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Federal Income Tax Law

Additional Law Flashcards




Horizontal and Vertical Equity
Horizontal Equity - treat equally situatin TPs equallty
Vertical equity - treat unequally situated TPs justly by
1. flat tax
2. regressive taxes
3. progressive taxes (U.S. method)
Publically traded stock wrt capital asset status
Publically traded stocks in hands of dealer (or issuer) is not capital asset
Publically traded stock in hands of investor are capital assets
1. must be in cash
2. must be received on behalf of the spouse or exspouse
3. must be pursuant to a written divorce or separation agreement
4. payor and payee must live separately
5. payment must not be for child support
6. payment obligation cannot extend past the death of payee spouse
7. anti-frontloading - substantially equal payments in the first three years

Entertainment Expense Deduction


Expenditures incurred for meals, entertainment, amusement recreation activities or for gifts must meet certain criteria:


1. entertainment must be directly related to the active conduct of the trade or biz or income producing activities


associated with trade or business or income producing activities if the expenditure directly proceeds or follows a substantial bona fide business discussion


2. 50% cap on food and bev

3. No deductions for expenditure on facility related to entertainment such as yachts

4. No deduction for membership dues paid to club or organized for business

5. On tix, only deduct up to face value, usually 50 percent of face value

6. Must be able to substantiate

Capital Assets

Everything capital asset, unless

  1. Stock in trade
  2. Inventory
    • Hedging transactions (futures buying to control inventory costs) that are an integral part of a business inventory purchase system fall WITHIN the inventory exception (i.e. they are NOT capital assets)
  3. Property held primarily for sale to customers
  4. Depreciable biz property
  5. Real property used in a TP's trade/biz (e.g. cash registers)
  6. Notes or accounts receivable acquired in teh ordinary course of a TPs biz
  7. Copyrights, literary, musical compositions held in the hands of the creator
  8. US gov't publications received from govt other than by purchase

In ascertaining whether it is capital asset or it is property held by TP for sale in ordinary course of trade, consider:

  1. nature and purpose of acquisition of property
  2. duration of ownership
  3. extent and nature of the TPs efforts to sell the property
  4. number, extent, continuity and substantiality of the sales (i.e. are you a realtor) (most impt factor)
  5. use of biz office for sale of property
  6. character and degree of supervision of degree or control over a person selling property
  7. time and effort TP habitually devoted to the sales

Rule of Thumb: more activity TP understakes wrt sale, then it will more likely qualify for the held for sale exclusion


Arrowsmith - Characterization dependent on prior treatment. So if you treated certain assets as producing capital gains previously, repayment of those assets must be treated as a capital loss (even though there was no sale or exchange of a capital aset).


- Intent of the purchase is no longer the primary factor in determining capital asset status.



Capital Losses

1. Corporations may deduct capital losses only from capital gains


2. Individuals may deduct any capital losses against capital gains, and additionally, up to $3,000 per year of capital losses against ordinary income.


Basis of Property Received by Bequest or Inheritance
Always take basis in property of FMV at the time of decedent's death (step up). The decedent must have acquired the property at least one year before dying. If FMV is less than adjusted basis, still take FMV, and the loss is forever gone.
Sale or Loss between Related Taxpayers
No deductin allowed for any loss arising from the sale or exchange of property bt related taxpayers.
Part gift part sale

Seller - recognition of gain but not loss, so take amount realized and subtract adjusted basis, but only report gain


Recipient - Split Basis


For gain: greater of:

1) what they paid for it

2) transferred basis


For loss: basis limited to FMV at the time of the gift

Loans & Income from Discharge of Indebtedness
General Rule: Not taxed on amounts borrowed bc obligation to repay offsets
When can you deduct interest

Investment Interest

Qualified Residence Interest


Biz (trade or biz)

Estate Tax Deficiencies

Education Loans

Passive activity-related interest

Net Invested Income

For noncorp TP, TP investment interest deduction cannot exceed net investment income which is (investment income - investment expenses)


Investment expense is something like a realtor, or maintenance

Start Up Cost

TP can deduct up to $5,000 of start up expenses in the TY in which active trade/biz begins

- 5,000 is reduced by the amt the startup costs exceed 50,000


Remaineder of start ups costs that arent deducted in the first year are amortized over 180 month period


Amortization Requirement -

1) costs must be paid or incurred in connection with creating or investigating the creation or acquisition of a trade/biz enterd into by the TP

2) expense must be one which would be allowable as a deduction for the TY in which it is paid/incurred if it was incurred in connection with the expansaion of an existing trade/biz in the same field as that entrd into by the TP.


Can't capitalize a franchise fee, or any other startup fee that lasts for more than 1 year.


Capitalizing Acquisitions

- investment in new asset or investment that changes an asset by adding to the value of the asset, making the asset suitable for a different use, or substantially prolnging the useful life of the asset.


- Sometimes you can also expense a capital expenditure under 179


- Cant depreciate an asset more than its value


- Not all capital expenditures can be depreciated




basis = (original basis) + (buy back price - loss transaction price)


does not apply to gains

Time Value of Money, why care?
  1. inflation
  2. forgone income (can earn something with money)
  3. forgone use of money
  4. risk (won't pay 1$ today for 1$ in future)
  5. risk-free rate (risk at which tresury borrows is considered risk free) Depends on
    • premium for delayed gratification
    • inflation factor


the greater the interest rate, and the longer the time, the greater the future value

the greater the discount rate, and the longer the time, the less the present value 

Deductible IRA

Primary Rules found in 408:

What is not taxed:

Contributions to IRA account

Accrued income from IRA that has not been distributed (called tax-free "inside build-up")

What is taxed:

Accrued income from IRA that HAS been distributed


- No deductions for TPs who are active participants in a pension plan when gross income reaches $109,000 (join filers)

No deductions not in an active pension plan when gross income reaches $176,000 (join filers)

No deductions once TP has reached 70.5 years old.

Mandatory withdrawl at 70.5

Penalty for early distributions


 maximum contribution is $5,000.


Same as d-IRA except

no deduction for contributions made

still get tax free build up

no tax on basis or capital contribution made, but you are taxed on income upon withdrawal.



  1. tax free inside build up
  2. withdrawals are not taxed at all, even earnings
  3. no up front deduction


basically same if you look at present value and future tax free amount, so you arent saving that much


Qualified Withdrawals, must meet both:

1. account must exist for at least 5 years

2. they are made after TP is 59.5, dies, or is disabled

    (or using it for qualified first time homeowner ship)


cancellation of indebtedness income
  • price adjustment is not a discharge of debt and does not give rise to COI income. 
  •  If a cancellation of indebtedness is simply the medium for payment of some other form of income, §108 does NOT apply
  • Exception: §108, Provides an exclusion from gross income when discharge of indebtedness occurs in certain listed circumstances, including bankruptcy or insolvency.

  • Does not count if the indebtedness discharged is qualified real property business indebtedness

  • Contest liability doctrine - if the debt is legitimately in dispute, any negotiated settlement of the debt that otherwise would be a discharge, is not recognized as income. Instead, the agreed settlement amount is treated as the amount of the original debt.  

    •  liquidated debt, if unenforceable, would implicate the contested liability doctrine.

  • If you own more than 50 percent of stock in a corporation then you are deemed relatd to that corporation

  •  If a person related to a debtor acquires the indebtedness, the acquisition shall be treated as

    an acquisition by the debtor.


debtors can realize income from cancelled debts when they perform services in exchange for cancellation

bad debt

- debts arising out of services or sales of goods is a deductions only if you have taken the amount into income before the debt goes bad (i.e. you must be accrual)

- business bad debts are treated the same as corporation (i.e. persons running non-corporate business can still deduct partial worthlessness).

Individual Loss Restriction



  • 165c - restricts loss deduction for individuals to:
    •  Trade or business loss 
      1. (deducted above the line)
      2. trade or business is same in 165 as it was in 162
    • Losses in profit-seeking transactions (deducted blow the line unless resulting from sale or exchange of property)
    • Casualty and theft losses (165(h)
      1. casualty or theft involving the taxpayer's business or investment property is governed by 165©(1) or ©(2), not by ©(3)
        1. so even though the property is personal use property, if your loss results from casualty or theft then you are allowed to deduct it, if it exceeds 10 percent of adjusted gross income.
          1. each individual loss has to be reduced by $100. This is a housekeeping thing, we don’t want people claiming lots of small things.
Applies only to tangible property
related TPs
where two parties are related the receipt of the money for a cash method taxpayer determines when it will be included for both inclusion and deductibility.
mixed use
split when loss: choose lesser of adjusted basis and fair market value.
Hope Scholarship


Credit up to $1,500 per student for maximum of 4 years (usually just 2 years but currently it applies to 4 years), for qualified tution and related expenses of higher education. 100% of first $1000, plus 50% of the next $1,000, may be claimed by TP'er, their spouse or dependents.



Must be enrolled at least half-time in one of the first two years of postsecondary education in a program leading to a degree, certificate, or other recognized educational credential. Credit allowed for the maximum of 4 years, and not for years that begin after the student has completed the first 4 years of postsecondary education

Credit is phased out for TP'ers with modified gross incomes b/t $40k and $50k ($80k and $100k on joint returns)

Lifetime Learning
  1. Up to $2,000 credit per taxpayer for the qualifed tuiton and related expenses of higher education
  2. 20% of no more than $10,000 of qualifying expenses may be claimed by TP'er, their spouse or dependents.
  3. Same phase out rules apply here as apply in Hope
  4. Cannot take both this and Hope during the same year
  5. No durational issues
  6. No requirement that the student be enrolled at least on a half-time basis in a degree granting program: a single course will suffice
  7. Calculated on a per student basis


Education Individual Retirement Accounts (aka Coverdell Education Savings Accounts - See Section 530),



  1. Trust accounts that may be created for any child under 18 for purpose of paying the child's qualified higher ed expenses or qualified elementary and secondary education expenses.
  2. Total contributions to one or more ESAs for benefit of any given child may not exceed $2,000/year
  3. Balance in account must be distributed to a beneficiary w/in 30 days after the beneficiary attains age 30.
  4. Qualified education expenses include: expenses for tuition, fees, academic tutoring, special needs service sin the case of special needs beneficiaries, books, supplies, computer equipment, and other equipment, room board, uniforms, transportation
  5. Can contribute up to $2,000 maximum, except that for individuals with modified AGI b/t $95k and $110 ($190k and $220k for joint return), the $2,000 maximum is phased out
  6. Contributions to ESAs are nondeductible
  7. Contributions grow tax-free until withdrawal, and withdrawal itself is tax-free to extent it does not exceed the child's qualified higher ed exenses
  8. Withdrawals that exceed expenses are taxed, plus 10 percent penalty tax on that portion of excess that represents earnings on the contribution.
  9. Unused portions may be rolled over to other ESAs of child or members of the childs family
  10. Amounts distributed from ESA will be excluded even though TP'er taxes advantage of Hope or Lifetime in the same year so long s the amts distributed from ESA are not used for the same qualified expenses for the Hope or Lifetime
  1. prop transfer b/t spouses no gain or loss even if bona fide biz transaction
  2. basis in prop transferred between spouses is carryover of transferrors basis
  3. b/t former spouses you get same treatment as spouses, as long as its incident to divorce --> presumed within 1 year or it is related to the succession of the marriage (i.e. within 6 years pursuant to a divorce or separation agreement)

sale of principal residence

  1. ownership and occupancy requirements
  2. tack on ownerhsip, ex spouse can claim ownership of her exspouses time occupying.
  3. spouse kicked out bc of divorce still treated as occupying as long as the kicking-out spouse still resides there.
162 biz deductions
  1. expenses must be incurred while carrying on, cannot be start up, cannot be expansion into a new trade or biz

biz vs non-biz vs corp

bad debts



Business debts

  • Deductable under in year they become:
    • wholly worthless; OR
    • Partially worthless, up to amount charged off w/in the year
  • No distinguishing b/t individuals and corporations


remodeling capitalization
if you are doing a remodeling job, you cannot pick and choose to expense parts of the job that would, by themselves, have been able to be expensed (e.g. painting done when remodeling must be capitalized even though painting a house can be deducted if it is being done outside of the remodeling context)
  1. amt received - adjusted basis = gain
  2. amt received - amt reinvested = must recognize gain
  3. amt reinvested - (gain - must recognize gain) = basis in new property


casualty loss and involuntary conversion
  1. condemned = like kind (note: all RE = RE)
  2. for non-condemned must end up similar situated (TP has end up doing what they were doing before generally)
unequal exchange
in case of unequal exchange, the TPs basis in the property received equals the FMV of that property
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