Three different courts for tax matters
1. Fed. Dist. Ct.
2. US Ct of Federal Claims
3. Tax Court
1 & 2 are for refund actions. 3 is for prepayment tax cases; jurisdiction if there‘s a
deficiency after an audit, review before you pay deficiency.
GI – Deductions = Taxable income
TI can be divided into Ordinary Income (ORD) and Capital Gains (CAP)
Section 61 defines GI as income, from whatever source.
Income is going to essentially be any accretion to wealth.
Amt realized – adjusted basis = gain/loss
CBp49 Caeserini- Family finds money in a piano. Is it taxable? There‘s a treasury
regulation right on point that says ―treasure troves‖ are taxable. Treasury regs are
entitled to more deference by courts than Revenue Rulings. Statute of limitations,
according to court, starts to run when you find the money. Title in found money vests in
accord with state property law.
For a gift there must be ―donative intent‖
Next case (55?): Company adopts a resolution to pay taxes for its executives (gross-up
clause). This counts as more income for the taxpayer.
Car $5000 Student Loans $50,000
House $200,000 Mortgage $150,000
Stocks $30,000 Total Assets: $235,000 Total Liabilities: $200,000
N.W. = $35,000
If this person finds $5k, we can see that his net worth is increased by 5k.
Similarly, if a benefactor pays off the student loan, N.W. is increased by 50K. This may
be excludable as a gift. However, if employer pays off the student loan, this would be
compensation and taxable.
Borrowing 10k creates an entry of 10k in cash on asset side and 10k on liability side. No
change in N.W. Discharge of indebtedness qualifies as GI.
Lost profits were stipulated as taxable. In cases on p57, parties were arguing about
exemplary damages. These are an accretion to wealth and thus taxable. (Some damages
may be excludable depending on the origin of the claim, more to come later)
Problems p. 65
1) No realization event
2) It‘s an accretion to wealth. It‘s not a gift, because the store wants people to come in.
3) In most cases, stock in a compensation package will be includable. There are special
rules for restricted stock; you may be able to defer. There does not have to be a
realization event, because there was no initial investment of money that had been
previously taxed. The value of the stock when given as compensation becomes your
basis moving forward.
For the car, it would probably be viewed as compensation to the husband and a
subsequent gift to the wife.
4) (a) Adjuster‘s kickbacks are gross income
(b) Even if it‘s illegal, it‘s still gross income.
5) (a) $1000 is clearly taxable. For the $3000 in improvements, it‘s either includable
now or when the lake house is sold.
What if T pays $4000 for rent, then L pays T $3000 for repairs. Materials cost T $500
for repairs. L should pay taxes on $4000. T should pay taxes on $2500
Helvering (p66)- You don‘t have income when you use your own property or perform services for yourself. This type of ―income‖ is not imputed for tax purposes.
Rev. Ruling 79-24: Fair market value of property or services taken in payment must be
included in income. Barter situation.
Dean (p67)- Couple occupied a house owned by a corporation. The rental value is
imputed income. You could also look at this as a dividend from the company.
Problems on p68
1a) Vegy harvest her own crops. No income unless sold. TR. 1.61-4(a)(1)
1b) Vegy and her family consume $100 worth of vegetables. Same result.
1c) Vegy sells $100 worth of crops. Income
1d) Vegy barters $100. Income
2a) Doctor and lawyer swap services. Both have income.
2b) Lawyer fills out her own tax return. No income.
Exclusion of Gifts and Inheritance
IRC ? 102(a) and (b)
At common law a gift is generally something given in the absence of a legal obligation to do so. Does a gift have the same meaning in the IRC?
Salesman gave Duberstein a car after Duberstein gave the salesman leads on business. Duberstein agrees to accept, reluctantly. Salesman deducted car as a business expense. Tax Court says Income; Court of Appeals reverses; Supreme Court reverses.
Stanton case decided with Duberstein. Stanton works for a church. Stanton decides to resign. The church board votes to give him a severance package, even though they had no obligation to do so. Court remands for further factual development. On remand, the district court found donative intent.
p74 ―A gift in the statutory sense … proceeds from a ‗detached and disinterested
Today, Stanton is essentially overruled by statute in 102(c), a transfer from employer to employee cannot be a gift.
1) Employer gives EEs $100 TVs. She gives son, who is an EE, a $500 TV.
If son can prove that the TV was intended as a normal gift from his mother, he can exclude it. Generally the IRS won‘t go to trouble of bifurcating into $100 and $400.
2) Louie gave tip to Maitre d‘ and croupier in Vegas. INC.
Lyeth v. Hoey- Will contest settlement. Descendant gets money. Is this an inheritance? IRS argues that heir received money by contract. Under state law, heir would have lost,
but Court viewed it as a federal question and decided that it was in fact an inheritance.
Court took the counterfactual position. If son won, he would have taken whole estate by
the laws of intestacy, which clearly would have been an inheritance. Accordingly, the
settlement proceeds should receive the same tax treatment.
Wolder v. Commissioner- lawyer gets bequest under the will. IRS argues that the bequest is compensation for preparing the will. Again, look to donative intent. Court
says that bequest was intended to satisfy Mrs. Boyce‘s obligation under her contract with
the lawyer for his services.
Today, Sup Ct leans toward strict construction of statutes, unlike the Wolder court.
Thomas recently cited the old 30‘s rule that tax statutes are strictly construed against the
government. As a lawyer, you need to consider how the court will view a statute in the
event that the transaction is challenged by the IRS.
Problems, p91, Exclusions under ? 102
1a) Father leaves daughter 20k in will. Excluded as a bequest.
1b) Same, but father dies intestate. Same.
1c) Will is contested and Daughter receives 20k in settlement. Excludable, look to nature
of underlying claim.
1d) Father leaves daughter 20k in will in appreciation for ―long and devoted service.‖
Probably just flowery language. Depends on facts.
1e) Father leaves daughter 20k in will pursuant to a written agreement in which D agreed
to care for Father as he wanes. Includable. Wolder
1f) Daughter successfully enforces above when Dad dies intestate. Money is taken of the
top of the estate. Includable.
1g) Same except settles for 10k. Same.
1h) Will provides that daughter will receive 20k for services as executrix. Includable.
1i) Father made 20k bequest in lieu of compensation as executrix. Under Merriam, this is
a bequest, although Wolder questions this logic.
2) Boyfriend agrees to leave everything to girlfriend. He dies intestate. She sues under a theory of quantum meruit. She settles. It should be included due to the underlying theory of the case. It would have been better to make a claim of common law marriage. Maybe in some states, an oral will would work.
? 132 Also see ? 61(a)(1); 79; 83; 112; 120; 125
? 132 (b) Parsed
2) provided by employer to employee
3) for use by the employee
(employee includes family sometimes, see (h))
4) service is provided by employer to customers
5) service is offered in the line of business in which the EE works
6) ER incurs no additional cost or loses no revenue
7) Without regard to any amount paid by EE
1) Must be for convenience of employer
2) EE must be required to accept
3) Lodging must be on premises
1) Furnished by ER for convenience of employer
2) On the business premises
Hatt Case- Majority owner lives on business premises. Issue: Was he required to accept
the lodgings as a condition of the employment? Ct says it‘s a fine exemption based on
the nature of the funeral home business. If he didn‘t live there, he would have had to pay someone else to live there.
Problems p 106
1. ER provides lodging with $5,000 rental value. EE pays $2,000.
(a) EE not required to live there, then $3,000 of income.
What if ER is in business of rental property? ? 132 Depends on facts. Is it really a fringe benefit or is it something else?
(b) ER and EE simply agreed to a clause in employment contract that requires EE to live on premises? Is it really for convenience of EE or just a sham? If sham, $3,000 of income.
(c) EE required to live on premises. ER provides $3,000 worth of groceries during the
year. Do groceries equal meals?
(d) ER transfers title in fee simple. This probably amounts to a transfer as compensation.
2) Motel owner incorporates, purchases residential property adjacent to the motel and
provides meals to herself. She‘s there and on call 24 hrs a day. Probably excludible
despite the residential property is adjacent to the business premises.
3) Cash reimbursements to highway patrolman for meals eaten at restaurants right next to
the highway. Issue: Does this count as on business premises? Most courts say no, but
you could make the argument. Usually business premises must be under control of the
business. Is he on duty when he‘s eating?
Reimbursement probably not the same as furnishing meals
Awards and Scholarships
? 74 creates a presumption that awards are income
?? 117, 127 for scholarships
Scholarships for room and board are not excludible
Donee takes donor‘s basis. If there‘s a built in loss in the asset, donee takes the FMV as
Problems p 128
Why do facts suppose no gift tax? ? 1015(d) allows donee to increase basis based on gift
Formula: Amount Realized (AR) – Adjusted Basis (AB) = Gain or Loss (G/L)
1) What gain or loss?
(a) Cost to Donor = 20k. FMV = 30k at time of gift. This means there‘s an inherent
gain of 10K built in. Because there‘s a built in gain, we only have to track one basis, 20k.
Donee sold for:
(1) 35k? Gain = 15k
(2) 15k? Loss = 5k
(3) 25k? Gain = 5k
(b) Cost to Donor = 30k. FMV = 20k at time of gift. Built in loss of 10k. Donee sold for:
(1) 35k? Gain = 5k (basis = 30k)
(2) 15k? Loss = 5k (basis = 20k)
(3) 24k? No gain or loss. When 20k is used as basis, 4k gain. When 30k is used
as basis, there‘s a 6k loss. In this situation there‘s no gain or loss.
2) Father purchased land for 120k. FMV = 180k. Built in gain of 60k. Father transfers
to daughter for 120k; a transaction, which is part gift, part sale. Assume no gift tax.
(a) See Reg. ?? 1.1001-1(e) and 1.1015-4. Transferor has a gain to the extent the AR
exceeds his adjusted basis in the property. Here F has no gain or loss. If AR is less than
the adjusted basis, F may not recognize a loss.
What is the basis for the transferee? ? 1.1015-4. Unadjusted basis is whichever is greater
of 1) the amount paid or 2) the carryover basis from the donor. In this case, it‘s the same
in either case, 120k.
Assume that she paid 80k. Donor is allowed no loss. Donee‘s basis is the greater of
amount paid, 80k or carryover basis, 120k. Basis = 120k.
Assume she paid 160k. Donor has a gain of 40k. Basis for donee is 160k. There was
60k of built in gain. Donor pays taxes on 40k of that gain. Donee now has built in gain
of 20k, so 60k of built in gain is preserved.
(b) Suppose the trxn were viewed as a sale of 2/3 for full consideration and an outright
gift of the other one third. Father received 120k with a basis of 2/3(120k). So he has a
gain of 40k. Daughter receives a gift of 1/3 of the property. Her basis in that 1/3 is 40k;
there is a built in gain of 20k in that 1/3.
Transfer b/n spouses or incident to divorce, p 129.
? 1041 says there‘s no gain/loss on transfers b/n spouses and transferee spouse takes
same basis. Also, no part sale/part gift allowed. You essentially treat the spouses as one
Problem 1 p131.
H purchased land for 4k. Land appreciated. W paid 7k for land.
(a) No gain or loss to H
(b) W‘s basis is still 4k (c) W sells to third party for 7k, what consequences? W has 3k in gain
(d) If property had declined in value to 3k and H sold for that amt to W, what result?
No gain or loss for H. W‘s basis is still 4k. On resell, W has 1k loss.
Property acquired from a decedent, p 131
We know that a cash bequest is not income. What about a bequest of property? ? 1014 allows basis to be stepped up (or stepped down if property has declined in value) by mandating that the basis equals the FMV of the property at the date of death.
? 1022 stipulates that basis will be the lesser of FMV at death or decedent‘s basis, IF the estate tax is repealed
Problem p 133
Crane case holds that nonrecourse debt will be treated the same as recourse debt for FIT purposes.
2) You took depreciation, which effects your basis. For symmetry, nonrecourse debt is included in the AR
Crane leaves question: What happens if bldg is worth less than the debt?
Commissioner v. Tufts
Tufts borrows 1.8M on a nonrecourse basis. Holds for a number of years and claims 400k in depreciation. FMV = 1.4, but principal on debt is still 1.8M. Tufts sells the bldg to Bayles for essentially nothing. Bayles takes subject to (does not assume any liability) the mortgage.
IRS claims 1.8 = initial basis, claimed .4 in depreciation. AB then = 1.4M. Amount realized = 1.8, since he is relieved of the debt. Gain = .4M.
Court takes second theory from Crane (symmetry argument) and approves the IRS treatment.
O‘Connor‘s theory: FMV = 1.4, that‘s AR. There‘s 0 gain on the sale, but since 1.8M in debt is terminated f ??? There‘s .4M of discharge of indebtedness income. Luckily this
is not law.
What‘s Bayles‘s basis? It may be 0. There are cases that say that when the debt is so far
above the value, the debt is not real. TR 1.1001-2(a)(3). If it‘s close, the basis will
probably be just the value of the debt.
Problem p 153.
1) Investment of 20k and nonrecourse of 80k
(a) What‘s adjusted basis? 100k (b) 2 years later, FMV = 300k. Principal amt of 80k still in place. Owner takes out 2d
nonrecourse mortgage of 100k. Income to owner? No. There‘s an offsetting obligation to pay.
(c) What basis in above, if proceeds of 2d loan used to improve the land? Bumps the
basis by 100k to 200k.
(d) If used to purchase stocks and bonds? Basis stays at 100k. Basis in securities = 100k.
(e) Same facts as (d). Mortgagor sells property subject to both mortgages for 120k in
cash. What is Purchaser‘s basis? 300k Seller has 200k gain.
(f) Facts of (d). Mortgagor gives property to Son. What result? It‘s like father is
receiving 180k in the transfer, since his debt is released. Part sale, part gift. AR = 180k,
AB = 100k, gain = 80k What basis for Son? Greater of mortgage assumption and 100
basis, = 180k. IF Son sells immediately for 300k, he has 120k gain, which when added to
father‘s gain = the original built in gain.
(g) Facts of (f), but Mortgagor gives to Spouse. What result? What‘s Spouse‘s basis?
What‘s Spouses basis after paying off 180k mortgage? ? 1041. Transfers between
spouses are ignored.
(h) Facts of (d), land declines in value from $300k to $180k. Mortgagor transfers by
quitclaim to bank. What result? AR = debt relief = 180k.
(i) Facts of (h), land declines to $170k. What result? Same. AR = debt relief = 180k
2) Investor purchases 3 acres for 30k. Sells one acre for 14k. Sells a second for 16k.
Basis is allocated on a pro rata basis at the time of initial investment. Basis = 10k for
Assignment 8: Discharge of indebtedness
If you borrow money, there‘s no income, as you get the benefit of the doubt that you will
repay. However, if that assumption is no longer true, i.e. the debt is cancelled, then you
have to report income.
Hypo: Joe takes out a business loan. His business goes south, and he is insolvent. The
bank forgives the debt. What tax consequences? If Joe is in fact insolvent, there is no tax
liability. The tax code does not view debt forgiveness as income, when the effect is
merely bring you from in the hole to having nothing. ? 108.
? 61 says discharge of indebtedness = income
? 108 exceptions
? If you‘re insolvent
? If debt forgiven in a bankruptcy proceeding.
? 108(e) (e) General rules for discharge of indebtedness (including discharges not in title
11 cases or insolvency). For purposes of this title—
(2) Income not realized to extent of lost deductions. No income shall be realized from the
discharge of indebtedness to the extent that payment of the liability would have given rise
to a deduction.
? ―payment of the liability‖- means that (e)(2) only applies to a cash method
taxpayer, not an accrual method taxpayer
5) Purchase-money debt reduction for solvent debtor treated as price reduction. If--
(A) the debt of a purchaser of property to the seller of such property which arose out
of the purchase of such property is reduced,
(B) such reduction does not occur--
(i) in a title 11 case, or
(ii) when the purchaser is insolvent, and
(C) but for this paragraph, such reduction would be treated as income to the purchaser
from the discharge of indebtedness,
then such reduction shall be treated as a purchase price adjustment.
? Must be a solvent debtor
? Debt must arise out of acquisition of property
? Seller has to be lender
? You still own the property
This might arise if purchaser believes that perhaps, he didn‘t get what he paid for, and
seller agrees and knocks off some portion remaining on the note. This is more like a
purchase price adjustment than income.
Zarin- Zarin has gambling debt forgiven. This was an unenforceable debt, but Casino sues. They settle 3.4M debt for .5M. IRS says 2.9M of discharge of indebtedness
income. He owes 70% of the debt, plus interest = 5.2M total.
1. Debt was not enforceable.
(He did not raise the issue of insolvency properly. This issue very well could
have resolved the case)
This is a strange argument, b/c if the debt was unenforceable, he should have paid
taxes when he initially received the 3.4M. Accordingly, the court says this is only
a factor in their holding.
2. Property. Court suggests that this was not a true loan, b/c indebtedness is defined
in ? 108(d) as any indebtedness (A) for which the taxpayer is liable, or (B) subject