Glossary Flashcards
Basis
Generally, what you pay for something, your capital investment.
Example: I buy Google stock for $100. My “basis” in the stock is $100. This would also be my “cost basis,” reflected in § 1012.
“GAIN” FOR TAX PURPOSES
Amount Realized (AR) less Adjusted Basis (AB) = Gain
“LOSS” FOR TAX PURPOSES
Adjusted Basis (AB) less Amount Realized (AR) = (Loss)
Amount Realized
Proceeds from a sale, the value of what you receive in a sale or exchange.
Example: I sell my above Google stock for $150. My “amount realized” is $150.
Adjusted Basis
Basis can go up, down, or remain the same while a taxpayer holds an asset. In all three instances, “adjusted basis” is the correct terminology when referring to the asset’s basis (even if basis has remained the same from the date of acquisition—i.e., when you acquired the asset—to its disposition—i.e., when you disposed of it by sale, exchange, or transfer).
Example: I sell my Google stock for $150. My “adjusted basis” is $100 (the basis has not gone up or down since acquisition).
Example: I buy a house for $100,000. My “cost basis” is $100,000. I add a $10,000 garage to the house. My “adjusted basis” is $110,000, because I’ve increased my capital investment by $10,000.
“GAIN” FOR TAX PURPOSES ONCE MORE
I sell my Google stock for $150, which I purchased for $100. What is my “gain”? AR – AB = Gain. So, $150 - $100 = $50 gain.
“LOSS” FOR TAX PURPOSES ONCE MORE
I sell my Google stock for $50, which I purchased for $100. What is my “loss”? AB – AR = Loss. So, $100 - $50 = ($50) loss.
TAX DEDUCTION
Can reduce income subject to tax. Measured according to a taxpayer’s total income and “marginal tax rate.” Accounts for certain expenses incurred during the taxable year.
Example: I take a deduction of $1,000 under some Congressionally-authorized tax provision. I am in the 30% marginal tax bracket (i.e., the last dollar I earn gets taxed at 30%). The $1,000 deduction has a value to me of $300 (i.e., $1,000 x 30%), and it thereby reduces my taxable income (i.e., my income subject to federal income tax) by that amount.
CAPITALIZED EXPENSES
Both “capitalized expenses” and “ordinary and necessary” business expenses reflect expenses incurred by businesses during the taxable year. However, while tax deductions for qualifying business expenses provide an immediate benefit to the taxpayer (by reducing taxable income by some amount), capitalized expenditures get added to basis of an asset and are “recovered” only in later years, either through depreciation (see below) or when the asset is sold (by creating a higher basis to offset sales proceeds, thereby reducing taxable gain). Think of capital expenditures as costs expected to contribute to generating income over future years; correspondingly, they are recovered over time rather than immediately.
Example: Every year, Bob paints the stairs leading to his business office. This expense is deductible in the current tax year as a maintenance expense.
Example: Bob tears down the old wood stairs leading to his business office and installs new diamond-studded stairs. This expense is capitalized and added to basis.
IMPUTED INCOME
A form of income that does not take the form of monetary payments; also a form of income that goes untaxed under our federal income tax. Think of “imputed income” as an implicit transaction with oneself that provides a benefit otherwise obtainable only through the paid marketplace. What in the world am I talking about?!?!
Example: Imputed rental income from renting your house to yourself (i.e., imputed income from property). Effectively, you, as homeowner, are paying yourself, as landlord, to live in your house in the same way that a renter pays her landlord a monthly rental check to live in a rental property. Your “net” imputed rental income is that “gross” imputed rental income less any annual maintenance expenses, including the home’s annual depreciation, maintenance expenses, etc. (but not interest paid on your mortgage or paid property taxes, because the Internal Revenue Code already provides a tax benefit for those expenses).
Example: Imputed child-care income from caring for your own child (i.e., imputed income from services). Effectively, you are paying yourself to watch your own child.
TAX UNIT
The “entity” that gets taxed, either the individual or the family (at least under the personal federal income tax). The tax unit for childless single taxpayers is the “unmarried individual,” while the tax unit for single taxpayers with children or qualifying dependents is the “head of household” (effectively, a single-headed family). Meanwhile, the tax unit for spouses (with or without children) corresponds either to “married filing jointly” or “married filing separately” status. The tax code does not consider cohabiting unmarried individuals as families for federal tax purposes (despite the sharing arrangements and economic interdependencies that may be present within those households nor whether the households are opposite-sex, same-sex, committed, intimate, or platonic).
SUBSTITUTED BASIS
Example: Living donor transfers stock with a basis of $100 and fair market value (FMV) of $200 to living donee. Donee takes the stock with a “substituted basis” of $100.
NB: According to § 1015, if, at the time of transfer from a living donor to a living donee, the FMV of the property has fallen below the donor’s adjusted basis, the donee’s basis in the property will be the FMV of the basis (rather than substituted basis) for purposes of determining LOSS at disposition (i.e., when the donee sells or transfers the property at some later date). See § 1015 handout.
TAX-FREE STEP UP IN BASIS
Associated with § 1014. Generally, when a dead donor (i.e., a decedent) transfers property to a living donee (i.e., a recipient), the donee takes basis in the property equal to its FMV at the time of the decedent’s death rather than equal to the decedent’s adjusted basis at the time of the decedent’s death.
Example: Decedent transfers stock with a basis of $100 and FMV of $200 to donee. Donee takes the stock with a “stepped-up basis” of $200. No tax is ever paid on the $100 of appreciation in value while the decedent held the stock. The tax liability goes “poof.”
TAX EXPENDITURES
How Congress spends money through the tax code. Think of tax expenditures as tax provisions enacted by Congress to accomplish non-tax objectives (i.e., economic or social policy objectives).
Example: The Earned Income Tax Credit (EITC), a low-income tax credit for the working poor, is designed to encourage low-income workers to enter the labor force and, for those already working, to remain in the paid labor force. It also offsets Social Security taxes for low-income workers.
“NON-REFUNDABLE” TAX CREDIT
Directly (and only) offsets tax owed.
Example: My accountant tells me that I owe $1,000 in federal income tax. But she also tells me that I can take advantage of a Congressionally-mandated $500 tax credit, which offsets my tax liability by a corresponding $500. Thus, I owe only $500 in tax rather than $1,000.
“REFUNDABLE TAX” CREDIT
Compared to “non-refundable” tax credits, “refundable” tax 3 credits offset tax owed and can provide a cash subsidy in the event the value of the credit exceeds tax liability.
Example: My accountant tells me that I owe $1,000 in federal income tax. But she also tells me that I can take advantage of a Congressionally-enacted $1,500 tax credit. Here, the credit wipes out my $1,000 tax liability, and provides a $500 cash payment.
EXCLUSION
Forms of income that are excluded altogether from calculating taxable income.
Example: Transfers qualifying as gifts under § 102 are excluded from income of the recipient; that is, they appear nowhere on federal (or state) income tax returns.
TAXABLE INCOME
Total income subject to tax. On an individual’s tax form (Form 1040), taxable income is derived from (i) total sources of income for the year; (ii) less itemized deductions (for those taxpayers itemizing deductions for the year); (iii) less the standard deduction (for those taxpayers not itemizing deductions for the year); (iv) less applicable personal exemptions; (v) less any applicable taxes paid and credits; (vi) multiplied by the applicable tax rates.
EXEMPTION
A tax-free threshold or “zero bracket” that exempts a specified dollar amount of income from tax. Exemptions reduce “adjusted gross income” and, ultimately, taxable income.
From its inception in 1913, the federal income tax used a personal income tax for taxpayers and their dependents. In 2017, the Republican-led Congress and a Republican president enacted the Tax Cuts and Jobs Act, which eliminated personal exemptions under the federal income tax.
STANDARD DEDUCTION
A tax-free threshold or “zero bracket” that reduces a specified dollar amount of income from tax. Taxpayers use the standard deduction when the sum of their itemized deductions (e.g., the deductions for mortgage interest, property taxes, or charitable contributions) do not exceed the standard deduction amount, which for tax year 2019 is $12,200 for individual taxpayers, $18,350 for heads of household, and $24,400 for married taxpayers (filing jointly).
ADJUSTED GROSS INCOME
Income after accounting for itemized deductions but before accounting for the standard deduction, exemptions, taxes paid, and credits.
ORDINARY INCOME
Generally, income from wages, interest, dividends, profits from business, and other § 61 forms of income. For tax year 2019, ordinary income was subject to seven different tax rates (ignoring the zero bracket amount), depending on the taxpayer’s total taxable income: 10, 12, 22, 24, 32, 35, and 37 percent.
CAPITAL ASSET
Generally, property held by a taxpayer (whether or not connected with a trade or business), but not including eight exceptions, the most significant of which are inventory, 4 stock in trade of a business, or property held primarily for sale to customers in the ordinary course of a trade or business. See § 1221(a)(1).
CAPITAL GAIN INCOME
Generally, income from the sale or exchange of a capital asset (such as real estate, stocks, taxable bonds). “Short-term” capital gain/loss refers to the gain/loss from the sale or exchange of a capital asset held for not more than one year. “Long-term” capital gain/ loss refers to the gain/loss from the sale or exchange of a capital asset held for more than one year.
Long-term capital gains are taxed at favorable rates, while short-term capital gains are taxed at ordinary income tax rates. The rates for long-term capital gains depend on a taxpayer’s taxable income: 0 percent for taxpayers with taxable income less than $40,000, 15 percent for taxpayers with taxable income over $40,000 but less than $435,000, and 20 percent for taxpayers with taxable income over $435,000.
NOTE: Taxpayers with capital losses can only offset those losses against capital gains (see concept of “Basketing” below). To the extent a taxpayer’s capital losses exceed capital gains for the year, the tax code allows a $3,000 offset to ordinary income and a limited carryover of those losses. The carryover is not very useful, however, unless the taxpayer can show gains in those years, and even then the gains must be capital gains.
BASKETING
A concept whereby we group or “basket” gains/losses from a particular source of income with losses/gains from that source.
Examples: capital gains/losses; gambling gains/losses; passive gains/losses.
RECOURSE LOAN
Loans on which the buyer is personally liable.
NONRECOURSE LOAN
Loans on which only the collateral property securing the loan is at risk.
Example: Home mortgages are nonrecourse loans. Thus, if you stop paying the mortgage loan on your house and the bank forecloses on the loan, you lose your home (which is sad), but you are not personally liable to the bank for the remaining balance of the loan (which is glad).
DEPRECIATION
A tax deduction allowed for the predictable decline in the value of a business asset. Set by the government. The concept of depreciation is an exception to the realization requirement (see below) in that we do not usually allow a deduction due to declines in value until the asset is sold or junked.
PUTATIVE TAX
In the context of tax-exempt bonds (which is the only context for which you will be responsible for understanding the concept of “putative tax”), “putative tax” can be thought of as the additional pretax return that the investor foregoes by investing in tax-exempts. It equals the spread in interest rates between the taxable and the tax-exempt debt instrument, and it is uninfluenced by a taxpayer’s marginal tax rate (though, as we will discuss in class, the decision to invest in a tax-exempt versus a taxable instrument may be influenced by a taxpayer’s marginal tax rate).
CORPORATE DIVIDEND
A payment made to a shareholder out of retained earnings or “earned surplus.” Cash dividends are taxable under § 61, while stock dividends are not taxable (see Eisner v. Macomber).
REALIZATION
Concerns whether what has happened crosses some threshold of significance derived from the IRC, the regulations, or common law that would justify taxation. Involves when to tax: now, later, never.
Example: I own a primary residence with basis of $80 and FMV of $100, which I sell for $100. I “realize” $20 of income, but I may not have to “recognize” it (see below) due to a specific nonrecognition rule (or exclusion) in the Code.
RECOGNITION
Concerns the applicability of the various statutory nonrecognition rules, in which case gain or loss may or may not be recognized. Again, involves when to tax.
Example: I own a primary residence with basis of $80 and FMV of $100, which I sell for $100. I “realize” $20 of income, but § 121 may allow me to exclude the entire gain from income if I meet certain statutory requirements.
Example: I own a working farm with a basis of $80 and FMV of $100, which I exchange for another working farm with a basis of $90 and a FMV of $100. I “realize” $20 of income, but § 1031 (the like-kind exchange provision) may allow me to defer recognizing my realized gain of $20 until a later date.
CASH METHOD OF ACCOUNTING
Amounts are treated as income when received in cash or cash equivalent and deductible when paid. Individual taxpayers are typically subject to the cash method of accounting.
Example: I perform services in December 2014, for which I am to be paid $100. I am not paid until June 2015. I include payment in the year of receipt (i.e., 2015), because I am on the cash method.
ACCRUAL METHOD OF ACCOUNTING
Items are included in income when earned (regardless of receipt of payment), while items of expense are deductible when the obligation to pay is incurred (regardless of when payment is made). Business taxpayers are typically subject to the accrual method of accounting.
Example: I perform services in December 2014, for which I am to be paid $100. I am not paid until June 2015. I include payment in year of performance (i.e., 2014).
DOCTRINE OF CONSTRUCTIVE RECEIPT
A payment is treated as received (i.e., constructively received) if it is made available to the taxpayer so that she can receive it even though she may choose not to receive it.
Example: A pay envelope is made available to a taxpayer at the end of the year. Taxpayer is treated as being paid even if she does not retrieve the envelope until the following taxable year.
ECONOMIC BENEFIT DOCTRINE
A cash method taxpayer recognizes income as soon as a payor irrevocably sets aside funds for the taxpayer in a manner that prevents the payor’s creditors from reaching them.
Example: Money set aside in an escrow account.
CLAIM OF RIGHT DOCTRINE
Two taxpayers claim ownership over the same stream of income. The taxpayer with possession of the income is taxed on the income despite the ongoing dispute.
Note: If the income item must be returned at a later date, the taxpayer generally will be entitled to take a deduction for the returned amount in the year the item was returned.
STOCK OPTIONS
Stock options provide an employee the right, but not the obligation, to purchase shares of an employer’s stock at a certain price (i.e., the “strike price” or “exercise price”) for a certain period of time. Options are granted (or “issued”) to an employee on the grant or issue date (T1), but only later “vest” (T2), at which point the employee can “exercise” her options. During the vesting period (i.e., between T1 and T2), the employee may not have an unrestricted right to the shares; that is, they may not necessarily be transferable and they may be forfeitable (meaning the employee may lose the shares if she does not meet certain terms of the grant, such as remaining employed with the same employer for some specified period of time). A taxpayer may have to include the value of her options in the year of the grant if the options have a readily ascertainable market value and the options are transferable or not subject to forfeitability (in other words, we know their value and the taxpayer can receive that value today or it is relatively certain she can if she desires convert them into actual shares of stock at a later date). We will discuss both non-statutory stock options (governed by § 83 and described above) as well as incentive stock options (ISOs) (governed by § 422).
