Gross Income

Code 61(a)

Gross income includes all income derived from any & all sources including rent,
compensation for services, etc.
Gross Income is anything where there is:
o Undeniable accession to wealth
Accession to wealth is determined by each transaction
Leaving better off than before
o Clearly realized
Disposal of the property
o Taxpayer has complete dominion over
Rent is gross income.
o Other than cash, the taxpayer must include the fmv of the property in gross
income.
o Do not know the value of the property received in an arms length transaction,
assume it is equal to the value of what was received from the other party. Philly
Park.

Deposits, and Prepayments

Definition:
Whether payments constitute income when received depends upon the parties' rights and
obligations at the time the payments are made.
Determine who has complete dominion over the $, who gets to keep it
o Deposits: The customer who submits a deposit retains the right to insist upon
repayment.
Landlord isnt wealthier so no accession to wealth, no reporting
o Advance Payments: The individual retains no right to insist upon the return of the
funds; so long as the recipient fulfills the terms of the bargain, the money is his to
keep

Prizes and Awards

Prizes and Awards are gross income.

They are an accession of wealth and must be reported unless there is an exclusion
Prizes (Religious, charitable, scientific, educational, artistic, civic)
1) Recipient selected without any action on his part to enter contest
2) Not required to render future services
3) Transfer $ to govt or charitable organization
Awards Employee
1) $400 or less not gross income
Depending on the award they are seen as compensation of services which is gross
income.
Treasure Trove is gross income
Code 74; 274(j)(1)-(4)

Reg. 1.74-1(a)

Property
Gains Involving Property
Gains from dealings in property are in gross income.
Gain is the excess of the taxpayers amount realized less his adjusted basis.

Definition:
o A gain or loss is determined by AR-AB. AR is the amount received when the
property is sold. AB is cost plus gross income inclusion.
In property for property exchange AR is what the TP recd for the property if
known, if not known presume equal to services

Bargain Purchase is not gross income but must look at substance of the form
to determine
Code 61(a)(3), 1001(a), (b), (c); 1012(a); 1016(a)(1)
Reg. 1.61-2(d)(2)(i); 1.61-6(a); 1.1001-1(a); 1.1001-2(a)(1).

Losses from Disposition of Property

Personal Losses are not deductible.

Individuals may take deductions for losses incurred in
o Trade or business,
o Transaction entered into for profit, or
o as a result of fire, storm, shipwreck or other casualty, or from theft.
Trade, Business, or Investment losses are deductible.

Disposition of Principal Residence

Own 2 out of 5 yrs

Can only use once within 2 yr period
$250,000 gain exclusion up to $500,000 if married
Code 121
Reg. 1.121-1(a), (b)(1), (2) (3)(i), (c)(1), (2)(i).

Like Kind Exchange

Mandatory no reporting:
1) Like-Kind exchange of property
2) Holding gave up trade, business, or investment
3) Holding recd trade, business or investment
Boot is only calculated if there is gain
Boot:
cash received
+ fmv of non-like kind property received
+ Net positive debt relief
- Cash and fmv of non-like kind property paid

Total boot received* (recognized cant be more than realized though)

Code 1031(a)-(d)
Reg. 1.1031(a)-1(a)-(b).

Involuntary Conversion

Only applies to gains not loss

Conversion based on:
o Destruction
o Theft
o Seizure
o Condemnation
Have 2 yrs to replace the property
Functional Test:
o If owner physically used prop then must physically use prop
o If not physically used:
Services provided before & after
Financial Risk involved
Management activities
To determine if gain, AR less AB to determine realized gain, AR less new Replacement
property cost to determine recognized gain.
o New Basis: AR less (Realized gain less Recognized Gain)
Code 1033(a)(1), (a)(2)(A), (a)(2)(B), (a)(2)(E)(ii).
Reg. 1.1033(a)-1(a). 1.1033(a)-2(c).

Gifts and Inheritances

Gifts
o Definition: Gifts are not gross income. Detached & Disinterested from moral
or legal obligation
Unless theres income made off gift (rent from getting a gifted apt. bld)
o Basis: The gifted propertys basis is the Donors AB
Unless AB is greater than FMV and donee sells at loss must use FMV NO
LOSS
Exception triggered if:
o FMV is less than AB of donee
o Creates a loss when using AB of donee & AR of Donor
o There are no exception for a gift from an employer; Employers cant give gifts
o Part Sale/Part Gift
Look to intent of Donor
Excluded from gross income

Basis is the greater of cost basis or Donors carry over basis

Inheritance

o Definition: Inheritance is not included in gross income.

o Basis: The recipient of inheritance receives a basis in the property equal to the
FMV at the time of death
Code 102, 1014(a)(1), 1015(a).
Reg. 1.102-1(a), (b); 1.1001-1(e); 1.1001-2(a)(1). 4(iii);
1.1015-1(a); 1.1015-4; Prop. Reg. 1.102-1(f).
Code 101(a), (c).

Life insurance

Not gross income

o Unless earning component, earning are gross income

Damages

Definition: Look to what the damages are replacing

o If for services = gross income
o Property = AR AB
o Personal Physical Injury not gross income
Includes loss wages, medical expenses
NOT punitive damages

Loans and Cancellation of Debt

Loans
o Definition: Loans are not gross income because there is no accession of wealth
due to assets and liability being equal.

Discharge of Debt
o Definition: gross income because its making wealthier
o EXCEPTION:
Bankruptcy
Insolvent (up to insolvency)
Assets less Liability determines amount insolvent. Not gross
income up to amount insolvent, but anything above is gross
income
Disputed Liability
Not part of gross income
Contested liability
Not considered debt discharge

Deductions
Personal

General rule (262):

o You must provide authority for any expenditure.
o In general, no expenditure is allowed for personal items.

o Exceptions:
Tax return preparation ( 212(3))
Tax advice ( 212(3))
Mortgage interest ( 163(h))
Charitable contributions ( 170)
o 12 Month Rule
Does not last longer than one month
The benefit doesnt extend past yr 2

Business Expenditures (162)

1. Ordinary and

Customary or expected in that business

2. Necessary

Appropriate and helpful

Brings in revenue

3. Expense

life less than one year

If more than one year not deductible under 162
More than one year usually means capital expediture

4. Paid or incurred during the taxable year

5. In carrying on

Operational, activity conducting business

Startup is not covered under 162

195(b) covers startup costs in active trade or business

Amount of startup up to $5,000 if less than $50K 1st year

If over $50,000 reduce by $1 for every dollar over
Then remainder spread over 180 mths

6. A trade or business

Continuous & regular activity for profit

NOT investment
Meets all but CARRY ON
May elect to deduct startup expenses under 195
Clothing
Not considered deductible UNLESS
1. Attire required for employment
2. Objectively not suitable for outside work
3. Not worn outside work

Investment Expenditures
o Buying stocks/rental property
o Ordinary & necessary
o Paid or incurred during taxable year
o Production of income or
o Maintenance or property for income or
o Tax return advice

Capital Expenditures
o Not deductible generally
o Last more than a year
o Tangible
o Wears out
o Trade, business or investment
o Training of Employee (more than 1yr)
o Advertising (not a physical asset)

Depreciation (168)
1.
2.
3.
4.
o

Tangible property
Subject to exhaustion, wear and tear,
Placed in service after 1980,
Used in trade of business or held for production of income
Adjusted Basis
o Basis must be reduced by the amount of depreciation allowed or
allowable. In other words, the basis must be reduced by the greater of the
amount of depreciation allowed under the code or the amount claimed by
the taxpayer.
179 Requirements
1. Tangible personal property
2. Subject to depreciation
3. Acquired by purchase for use in Trade or business
Can deduct up to $500,000 but subject every dollar over $2mil

Amortization (197)
1. Acquired intangible
2. 197 intangible (includes customer list, going concern value and goodwill)
3. Held in Trade or Business or production of income activity

Interest
o Trade or business interest- yes
o Investment interest- yes
o Personal- no

Charitable Contributions
o Requirements:
1. Contribution (no return benefit),
2. To of for use of Qualified recipient,
o United States
o States or political subdivisions
o Religious, charitable, scientific, literary, education organization
o Cannot be an individual
3. Actual payment, and
4. Sufficiently substantiated

o look at intent of donor

o Cannot expect quid pro quo
o If pay more than value of what receive, excess may be a charitable
contribution
o **Subject to certain limitations.
o No deduction for services
o Limit of 50% of AGI

Loss From Disposition of Business Property

Cannot recognize a loss on the sale/exchange of property to a related person.

o Members of a family:
o An individual and a corporation more than 50% percent in value of the
outstanding stock of which is owned by such individual:
o A grantor or fiduciary of any trust
Use:
o Time of Sale to determine
o Person, business, trade or investment
Disposition is AR-AB
AR is determined by:
Cash
+ fmv property
+ fmv services
+ debt relief (recourse or non-recourse)
Amount realized
AB is determined by:
Basis = Cost = fmv
+ Capital expenditure
- Depreciation
Adjusted basis
o Report:
o Gain
Report (unless non-recognition provision applies)
Sec. 61(a)(3)
o Loss
Must provide authority
Sec. 165(c)

Business Bad Debts

1.
2.
3.
4.

Is there a bonafide debt?

Is it a bad debt?
Business vs. Non-business debt?
What is the TPs basis in the debt? (bad debt deductions limited to basis)
Non-business
a. STCL
business
a. ordinary

The amount that can be deducted is limited to basis.

Lesser of:
Basis or
Decrease in value
(value before value after)

Capital Assets
o All gains/losses will eventually fall into one of two categories:
o Those taxed at ordinary rate.
o Those taxed at preferential rates.
Those assets that potentially can be taxed at preferential rates are
called capital assets.
o Determine the characterization:
o Capital
o 1231 hotchpot
o Ordinary
o Not Capital Assets:
o Inventory
o Property - sale to customers
o trade or business
Depreciable property
Real property (land)
o Accounts receivable generated from services or the sale of inventory
o Supplies
o Calculating Capital Assets
1. Divide into short-term and long-term categories.
2. Determine net amount in each category.
3. If one is a loss and the other is a gain, net them.
4. If both are losses or both gains, keep separate.
5. Determine tax result.
o Net short term capital gain => ordinary
o Net long term capital gain => reduced rate
o Net capital loss => limited to $3,000
- use short term first
- carry excess forward to next year
o Determining Tax Result
o Ordinary income: regular rates
o Ordinary losses: no limitations
o Short-term capital gains: regular rates
o Long-term capital gains: preferential rates
o Capital losses: limited to $3,000
- use short term first
- carry excess forward to next year
o 1231 Hotchpot
o Depreciable property used in a trade or business and held more than one
year;
o Real property (land) used in a trade or business and held more than one

year.
o Calculations
Gain = all capital
Loss = all ordinary

Recapture

Converting gain to ordinary income.

o Depreciable tangible property
o Depreciable intangible property
(i.e., everything depreciable/amortizable except buildings)
Re-characterizes gain as ordinary income to the extent of depreciation taken.
However, recapture amount cannot exceed realized gain.

Installment Method

Cannot be reported under the installment method

o losses (453(a))
o inventory (453(b)(2))
o Publicly trade property
o recapture of depreciation

Application of Characterization
First: What is the amount of gain or loss realized?
Second: determine the characterization

Capital
1231 hotchpot
Ordinary

Third: Apply section 1245

Rule: recharacterizes gain as ordinary income to the extent of depreciation taken.

Fourth: Installment sales

If payments are to be made under the installment method, calculate the amount of
gain to be reported in the current year.

 Fifth: determine if net 1231 gains/losses should be ordinary or

capital.
Sixth: Sub-dividing the capital gains/losses

Divide into short-term and long-term categories.

Determine net amount in each category.
After netting each category:
If one is a loss and the other is a gain, net them.
If both are losses or both gains, keep separate.

Seventh: Determine tax result

Ordinary income: regular rates

Ordinary losses: no limitations
Short-term capital gains: regular rates
Long-term capital gains: preferential rates
Capital losses: limited to $3,000
use short term first
carry excess forward to next year

Cash Basis Accounting

Gross Income Inclusion based on Receipt

1. Actual
2. Constructive
Funds made avail to TP
No restriction of limitation
Not when mailed
Delivered
3. Economic Benefit
Money Set aside in an account
TP to be paid in the future
Account Subject to valuation
Fully vested
Non forfeitable
Secured creditors
4. Cash Equivalent

Accrual Basis Accounting

Gross Income Inclusion based on earlier of the receipt or all events test
o Right to income is Fixed
o Amount can determined w/ reasonable accuracy
Prepayments
o Deferred to yr 2
o If earned & provided in year 1 must report
Deductions
o All events test
Right to income is Fixed

Amount can determined w/ reasonable accuracy

Economic performance

Claim of Right

Applies to Cash & Accrual

Legal contingency over taxpayer on whether can keep
Someone else claiming a right to the interest
1. Report as income when recd
2. Holding as claim or right
3. w/out restrictions
Options
1. Take a deduction in the year discover not entitled to income; or
2. Compute tax without deduction, but get credit for having paid tax on
money not entitled to.

Tax Benefit Rule

Tax payer took a deduction but later recover the funds

Assignment of Income

The person who provided the service

The person who has control over the asset

Kiddie Tax

Under 18 before end of tax year

Tax rate is higher of childs rate or parents rate

Tax Consequences of Divorce

Alimony
o Recipient includes in income ( 71)
o Payor can deduct ( 215)
Cash
To or for the benefit of the spouse
o Pursuant to a divorce or separation agreement
o Parties did not elect non-alimony treatment
o Not members of same household if legally separated or divorced
o No liability after death of payee
o Not child support
Child Support
o Not included in income.
o No deduction upon payment.
Division of Property
No gain or loss recognized.
Basis = carryover basis
Applies to:
o Transfers during marriage
o Transfers incident to divorce

applies if transfer occurs within 1 year of divorce

applies if occurs within 6 years of divorce and pursuant
to divorce decree
o Cannot elect out