Chapter 5-7 Flashcards
Chapter 5 Awards and Prizes
What is Code section 74a?
General rule: Gross income includes amounts received as prizes and awards. IRC §74(a).
Definition of prizes and awards: Prizes and awards include amounts received in contests, door prizes, radio and television promotions and games,
and employee prizes. Reg. §1.74-1(a)(1).
Chapter 5 Awards and Prizes
What is Code section 74b?
Section 74(b) Exclusion: The amount of the prize or award will be excluded from the gross income of the recipient if three conditions are met.
- Passive recipient: The recipient must have been selected without any action on his or her part to enter the contest, IRC §74(b)(1);
- No services: The recipient must not be required to render substantial future services as a condition of receiving the prize, IRC §74(b)(2); and
- Charity: The recipient must immediately transfer the prize to charity. IRC §74(b)(3).
Example:
The only way to exclude is never to receive the award.
Example: Amy’s mother secretly entered her name in a drawing for a trip to Hawaii. Much to Amy’s surprise, she won the trip, and there were no conditions that she endorse any product or perform any services for any person. Amy enjoyed her trip to Hawaii immensely. However, she must include in her gross income the fair market value of the trip, as §74 includes this amount in gross income, and she fails the third of the three
requirements for exclusion—she didn’t immediately transfer the trip to charity.
Chapter 5 Awards and Prizes
What is Code section 74c?
Section 74(c) Exclusion - Employee achievement awards: Employee achievement awards (defined at Code section 274(j)) are excludable up to the amount of the cost of the award to the employer that is deductible. Code section 74(c)(1).
Definition: Awards for length of service or safety that are meaningful and not disguised compensation.
Deduction: If “ not qualified”, deductible up to $400. If “qualified”, deductible up to $1,600.*
Qualified: Plan does not discriminate in favor of highly-compensated employees
Example:
Remember, 102 does not provide for gift exclusion between employer & employee
Gift could still be deductible as a de minimis fringe (132(a)(4)).
* These amounts can be changed based on inflation.
Chapter 5 Awards and Prizes
Describe the Allen J. McDonnell case
Prizes & Awards Case:
Allen J. McDonnell, 26 TCM 115 (1967): An all-expenses-paid business trip does not constitute taxable "disguised remuneration" when the recipient is required to go as an essential part of his employment and is expected to devote substantially all of his time on the trip to performance of duties on behalf of the employer.
Chapter 5 Awards and Prizes
What is Scholarships & Fellowships Code section 117
Code section 117 excludes from gross income the amount received as a “qualified scholarship” by students at qualifying educational institutions.
Policy: The legislative history for §117 reveals no rationale for its exclusion of scholarships from gross income. It may reflect a desire to treat similarly those who receive gifts from family to attend school and those who receive “institutional gifts” such as scholarships.
Note:
While such a rationale is consistent with §117’s restrictions as to services, it does not explain the denial of an exclusion for amounts attributable to room and board.
Chapter 5 Awards and Prizes
What is the general rule of scholarships?
General rule: A candidate for a degree at a qualifying educational organization may exclude from his or her gross income the amount he or she receives as a qualified scholarship or as a qualified tuition reduction. Code section 117(a).
Definitions:
Qualifying educational organization: The educational organization must qualify as one under Code section 170(b)(1)(A)(ii), i.e., one that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance where its educational activities are regularly carried on. Code section 117(a).
Qualified scholarship: The scholarship or fellowship must be for tuition, books, fees, and supplies (not room and board). Code section 117(b).
Qualified tuition reduction: This is a reduction in tuition provided to an employee (or family member of the employee) of the qualifying educational organization, if the benefit does not discriminate in favor of highly compensated employees and is used for undergraduate study. Code section 117(d).
Example:
Example: Victor is the son of Wanda, a professor at a small college in the Pacific Northwest. Under the terms of Wanda’s employment agreement, her children may attend the college for four years of undergraduate study by paying only 20% of the tuition charged students whose parents are not employees. Victor opts to do so and thus enjoys a tuition reduction of 80%. Assuming this benefit does not discriminate in favor of highly compensated employees of the college, it is excluded from the gross income of both Victor and Wanda because it is a qualified tuition reduction.
Chapter 5 Awards and Prizes
What are the scholarship exemptions?
Services Exception: The exclusion does not apply to any portion of the amount received that represents payment for services—teaching, research, or other services—required as a condition of the grant. Code section 117(c).
Educational assistance: An employer’s expenditures for educational assistance to employees will not be included in the employee’s gross income. Code section 127(a)(1).
Educational assistance is limited to $5,250 per employee. Code section 127(a)(2).
Does not include assistance for courses involving sports, games & hobbies.
Example:
Example: Zach is offered a fellowship at a nationally acclaimed graduate program. As a condition of the fellowship he must teach a section of Economics 101. The portion of the fellowship attributable to teaching activities will not be excluded from Zach’s gross income.
Services must be mandatory. For example, athletic scholarships, in which (1) students are expected but not required to participate in athletic events, (2) no particular activity is required in lieu of participation, and (3) no cancellation will occur if the student cannot participate, do not carry with them a service requirement that would result in the amounts received being taxable. Rev. Rul. 77-263, 1977-2 C.B. 47.
Contrast 117 Services with 127: The fact that educational assistance requires that services be rendered is not a bar to deduction.
Chapter 6
Gains from Dealings in Property
For Dispositions of Property what are the factors for determination of Gain (and Loss)?
Factors in Determination of Gain (and Loss): Gain is the excess of amount realized over basis. Conversely, loss is the excess of basis over amount realized. Gains are included in gross income (and losses may be deductible). Basis represents the taxpayers investment in the property, and the recovery of investment (i.e., return of capital) is always excluded.
Realization event: There must be a disposition
Basis: The amount of the taxpayer’s investment. More correctly, we must determine “adjusted basis.”
Amount Realized: The amount of money received and fair market value of property (other than money) received on the disposition (Section 1001(b)).
Chapter 6
Gains from dealing in property
What questions arise during Disposition of Property?
Several questions address the issues that potentially arise upon the sale or exchange of property.
Has there been a transaction in “property” ?
Has a realization event occurred?
What is the taxpayer’s basis in the property transferred?
What is the taxpayer’s realized gain or loss on the transaction?
What is the taxpayer’s recognized gain or loss on the transaction?
What is the taxpayer’s basis in any property (other than money) received?
What is the character of recognized gain or loss on the transaction?
Notes:
Today, we’re really assuming that a realization event occurred and we are focused on realization (not recognition). We are also focused on the seller’s (transferor’s) basis in the property transferred.
We will work on recognition and character later in the course.
Chapter 6
Gains from dealing in property
What is Basis?
Basis
Adjusted basis: In order to calculate realized gain or loss, the adjusted basis of the property transferred must be determined.
The adjusted basis of property is its basis when acquired by the taxpayer and adjusted thereafter as required by §1016.
Adjusted basis is the way the Code keeps track of a taxpayer’s unrecovered economic investment in property for purposes of calculating the taxpayer’s gain or loss upon sale or exchange of the property.
Chapter 6
Gains from dealing in property
What is Cost Basis?
Property acquired by purchase: The purchaser’s initial basis is the cost of the property. IRC §1012. The cost of property is equal to:
the amount of money paid for the property,
the fair market value of the property or services given in exchange for the property,
and the face amount of liabilities assumed in acquiring the property.
Remember to include in initial cost any expenditures made to acquire the property and ready it for use (i.e., sales commissions, property and transfer taxes).
Property received in exchange for services rendered: The cost is the amount of the income included in gross income as a result of the services transaction. Essentially, the taxpayer “purchased” the property through recognizing services income for tax purposes, and the “purchase price” is the amount of income recognized. (known as tax cost basis).
Example:
Example —Cash: Bill purchases Blackacre for $100,000. His initial basis in the property is his purchase price, $100,000.
Example —Cash and property: Allison purchases Whiteacre from Penny, giving Penny $50,000 cash and a parcel of raw land worth $60,000. Allison’s initial basis in Whiteacre is its cost, or $110,000, equal to the cash plus the fair market value of the property given Penny to acquire Whiteacre.
Example—Cash, property, liabilities: Frank purchases Blueacre by transferring to the owner $30,000 cash and a parcel of real property worth $50,000. Frank also assumes a $40,000 mortgage to which Blueacre is subject. Frank’s initial basis in the property is equal to his cost, or $120,000 (the total of the cash, fair market value of the property, and the liability Frank assumes).
Example—Tax cost basis: Mary Ann is a lawyer who provides legal services for her client, who pays her with a sports car worth $20,000. Mary Ann includes the fair market value of the sports car received ($20,000) in her gross income, and her basis in the sports car is $20,000.
Chapter 6
Gains from dealing in property
Review Case: Philadelphia Park Amusement Co. v. U.S
Case related to Cost Basis:
Philadelphia Park Amusement Co. v. U.S.: Where a taxable exchange of property occurs, gain or loss should be recognized in establishing the basis for the property on the date of the transfer.
Note: In this case, the basis focus was one for determining the taxpayer’s claim of depreciation deductions after acquiring the franchise (not determining the taxpayer’s gain or loss on later disposition). We will address depreciation later in the course. Basically, basis is required in order to determine gain or loss on later disposition and also to establish the amount on which cost recovery deductions (such as depreciation) may be taken where allowed by the Code.
Chapter 6
Gains from dealing in property
What is Gift Basis?
Property Acquired by Gift: Code section 1015(a). The donee’s basis in gifted property depends whether, AT THE TIME OF THE GIFT, the gifted property had built-in gain (FV of property > donor’s basis) or built-in loss (donor’s basis > FV of property).
Built-in Gain Property at time of gift: Donee’s basis is equal to donor’s basis (plus any gift tax paid with respect to the gift). This is known as “carryover” basis (specifically, “transferred” basis – the basis in the hands of one person is transferred to another person).
Built-in Loss Property at the time of gift: The basis to use depends whether the amount realized by the donee on later sale is more or less than the donor’s basis.
Amount realized > Donor’s Basis (Gain Basis): Use donor’s basis (same as above) to measure gain.
Amount realized < Donor’s Basis (Loss Basis): Use the fair market value of the property on the date of the gift as basis to determine the loss.
NO GAIN OR LOSS: If the amount realized is between the gain basis and the loss basis, no gain or loss will be recognized (i.e., the gain basis will not yield gain and the loss basis will not yield loss).
the donee will not know which basis to use until the property is sold
Chapter 6
Gains from dealing in property
See Gift Basis example
Gift Tax Basis Examples:
Built-in Gain: Ten years ago, donor purchased common stock for $10,000. Two years ago, donor gave the donee stock when it was worth $11,500 and no gift tax was paid. Because the value > donor’s basis at the time of the gift, the donee takes a carryover basis of $10,000 in the stock. This year, donee sold the stock for $14,500. Donee has realized a gain of $4,500, the difference between the amount realized ($14,500) and the donee’s carryover basis ($10,000).
Built-in Gain: Assume same facts as in the prior example, except that this year, the donee sells the stock for $7,000. Because the value > donor’s basis at the time of the gift, the donee’s basis in the stock is still $10,000 (carryover). Thus, this year, donee recognizes a loss of $3,000 on the sale ($10,000 basis - $7,000 sales price).
Built-in Loss: Donor acquired property several years ago for $6,000. Last year, when it was worth $4,200, donor gave it to done (no gift tax was paid).
Donee’s gain basis is $6,000 (carryover basis).
Donee’s loss basis is $4,200 (value at gift date).
If the stock is sold for more than $6,000, gain basis is used to determine gain.
If the stock is sold for less than $4,200, loss basis is used to determine loss.
If the stock is sold for between $4,200 and $6,000, the donee will recognize no gain or loss.
Chapter 6
Gains from dealing in property
Gift Basis Notes
Gift Basis, cont’d:
Policy (or…why so complicated?): A gift is not taxable to the donee (i.e., is an exclusion). These basis rules ensure that, when the property is sold in a taxable transaction, the amount of gain recognized is at least what the donor would have recognized had he held the property and sold it, and the amount of loss recognized is limited to what the donor would have recognized had he sold the property at the time of the gift.
Planning note: It might be better for a donor to sell depreciated (i.e., built-in loss) property (for which he might claim a loss deduction), then gift the cash to the donee.
