment of, 3:27–29, 3:27t treatment, 11:11t Capital losses, 2:13, 3:24–32, 11:7–18 conduit entities, 3:31–32 corporations, 7:23–24, 14:10–11 deductions, 1:25 individuals, 7:23 investment-related, 7:23 long-term vs short-term classification, 11:8–9 netting procedure, 3:25–27, 11:9–15, 11:10f personal casualty, limitations, 7:27 personal use, 7:26 planning strategies, 11:15–17 related party sales, 7:25 small business stock, 7:24 sole proprietorship, 14:2 tax treatment of, 3:30–31 treatment, 11:11t wash sales, 7:26 Capital recovery, from depreciation or cost recovery, 10:3–5 Capital recovery concept, 2:13, 2:20–22 Carryback, 7:4 Carryforward, 7:4 Carryover basis, 9:12 Cash basis of accounting, 2:9 Cash equivalent approach, 3:9 Cash method of accounting, 3:32–34 exceptions to, 3:33 timing of deductions, 5:29–31 Centralized management, 13:5 Certainty, standard for evaluation of tax, 1:6 Certified Public Accountants (CPA), 1:33 Charitable contributions corporation, 14:14–15 as deductions, 1:27 as itemized deductions, 8:16–18, 8:17f sole proprietorship, 14:3 Chicago Manual of Style, 1:16 Chief Counsel’s Memoranda, tax law, 16:11 Child- and dependent-care credit, 8:27–28 Child and dependent care services, 4:12 Child care cost credit, 15:26 Child credit, 8:23–24 Children as employees, in tax planning, 14:30–31 Child support payment, 3:18 Citator (CCH), 16:18 Citators, 16:17 Cited/citing case, 16:17 Citizen or residency test, dependency requirement, 8:4, 8:6 Claim-of-right doctrine, 2:14, 2:16, 2:16t, 4:19 Class life, 10:12 Closely held corporation, 7:15 Code and regulations, as source of tax law, 16:14, 16:19 Collectible gains, 3:25 Collectible losses, 3:25 Commerce Clearing House (CCH), 16:16–17 Compensation of employees business expense, 6:11–12 reasonableness, 15:22 Compensation plans, 15:2–23 Compensatory damage payments, 4:13 Compliance work, 16:18 Computer-assisted tax research, 16:16–17 Concept, 2:2 Conduit entities, 2:6 basis, 9:9–11, 9:10f capital gains and losses of, 3:31–32 income from, 3:14 reporting, 5:7–8 Construct, 2:2 Constructed assets, 9:17–18 Constructive ownership rules, 2:4 Constructive receipt doctrine, 2:15–16, 2:16t, 3:9, 3:32 Continuity of life, 13:5 Contributions to IRA, deductions for, 1:25 Contributory pension plan, 15:2 Controlled foreign operations (CFC), 15:37–39 Convenience, standard for evaluation of tax, 1:6 Conventional IRA, 6:26–28 Corporate depreciation recapture, S corporation, 14:17 Corporate stock, purchase of, 9:16–17 Corporate tax rate schedules, B:4 Corporation(s), 13:7 accounting methods, 13:33–34 basic considerations, 13:28–29 debt effects, 13:28–29 depreciation capture calculation, 14:11f distributions, 14:24–26 incidence of taxation, 13:13 operations, 14:10–16 taxable income computation, 14:10f transfers to, 13:24 Correspondence examination, 1:23 Cost depletion, 10:26 Cost recovery, capital recovery from, 10:3–5 Court decisions, as source of tax law, 16:14–15, 16:20 Coverdell Education Savings Account (CESA), 6:29 Cumulative Bulletin (C.B.), 16:14 D Damage payments for personal physical injury or sickness, 4:14–16 Death benefit payments, income from, 3:19 Debt assumptions, effect of, 11:5–6 Deductibility tests, 5:15–23 Deduction(s) for AGI, 1:25–26 from AGI, 1:26–27, 8:8–20 classifications, 5:5–9, 5:9f definition, 1:19 higher education expenses, 6:29–31 individual, for AGI, 6:20–33, 6:21f interest on education loans, 6:31 itemized, 8:9–20, 8:11t moving expenses, 6:32 reporting, 5:5–8 restrictions on dependents, 8:20–21 retirement plan contributions, 6:25–29 self-employed taxpayers, 6:24–25 standard, 8–9, 8:9t timing of, 5:28–36 accrual method, 5:31–34 cash method, 5:29–31 financial and taxable income differences, 5:34–35 related party accrued expenses, 5:34 Deduction concepts, 2:18–22 Deferral, 1:18 Deferral method, 3:34 Deferred (third party) exchange, 12:8 Defined benefit plan, 15:4 Defined contribution plan, 15:4 De minimis fringe benefits, 4:12 Dependency exemptions, 1:27, 8:3–6 requirements, 8:3–4 Dependent, 8:3 Depletion, 10:25–27 cost depletion, 10:26 methods, 10:25–26 percentage depletion, 10:27 Depreciable basis, 10:12 Depreciation capital recovery from, 10:3–5 changes in methods, 10:4f Depreciation capture, 14:11 Depreciation recapture, 11:21–26 INDEX Direct construction costs, 9:17 Directly related, 6:3 Disability payments, 4:16 Discharge of indebtedness, as income exclusion, 4:19–20 Discriminant Function System (DFS), 1:23 Dispositions death, 7:17 gift, 7:18 property, 9:11–12, 10:1–43 sale, 7:17 Distribution(s) business entity, 14:21–30 corporations, 14:24–26 liquidating, 14:28t nonliquidating, 14:28t partnership, 14:22–24 pension plans, 15:10–12 S corporation, 14:26–27 Dividend(s) eligible, 3:29 stock, 9:24–26 tax treatment of, 3:29–30 Dividends-received deduction (DVD) corporation, 12t, 14:12–13 S corporation, 14:17 Doctrine, 2:2 Document perfection program, 1:23 Dominant motive, 5:8 Donative items as income exclusions, 4:2–6 inventory, 14:14–15 Double taxation, 13:15–16 E Early withdrawal, 15:13 Earned income, 3:8–10 Earned income credit, 8:25–26, 8:26t, 8:52–74f Economic Growth and Tax Relief Reconciliation Act of 2001, 8:7 Economic performance tests, 5:32t Economy, standard for evaluation of tax, 1:7 Educational assistance program, 4:13 Education expenses, business purpose, 6:10–11 Education loans, interest as deduction, 6:31 Effective tax rate, 1:7–8 Election to expense assets, 10:5–10 limitation on, 10:5t limitations on deductions, 10:6–8 qualified property, 10:6 qualified taxpayers, 10:6 Eligible dividends, 3:29 Employee(s) business expenses, deductions for, 1:25 children, 14:30–31 compensation, 6:11–12, 15:2 vs owner, income tax and, 13:16–17 Employee discount, 4:11 Employer athletic facility, 4:13 Employer benefit plans, as income exclusion, 4:13–14 Employer-paid benefits, as income exclusion, 4:12 Employer-provided lodging, 4:13 Employment tax, 1:12 Entity concept, 2:6–8 Equality, standard for evaluation of tax, 1:5 Estate tax, 1:15, 9:20 Ethical considerations, in tax practice, 1:33–34 Excess contribution, 15:12 Excise taxes, 1:15 Exclusion, 1:17 Executor, 1:15 Exemption(s), 1:19 dependency, 8:3–6 personal, 8:3–6 restrictions on dependents, 8:20–21 Expenses, 1:19 F Family entities, in tax planning, 14:31–33 Federal estate tax, 1:16 Federal gift tax, 1:15 Federal income tax overview, 1:1–42 terminology, 1:17 Federal income tax law, sources of, 1:16–17 Federal Insurance Contribution Act (FICA), 1:12 Federal Reporter, 16:15 Federal Supplement (F Supp.), 16:15 Federal Tax Citator, 16:18 Federal Tax Coordinator 2d, 16:16 Federal Tax Manual, 16:16 Federal Unemployment Tax (FUTA), 1:13 Field examination, 1:23 Filing requirements, 8:30–31, 8:31t Filing returns, 1:22 Filing status, 8:6–8 head of household, 8:8 married filing jointly, 8:6–7 married filing separately, 8:7 single, 8:7 Final regulation, 16:10 Financial and taxable income differences, timing of deductions, 5:34–35 Fiscal year, 13:30 Flat tax, 1:8 Flexible benefits plan, 4:13 Foreign corporations, taxation, 15:41–42 Foreign earned income, as income exclusions, 4:6–7 Foreign operations, 15:37–40 controlled foreign corporation, 15:37–39 foreign tax credit, 15:39 transfer properties and pricing, 15:39–40 Foreign tax credit, 15:39 Fringe benefits as income exclusion, 4:11–12 tax treatment, 13:18–19 Fully deductible expenditures, 8:18–19 I-3 G Gains, 1:18 See also specific type character of, 11:7 General asset class, 12:9 General business credit (GBC), 15:26–27 General concepts, 2:2–6 General Counsel’s Memoranda (GCM), tax law, 16:11 Generally accepted accounting principles (GAAP), 1:18 Gifts business purpose, 6:9–10 holding period, 9:20 as income exclusions, 4:2 property acquired by, 9:18–20 Gift taxes, 1:15 Goodwill, 9:15 Gross income, definition, 1:17, 3:4, 5:5 Gross income test, dependency requirement, 8:4 Gross sale price, 11:14 Group term life insurance, as income exclusion, 4:8t, 4:9–10 Guaranteed payment, 13:16 H Head of household, 8:8 Health and accident insurance payments, 4:16–17, 4:17f premiums, as income exclusion, 4:10 Health savings account, as income exclusion, 4:14 Helvering v Gregory, 1:16 Hidden inflation tax, 1:20t Higher education expenses, deductions for, 6:29–31 Higher education tax credits, 8:28–30 phase-out of, 8:30 Hobby expenses, 5:23–25 Holding period, 3:25, 11:8 gifts, 9:20 Home equity debt, 8:14 Home mortgage interest, as itemized deductions, 8:14–15 Home office expenses, 5:26–28 Horizontal equity, 1:5 Hybrid method of accounting, 3:35 I Illegal business, expenses of, 5:21 Improvements deductibility test, 5:19 by a lessee, as income exclusion, 4:21 Incentive stock options, 15:20–21, 15:21t Income, 3:8–24 See also specific type current view, 3:7–8 definition, 1:17 passive activity loss rules, 7:13–14 I-4 INDEX Income concepts, 2:12–18 Income exclusions, 4:1, 4:3f by category, 4:22t donative items, 4:2–6 employment-related, 4:6–15 investment-related, 4:18–21 Income reporting, partnership, 14:4–5 Income shifting, 1:31–32 Income sources by class of income, 3:37t derived from labor and capital, 3:5–6 imputed income, 3:19–24, 3:21f, 3:22t increase in wealth, 3:6 transfers from others, 3:14–19 Income splitting, in tax planning, 14:30 Income tax, 1:10–12 computational framework, 1:18t days worked to pay tax, 1:11f employee vs owner, 13:16–17 filing returns, 1:22 fringe benefits and, 13:18–19 general factors, 13:11–22 incidence of taxation, 13:11–15 individual calculation, 1:24–25, 1:25t social security tax and, 13:19–22 Income tax concepts, 2:23t Income tax credits, 8:23–30, 8:23t, 15:23–27, 15:24t child- and dependent-care credit, 8:27–28 child care cost credit, 15:26 child credit, 8:23–24 earned income credit, 8:25–26, 26t general business credit, 15:26–27 higher education tax credits, 8:28–30 rehabilitation tax credit, 15:25–26 reporting of, 15:27 research and experimental credits, 15:23–25 Income tax rates, 1:19–21, 1:20t schedules, 1:20t Indirect construction costs, 9:17 Individual income tax calculation, 7:29f, 8:2f Individual income tax computation framework, 5:6f Individual retirement accounts (IRA), 6:26, 15:5, 15:6–8 conventional, 6:26–28 deductions for, 1:25 Roth, 6:28 Individual tax rate schedules, B:2–3 Individual tax table, B:5 Information matching program, 1:23 Inheritances, as income exclusions, 4:4 Inherited property, 9:20–23 alternate valuation date, 9:21 distribution date, 9:21–22 primary valuation date, 9:21 Initial basis, 9:6, 9:12 Installment sales, 3:36 Insurance, business expense, 6:17 Intangible assets, 10:27–29 excluded from 15-year amortization, 10:29f 15-year amortization, 10:28f Intangible property, 9:5 Interest, as deductions, 1:27 Interest expense, as itemized deductions, 8:14–16 Internal Revenue Bulletin (I.R.B.), 16:14 Internal Revenue Code of 1986, 1:16 source of tax law, 16:5–9 subtitles of, 16:5–7f Internal Revenue Service (IRS) administrative appeals, 1:24 audit and appeal process, 1:23–24 definition of tax, 1:4 settlement procedures, 1:24 types of examinations, 1:23–24 International taxes, 15:36–42 organizational structure of foreign operations, 15:37–40 taxation of nonresident aliens and foreign corporations, 15:41–42 taxpayers subject to U.S taxation, 15:36–37 tax treaties, 15:37 Interpretive regulation, 16:9 Investment expense, 2:18 sole proprietorship, 14:2 Investment income, sole proprietorship, 14:2 Investment interest, as itemized deductions, 8:16 Investment-related losses, 7:22–28 Investments, sale of, 3:13–14 Involuntary conversions, 12:16 qualified replacement property, 12:19–20 treatment of gains and losses, 12:17–19 Itemized deductions, 5:6, 8:9–20 charitable contributions, 8:16–18, 8:17f interest expense, 8:14–16 medical expenses, 8:10–12, 8:12t miscellaneous, 1:27, 8:18–20, 8:19f taxes, 8:12–14, 8:13f J Jobs and Growth Tax Relief Reconciliation Act of 2003, 11:7 Joint return test, dependency requirement, 8:6 K Keogh plan, 4:8, 15:6 Kiddie tax, 8:22 L Legal fees, as business expenses, 6:20 Legislative grace concept, 2:12–13, 2:18, 4:2, 5:4, 5:8, 5:23, 7:2, 8:8 Legislative ruling, 16:9 Letter ruling, 16:11 LEXIS, 16:16–17 Life insurance proceeds, as income exclusions, 4:4–6 Lifetime Learning Tax Credit, 8:20, 8:28–30 Like-kind exchanges, 12:7–15 carryover of tax attributes, 12:15–16 exchange requirement, 12:7–8 property requirements, 12:8–11 related party exchanges, 12:14–15 Limited liability company (LLC), 13:9 Limited liability partnership (LLP), 13:10 Limited mixed-use expenses, 5:23–28 Limited partnership, passive activity losses, 7:11 Liquidating distributions, 14:28t Listed property rules, 10:24–25 Lobbying activities, deductibility test, 5:21 Long-term construction contracts, 3:36 Lookback recapture rule, 11:20 Losses, 1:19, 7:1–44 See also specific type character of, 11:7 general scheme for, 7:2t net operating, 7:4–6 passive activity, 7:9–19 tax shelter, 7:6–19 Loss-of-income damages, 4:16 Low-income housing projects, passive activity losses, 7:12 M Majority-interest tax year, 13:31 Marginal tax rate, 1:7 Married filing jointly, 8:6–7 filing separately, 8:7 Master Tax Guide, 16:16 Material participation, 7:9–10 Meals and entertainment, business purpose, 6:3–5 Meals and lodging provided by employer, as income exclusion, 4:10–11 Medical expenses as deductions, 1:27 as itemized deductions, 8:10–12, 8:12t Medical Health Insurance (MHI), 1:12 Mertens Law of Federal Income Taxation, 16:16 Mid-month convention, 10:15 Mid-quarter convention, 10:15 Mid-year convention, 10:14 Minor child, tax on unearned income, 8:21–22 Miscellaneous itemized deductions, 1:27 Mixed-use assets, 4:13–15 Mixed-use expenditures, 4:13–15 Mixed-use property, 9:5 Modified Accelerated Cost Recovery System (MACRS), 10:4–5, 10:10–25 basis subject to cost recovery, 10:12 conventions, 10:14–15 INDEX depreciation for nonresidential real estate, 10:16t depreciation for property other than real estate, 10–14t depreciation method alternatives, 10:18–19, 10:18f IRS table of classes, 10:13t overview, 10:30t percentage tables, 10:19–21, 10:20t property subject to, 10:11–12 recovery period, 10:12–13 straight-line election, 10:21 Money purchase plan, 15:4 Moving expenses as deductions, 1:25, 6:32 Multiple asset purchase, 9:15 Multiple support agreement, 8:5 Municipal bond interest, as income exclusion, 4:18 partnership, 13:6–7 planning commentary, 13:10–11 S corporation, 13:8–9 sole proprietorship, 13:5–6 North American Industry Classification System (NAICS codes), 12:9, 12:10f O Office examination, 1:23 Old Age, Survivors, and Disability Insurance (OASDI), 1:12 One-year rule for prepaid expenses, 5:30 Ordinary expenses, deductibility test, 5:15–16 Ordinary income, 2:13 definition, 1:18 Organizational costs, business entity, 13:29–30 Original issue discount (OID) securities, 3:33 N NAICS codes, 12:9, 12:10f Natural business year, 13:32 Necessary expense, deductibility test, 5:16–17 Net capital gain position, 11:15–16 Net capital loss, 3:30 Net capital loss position, 11:16 Net collectible gains, 11:11 Net investment income, 8:16 Net operating losses, 7:4–6 corporation, 14:16 partnership, 14:6–7 S corporation, 14:17–18 sole proprietorship, 14:3–4 Net unearned income, 8:22 No-additional-cost services, 4:11 Nonaccountable reimbursement plans, 6:21–22 Nonacquiescence, as sources of tax law, 16:10 Nonbusiness income, taxation of, 15:41–42 Nonliquidating distributions, 14:28t Nonqualified pension plans, 15:2–6 Nonqualified stock options, 15:14–20, 15:17–20t Nonrecognition transactions, 12:1–38 characteristics, 12:24t commonalities of, 12:3–7, 12:3f effect of boot, 12:11–14 rationale for, 12:2–3 related party exchanges, 12:14–15 Nonrecourse debt, 7:8 Nonrecourse loans, 13:26 Nonresident aliens, taxation of, 15:41–42 Non-support test, dependency requirement, 8:3 Nontax factors, 13:4–11 comparison among business forms, 13:11t corporation, 13:7 limited liability company, 13:9 limited liability partnership (LLP), 13:10 P Partially deductible expenditures, 8:19 Partnership, 13:6–7 accounting methods, 13:33 accounting periods, 13:31 basic considerations, 13:25–28 debt effects, 13:26 distributions, 14:22–24 formula for determining basis, 14:8f incidence of taxation, 13:12 operations, 14:4–10 recourse and nonrecourse loans, 13:26 transfers to, 13:23–24 Passenger auto limitation, 10:24 Passive activity items, sole proprietorship, 14:3 Passive activity losses, 7:9–19 active participation exception, 7:15–16 corporation, 14:13–14 disposition, 7:16–17 general rules, 7:15 taxpayers subject to, 7:14–15 Passive income, 7:14 Pay-as-you-go concept, 1:6, 1:21, 2:5–6 Payment of expenses by others, income from, 3:23–24 Payments made on behalf of employee, as income exclusions, 4:7–8 Penalties, pension plans, 15:12–14 Pension plans age and service requirements, 15:4 comparison of attributes, 15:15t contributory, 15:2 distributions, 15:10–12 IRA, 15:5, 15:6 Keogh, 15:6 lifetime distributions table, 15:11t nonqualified, 15:2–6 payments to as income exclusions, 4:8–9 penalties, 15:12–14 I-5 qualified, 15:2–6 Roth IRA, 15:6, 15:8 savings incentive match plan for employees (SIMPLE), 15:6, 15:9–10 simplified plan, 15:6, 15:9 Percentage depletion (statutory depletion), 10:27 Percentage-of-completed-contract method, 3:36 Per-diem payments, 6:21 Personal and dependency exemptions, 1:27 Personal casualty and theft losses, as deductions, 1:27 Personal casualty losses, limitations on, 7:27 Personal exemption, 8:3 Personal expenditures, 5:13 Personal expenses, 2:18 deductibility test, 5:17–18 sole proprietorship, 14:3 Personal property, 1:14 Personal service corporation, incidence of taxation, 13:14 Personal use loss, 7:26 Points, as itemized deductions, 8:15 Political activities, deductibility test, 5:21 Portfolio income, passive activity losses, 7:13–14 Primary sources, tax law, 1:16–17 Principal partner tax year, 13:31 Principal residence, sale of, requirements for exclusion, 12:20–23 Principal residence test, dependency requirement, 8:4 Private letter ruling (LTR), 16:10 Prizes, income derived from, 3:15 Product class, 12:9 Production-of-income expenses, 5:11–12 Profit-motivated expenditures, 5:8–9 Profit-sharing pension plan, 15:4 Progressive tax rate structure, 1:8–10, 1:8f Pronouncements, sources of tax law, 16:20 Property classes of, 9:4–5 dispositions, 9:11–12, 10:1–43 procedure, 11:2f process, 11:27f personal use converted to business, 9:23–24 types, 9:6t Property acquisition, 9:3–42 gift, 9:18–20 inheritance, 9:20–23 specially valued, 9:18 Property investment cycle, 9:5–12, 9:6f Property loss, split basis rule for, 9:19–20 Property settlement, 3:18 Property taxes, 1:14 Proportional tax rate structure, 1:8–9, 1:8f Proposed regulation, 16:9 Protest letter, 1:24 Public policy frustration, deductibility test, 5:20–21 Punitive damages, 4:16 I-6 INDEX Purchase of assets, 9:12–18 bargain purchase, 9:14 business, 9:15–17 determining amount of investment, 9:12–14 multiple, 9:15 Q Qualified home mortgage interest, 8:14 Qualified pension plans, 15:2–6 Qualified plans, 3:12 Qualified principal resident indebtedness, 4:20 Qualified production activities deduction (QPAD), business expense, 6:15–20, 6:16t, 6:17t Qualified replacement property, 12:19–20 Qualified retirement planning services, 4:12 Qualifying child, 8:3, 8:53f Qualifying relative, 8:4 R Real estate, 9:5 Real estate professional exception, passive activity losses, 7:12 Realization concept, 2:14 Realized gain, 9:11, 11:4–7 Realized loss, 9:11, 11:4–7 Real tax, 1:28 Reasonable in amount expenses, deductibility test, 5:17 Reasonableness of compensation, 15:22 Recognized gain, 11:3 Recognized loss, 11:3 Recourse loans, 13:26 Recurring item exception, 5:33 Refundable tax credit, 8:23 Regressive tax rate structure, 1:8–9, 1:8f Rehabilitation tax credit, 15:25–26 Reimbursed employee business expenses, 6:21–24 deductions, 1:25 Related parties, 5:17 Related party accrued expenses, timing of deductions, 5:34 Related party exchanges, 12:14–15 Related party relationships, 2:5t Related party rules, 5:34 Relationship, or member of household, test, dependency requirement, 8:5–6 Rental activity, 5:12–13 passive activity losses, 7:13f Rental and royalty expenses, deductions, 1:25 Rental and royalty income, 3:10 Repair-and-maintenance expenses, deductibility test, 5:19 Replacement, 5:19 Reports of the United States Tax Courts, 16:15 Required minimum distribution (RMD), pension plans, 15:11 Research and experimental credits (R&E), 15:23–25 Research Institute of America (RIA), 16:16–17 Residence, definition, 8:14 Retirement plan contributions, deductions, 6:25–29 Returns of human capital, 4:14–17 damage payments for personal physical injury or sickness, 4:14–16 payments from health and accident policies, 4:16–17, 4:17f workers’ compensation, 4:14 Revenue agent’s report (RAR), 1:24 Revenue rules and procedures, as sources of tax law, 16:10 Revenue ruling, 16:10 Roth IRA plans, 6:28, 15:6, 15:8 S Salary reduction plan, 4:13 Sales tax, 1:14 Savings bond (U.S government-issued), 3:34 Savings incentive match plan for employees (SIMPLE), 15:6, 15:9–10 Scholarships, as income exclusions, 4:6 S corporation, 2:6, 13:8–9 accounting methods, 13:34 accounting periods, 13:32 distributions, 14:26–27 formula for determining shareholder’s basis, 14:18f incidence of taxation, 13:14–15 operations, 14:16–19 Section 179, 10:5–10 Section 1231 property, 11:6 definition, 11:18 gains and losses, 11:18–21, 14:3 netting procedure, 11:18–21, 11:19f Section 1245 property, 11:24–25, 25t Section 1245 recapture rule, 11:22–23 Section 1250 property, 11:24–25, 25t Section 1250 recapture rule, 11:23–24 Section 1250 unrecaptured gain, 11:25–26 Securities basis in, 9:24–27 basis of securities sold, 11:16–17 worthless, 11:16 Securities dealer, 5:11 Self-employed taxpayers, deductions for, 6:24–25 Self-employment taxes, deductions, 1:25, 13:19 Self-insured medical plan, 4:10 Simplified employee pension plans (SEP), 15:6, 15:9 Single filing status, 8:7 Social Security benefits, 3:15–18, 3:16f, 3:18f Social Security taxes, 1:12, 13:19–22 rates for employees and employers, 1:12t Sole proprietorship, 13:5–6 basic considerations, 13:25 incidence of taxation, 13:12 operations, 14:2–4 transfers to, 13:23 Special audit programs, 1:23 Specific charge-off method, 6:13 Split basis rule gifts, 9:19 personal use property, 9:23–24 Standard deduction, 1:26, 8:9, 8:9t Standard mileage rate method, 6:6 Start-up costs, deductibility test, 5:19–20 Statements on Standards for Tax Services (SSTS), AICPA, 1:33 Statute of limitations, definition, 1:22 Statutory floor, 7:27 Stock dividends, 9:24–26 as income exclusion, 4:18–19 taxable, 9:26 Stock options, 15:14–22 incentive, 15:20–21, 15:21t nonqualified, 15:14–20, 15:17–20t Student loans, interest as deductions from AGI, 1:25 Subpart F income, 15:38 Substance-over-form doctrine, 2:10–12, 4:4 Substantial risk of forfeiture, 15:17 Substantiation requirements, for business expenses, 6:10 Support test, dependency requirement, 8:5 Supreme Court, as sources of tax law, 16:12–13 T Tangible property, 9:5 Tax(es) See also specific type as business expenses, 6:18–20 as deductions, 1:27 definition, 1:4 evasion and avoidance, 1:32–33 international aspects, 15:36–42 as itemized deductions, 8:12–14, 8:13f major types, 1:10–16 standards for evaluation, 1:5–7 taxpayers subject to U.S taxation, 15:36–37 Taxable entities, 2:6 Taxable income, 1:18 Tax Analysts, 16:16–17 Taxation nonbusiness income from U.S sources, 15:41–42 U.S trade or business income, 15:41–42 Tax attributes, carryover of, 12:15–16 Tax base, 1:7 Tax benefit rule, 2:10, 4:17 Tax Court Memorandum Decisions (TCM), 16:15 Tax Court Reporter, 16:15 Tax credits, 1:21 corporation, 14:16 sole proprietorship, 14:3 Tax directories, 16:17f Tax Equity and Fiscal Responsibility Act of 1982, 15:6 Tax-exempt income, deductibility test, 5:22 INDEX Tax forms, C:1–40 Tax guides, 16:16 Tax home, 6:8 Tax law active processes for, 16:8f primary sources of authority, 16:4f administrative sources, 16:9–10 citations to primary authorities, 16:13–14, 16:13f judicial sources, 16:11–12 legislative sources, 16:4–9 secondary sources of authority, 16:15–18 citators, 16:17 computer-assisted research, 16:16–17 tax periodicals, 16:18 tax services, 16:15–16 Tax liability alternative minimum tax, 15:27–36 calculation of, 8:21–30 considerations, 15:23–36 income tax credits, 15:23–27, 15:24t Tax Management Portfolios, 16:16 Taxpayer Compliance Measurement Program (TCMP), 1:23 Taxpayer’s benefit expenses, deductibility test, 5:22–23 Tax periodicals, 16:18 Tax planning, 1:27–33 AMT, 15:35–36 business entities, 14:30–33 compliance vs planning, 16:18 income shifting, 1:31–32 mechanics of, 1:28 timing income and deductions, 1:28–31, 1:30–31t Tax preference items, 15:27 Tax preparers, penalties for, 1:33t Tax prepayments, 1:21 Tax rates and structures, 1:7–10 definition, 1:7 Tax rate schedules and tables, B:1–16 Tax Relief Act of 2010, 1:13 Tax research, 16:3–36 comprehensive example, 16:21–24 memorandum, 16:24–25 Tax returns problem, A:1–24 selection process for audit, 1:23 Tax services, 16:15–16 statement on standards, D:2–37 Tax shelter losses, 7:6–19 Tax treaties, 15:37, 16:9 T C Memorandum Decision, 16:15 Technical advice memorandum (TAM), tax law, 16:11 Temporary regulation, 16:10 Tentative minimum tax liability, 15:29 Theft loss, 7:20 Time test, moving expenses, 6:32 Trade or business expenses, 5:9–11 deductions, 1:25 Trade or business losses, 7:19–22 Transaction losses, 1:18, 7:19–28, 7:20f investment-related, 7:22–28 trade or business, 7:19–22 Transactions between partners and partnerships, 14:7–8 Transferability of ownership interest, 13:4 Transfer of properties to foreign entities, 15:39–40 Travel expenses, business purpose, 6:8–9 Treasury regulation, 1:17 Treasury regulations, as sources of tax law, 16:9–10 Trial courts, as sources of tax law, 16:11–12 U Unearned income, 3:10–14 minor child, tax on, 8:21–22 Unemployment compensation, 3:15 Unemployment taxes, 1:13 Unified donative-transfers credit, 1:15 United States Reports, 16:15 Unrecaptured gain, Section 1250, 11:25–26 U.S Constitution, source of tax law, 16:4–5 U.S Tax Cases, 16:15 U.S trade or business income, taxation of, 15:41–42 V Vacation home expense, 5:25–26 use tests, 5:25t Vertical equity, 1:5 W Wash sales, 7:26 stock basis, 9:26 Wealth of Nations, The, 1:5 Wealth transfer taxes, 1:15 Westlaw, 16:16–17 Wherewithal-to-pay concept, 2:1 Workers’ compensation, 4:14 Working-condition fringe benefit, 4:12 Working interest in gas and oil deposits, passive activity losses, 7:11–12 Worthless security, 11:16 I-7 This page intentionally left blank How to Decode the Code The federal income tax is based on a system of rules and regulations that determine the treatment of various items of income and expense This system has been developed around general concepts that guide us in its application to various types of transactions The four major groupings are: l l general concepts accounting concepts l l income concepts deduction concepts Once you understand this small number of unifying concepts, you can apply them to almost every aspect of the system INCOME TAX CONCEPTS WITH RELATED CONSTRUCTS AND DOCTRINES General Concepts Accounting Concepts Income Concepts Deduction Concepts Ability to Pay A tax should Entity All items of income, All-Inclusive Income All Legislative Grace Any tax be based on the amount that deduction, and so on are income received is taxable relief provided is the result of the taxpayer can afford to pay, relative to other tax- traced to the tax unit responsible for the item (p 2-6) l Taxable/Conduit l Assignment of income unless a specific provision in the tax law either excludes a specific act of Congress that must be strictly applied and the income from taxation or interpreted All income Annual Accounting Period defers its recognition to a future tax year (p 2-12) received is taxable unless a specific provision in the tax All entities must report the Legislative Grace Any tax law excludes the income from results of their operations on an annual basis (the tax year) relief provided is the result of a taxation Deductions must be approached with the philoso- payers (p 2-2) l Income, exclusions, l deductions, losses, tax credits Progressive rate structure Administrative Convenience Each tax year stands on its Those items for which the cost own, apart from other tax years (p 2-9) l Accounting method l Tax benefit rule l Substance over form of compliance would exceed the revenue generated are not taxed (p 2-3) l Standard deduction specific act of Congress that must be strictly applied and interpreted All income received is taxable unless a specific provision in the tax law phy that nothing is deductible unless a provision in the tax law allows the deduction (p 2-18) excludes the income from taxa- Business Purpose To be de- Arm’s-Length Transaction tion Deductions must be approached with the philoso- ductible, an expenditure or a loss must have a business or A transaction in which all par- phy that nothing is deductible other economic purpose that ties have bargained in good faith and for their individual unless a provision in the tax law allows the deduction (p 2-12) l Capital asset l Capital gains and losses exceeds any tax avoidance motive The primary motive Capital Recovery No income is realized until the taxpayer Capital Recovery No income benefit, not for the benefit of the transaction group (p 2-4) l Related party l Constructive ownership Pay as You Go A tax should be collected as close as possible to the time in which the income is earned (p 2-5) l Withholding l Estimated tax payments receives more than the amount invested to produce the income The amount invested in an asset represents the maximum amount recoverable (p 2-13) l Basis Realization No income or loss is recognized until it has been realized A realization involves a change in the form and/or substance of a taxpayer’s property rights that results from an arm’s-length transaction (p 2-14) l Claim of right l Constructive receipt Wherewithal to Pay Income is recognized in the period in which the taxpayer has the means to pay the tax on the income (p 2-17) for the transaction must be to make a profit (p 2-18) is realized until the taxpayer receives more than the amount invested to produce the income The amount invested in an asset represents the maximum amount recoverable (p 2-20) l Basis l Capital expenditure 2010 TAX RATE SCHEDULES Single Taxpayers Married Taxpayers Filing Jointly and Surviving Spouse If Taxable Income Is Over But Not Over $ 8,500 34,500 83,600 174,400 379,150 8,500 34,500 83,600 174,400 379,150 The Tax Is of the Amount Over 10% $ $ 850.50 ỵ 15% 8,500 4,750.00 þ 25% 34,500 17,025.00 þ 28% 83,600 42,449.00 þ 33% 174,400 110,016.50 ỵ 35% 379,150 Head of Household 12,150 46,250 119,400 193,350 379,150 12,150 46,250 119,400 193,350 379,150 The Tax Is of the Amount Over 10% $ $ 1,215.00 ỵ 15% 12,150 6,330.00 þ 25% 46,250 24,617.50 þ 28% 119,400 44,323.50 þ 33% 193,350 106,637.50 ỵ 35% 379,150 Corporate Tax Rate Schedule If Taxable Income Is Over But Not Over $ $ 17,000 69,000 139,350 212,300 379,150 17,000 69,000 139,350 212,300 379,150 The Tax Is of the Amount Over 10% $ $ 1,700.00 ỵ 15% 17,000 9,500.00 ỵ 25% 69,000 27,087.50 ỵ 28% 139,350 47,513.50 ỵ 33% 212,300 102,574.00 ỵ 35% 379,150 Married Taxpayers, Filing Separately If Taxable Income Is Over But Not Over $ If Taxable Income Is Over But Not Over If Taxable Income Is Over But Not Over $ 8,500 34,500 69,675 106,150 189,575 8,500 34,500 69,675 106,150 189,575 The Tax Is $ of the Amount Over 10% $ 850.00 ỵ 15% 8,500 4,750.00 ỵ 25% 34,500 13,543.75 ỵ 28% 69,675 23,756.75 ỵ 33% 106,150 51,287.00 þ 35% 189,575 Social Security Tax Rates The Tax Is of the Amount Over 50,000 15%$ 50,000 75,000 $ 7,500 ỵ 25% 50,000 75,000 100,000 13,750 ỵ 34% 75,000 100,000 335,000 22,250 ỵ 39% 100,000 335,000 10,000,000 113,900 ỵ 34% 335,000 10,000,000 15,000,000 3,400,000 ỵ 35% 10,000,000 15,000,000 18,333,333 5,150,000 ỵ 38% 15,000,000 18,333,333 6,416,667 ỵ 35% 18,333,333 OASDI - 6.20%* on up to $106,800 of salaries and wages MHI - 1.45% on all salaries and wages *Employees’ share reduced to 4.2% for 2011 A step-by-step Q&A guides you through your return Automatically double-checks for errors and is guaranteed accurate Audit support with guidance, plus an H&R Block enrolled agent to represent you in the event of an audit.* Trust the tax experts at H&R Block to make it easy ® Two powerful programs in one for your personal and business taxes.† *Worry-free Audit Support® is available only for clients who purchase and use H&R Block tax software or online tax preparation solutions to prepare and successfully file their 2010 personal income tax return (federal or state) It does not provide for reimbursement of any taxes, penalties, or interest imposed by taxing authorities Additional terms and restrictions apply; see www.hrblock.com for complete details †One personal state program and unlimited business state programs can be downloaded at no additional cost from within the program Additional personal state programs may be downloaded for a fee Release dates vary by state DC, DE,HI, LA, NO, VT, and WV not support part-year / non-resident forms Federal and state e-file for a personal return is available within the program for an additional fee State e-file is not available in NH or TN © 2010 HRB Digital LLC All rights reserved H&R Block At Home is a trademark of HRB Innovations, Inc This page intentionally left blank INDIVIDUAL INCOME TAX FORMULA Income (broadly conceived) Less: Exclusions Gross income Less: Deductions for adjusted gross income Adjusted gross income $XX,XXX (X,XXX) $XX,XXX (X,XXX) $XX,XXX Less: Deductions from adjusted gross income— The greater of— The total itemized deductions or standard deduction Personal and dependency exemptions Taxable income BASIC STANDARD DEDUCTION AMOUNTS Standard Deduction Amount Filing Status Single Married, filing jointly Surviving spouse Head of household Married, filing separately 2010 2011 $ 5,700 11,400 11,400 8,400 5,700 $ 5,800 11,600 11,600 8,500 5,800 AMOUNT OF EACH ADDITIONAL STANDARD DEDUCTION FOR AGE AND BLINDNESS Standard Deduction Amount Filing Status Single Married, filing jointly Surviving spouse Head of household Married, filing separately 2010 2011 $1,400 1,100 1,100 1,400 1,100 $1,450 1,150 1,150 1,450 1,150 PERSONAL AND DEPENDENCY EXEMPTION AMOUNT 2010 2011 $3,650 $3,700 (X,XXX) (X,XXX) $XX,XXX PRESENT VALUE TABLES Present Value of a Single Payment Year 5% 6% 7% 8% 9% 10% 12% 10 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 0.614 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592 0.558 0.935 0.873 0.816 0.793 0.713 0.666 0.623 0.582 0.544 0.508 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 FUTURE VALUE OF AN ORDINARY ANNUITY OF $1 PER PERIOD Period (n) 4% 5% 6% 7% 8% 9% 10% 12% 10 15 20 25 30 35 40 1.00000 5.41632 12.00611 20.02359 29.77808 41.64591 56.08494 73.6522 95.02552 1.00000 5.52563 12.57789 21.57856 33.06595 47.72710 66.43885 90.32031 120.79977 1.00000 5.63709 13.18079 23.27597 36.78559 54.86451 79.05819 111.43478 154.76197 1.00000 5.75074 13.81645 25.12902 40.99549 63.24904 94.46079 138.2368 199.6351 1.00000 5.86660 14.48656 27.15211 45.76196 73.10594 113.28321 172.31680 259.05652 1.00000 5.98471 15.19293 29.36092 51.16012 84.70090 136.30754 215.71076 337.88245 1.00000 6.10510 15.93742 31.77248 57.27500 98.34706 164.49402 271.02437 442.59256 1.00000 6.35285 17.54874 37.27971 72.05244 133.33387 241.33268 431.66350 767.09142 ... Building Land Totals $ 100 $ 100/ $2, 800 Â $2, 100 ¼ $ 800 600 1,000 300 $2, 800 800/ $2, 800 600/ $2, 800 1,000/ $2, 800 300/ $2, 800 Â Â Â Â $2, 100 $2, 100 $2, 100 $2, 100 ¼ ¼ ¼ ¼ 600 449 750 22 5 $2, 100... the 22 0 shares remains at $22 ,000 However, the basis per share of the 22 0 shares is now $100 All 22 0 shares are deemed to have been held since December 15, 20 07 Basis before dividend ¼ $22 ,000 20 0... concerning property lines, James pays his attorney $2, 000 to protect his interest in the land Total depreciation deducted from 20 06 through 20 11 is $35,000 A fire in 20 11 results in an $8,000 uninsured