Income Tax

Question 1

What is in the main “hotchpot” of 1231?

Answer 1

• Depreciable business property held for more than 1 year
• Real property used for business
• Any compulsory/involuntary conversion of depreciable property

Question 2

Section 1231 Generally (Characterizing Gain)

Answer 2

If the gains on disposition of depreciable business property exceed the losses on that property, the gains are long term capital gains. If the losses exceed the gains, the losses are treated as ordinary income.

Question 3

What is the sub “hotchpot” of 1231?

Answer 3

If losses from involuntary conversions exceed gain, they are not applied to the main hotchpot and are ordinary income. If gains from involuntary conversions that exceed losses, the gain is put into the main hotchpot.

Question 4

How does the 1231(c) “Lookback Rule” work?

Answer 4

If there is a gain from the main hotchpot, use that to offset any of unrecaptured loss from the last 5 years. If the gain exceeds the losses, the losses become ordinary income, and the gain is characterized as long-term capital gain.

Question 5

What is the main takeaway of Williams v. McGovern (I.e. where TP argued sale of entire business was a capital asset)?

Answer 5

Treat the sale of a business as a fragment of all the business’ assets for tax purposes. So it’s an assessment of the various assets and not a single capital gain.

Question 6

What is the section 1245 Rule with depreciated property?

Answer 6

The gain minus the adjusted basis is treated as ordinary income.

Question 7

What is 1245 property?

Answer 7

Property that can be subject to depreciations allowed under 167, including personal property and other tangible property used for manufacturing, transportation, communication, etc. BUT not including real estate (which is subject to 1250 Rule).

Question 8

Can gifts or transfers at death (such as from a will) be considered 1245 property?

Answer 8

No

Question 9

What is recomputed basis?

Answer 9

The adjusted basis plus all allowed depreciation deductions. (Essentially, the original adjusted basis before deductions were allowed)

Question 10

How is 1245 property gain computed in case of a sale, exchange, or involuntary conversion?

Answer 10

Either the Recomputed Basis minus Adjusted Basis, OR the Amount Realized minus Adjusted Basis, whichever is lower.

Question 11

How is 1245 property gain computed in case of other dispositions?

Answer 11

Either the Recomputed Basis minus Adjusted Basis, OR Fair Market Value minus Adjusted Basis.

Question 12

What are the general factors for a business deduction?

Answer 12

1. Ordinary
2. Necessary
3. Paid during the taxable year
4. Paid in carrying on trade or business

Question 13

Are repairs deductible under Section 162?

Answer 13

Yes, so long as they are done for the intent of current repair and not for future improvement (think of the meat plant where they had to re-inject cement into walls)

Question 14

In general, are start-up costs of a completely new business deductible as ordinary or necessary in a trade or business?

Answer 14

No. If it’s a completely new trade or business, it’s a capital expense. However, if you’re investing in a new business that’s within your same trade, it may deductible.

Question 15

Can you deduct expenses when seeking a new job?

Answer 15

If it’s in the same trade or business, then yes you can deduct these expenses. However, if you’re switching careers (lawyer looking to become veterinarian) then it’s non-deductible and a capital expense.

Question 16

When you deduct expenses for seeking a new job, does it matter if you got the job or not?

Answer 16

No, as long as it’s in the same trade or business, it’s deductible whether successful or not.

Question 17

If you’re deducting ordinary or necessary expenses, do they have to be regular or habitual expenses?

Answer 17

NO. They do not have to be regular, they just have to be reasonably expected in that business. For example, if you have to pay off legal fees, that’s ordinary and necessary even though most companies aren’t paying for legal services on a regular basis.

Question 18

Are bonuses paid to employees deductible, and does it depend if they are paid in cash or by dividend?

Answer 18

YES they’re deductible (so long as they are reasonable and not excessive), NO it does not matter the form in which they’re paid out.

Question 19

What is the “independent investor” test for determining whether employee salaries are excessive?

Answer 19

It asks what the independent investor would be comfortable with the return or not. For instance, if an employee’s expected yield is 1%, but they are paid as if it would be 20%, then this would be determined to be excessive.

Question 20

What is the ceiling for covered employees of a publicly held corporation, and who are “covered employees”?

Answer 20

$1 million, and it usually includes the CEO, principal financial officer, and the three other highest paid employees.

Question 21

What are the requirements for travel expense deductions?

Answer 21

Must be away from home, in pursuit of business, and (for meals/lodging) cannot be extravagant or lavish under the circumstances.

Question 22

Can you deduct expenses for travel as a form of education?

Answer 22

No

Question 23

When are expenses deductible for education purposes, broadly speaking?

Answer 23

The first criterion for deductibility is that the education maintains or improves skills required in the taxpayer’s current employment, trade, or business. They also must be required by the employer or by law.

Question 24

What are the criteria for DISallowance of education expenses?

Answer 24

If it’s going toward a new trade or business, or if it’s going toward meeting the minimum educational requirements to qualify for entry for the taxpayer’s trade or business.

Question 25

What is the lesson from the Hill v Commissioner case (one where teacher deducted expenses for a class she had to take to keep her teaching certification)?

Answer 25

Education expenses are deductible when you are required by your employer to take a class, AND the class is not trying to seek a new trade or business, but rather maintain your current job.

Question 26

What is the lesson from the Coughlin case (lawyer needs to take tax course in order to continue practicing tax law at his firm)?

Answer 26

CLE and courses like those are deductible so long as it is not qualifying you for a job in a new trade/business.

Question 27

What types of losses are deductible?

Answer 27

Ones not covered by insurance and limited to losses in a trade or business, or losses incurred on a transaction but not connected through trade or business.

Question 28

Can you deduct for wholly worthless debts or securities?

Answer 28

Yes, as long as you are using the accrual method.

Question 29

What happened in the Bugbee case, where the man lent his patron money for his business ventures with a 6% interest rate, but the debt was never paid? (Walk through the gift-debt analysis)

Answer 29

The court ruled this was a worthless debt since the man couldn’t repay it, and thus deductible. Sometimes loans between friends are seen as gifts, but this is a debt because there were contracts, it was unsecured, unconditional, and there was interest. Essentially can be boiled down to this was a BUSINESS DEAL, not just a friendly venture. If it looks like there was no expectation to be repaid, it’s a gift and not a debt.

Question 30

How do courts determine if a loan is business or non-business bad debt?

Answer 30

Courts are just looking for the primary motive for the lender. If there are mixed motives, they must find the predominant motive. Courts are strict on this.

Question 31

What debts are “bad debts”?

Answer 31

Debts that are not collectible and were not gratuitously forgiven. If the creditor took the debtor to court, it’s more likely to be seen as bad debt.

Question 32

What is the approach to the bad debt deduction? (Hint: 3 step process)

Answer 32

1. Is there a debt? (I.e. gift vs. debt)
2. Is it a bad debt?
3. Is it a business bad debt?

Question 33

Are bribes or kickbacks to government officials deductible under S 162?

Answer 33

No.

Question 34

Are fines for violating the law deductible?

Answer 34

No.

Question 35

What exceptions exists to the rule which says one cannot deduct fines?

Answer 35

There’s an exception for fines for restitution or to become compliant under the law.

Question 36

Can you deduct business expenses in the trafficking of drugs?

Answer 36

No. This can apply to medical marijuana as well if it is controlled by the federal or state government.

Question 37

What is the holding from Tellier, where the TP deducted business expenses for defending himself from criminal charges associated with his work?

Answer 37

Business expenses for defending oneself legally are deductible so long as they are tied to the TP’s business.

Question 38

Are you able to deduct expenses for the maintenance or collection of income?

Answer 38

Yes, but only until 2025 as this section has been repealed.

Question 39

How does the code determine if an activity is engaged in for profit?

Answer 39

If, during 3 of the previous 5 years, gross income derived from the activity exceeds the deductions taken. (Horse breeding has its own time table)

Question 40

Can a corporation take deductions for expenses for activities not engaged in for profit?

Answer 40

No.

Question 41

Can an individual take deductions for expenses for activities not engaged in for profit?

Answer 41

There is a rebuttable presumption that they may not, but if they are able to show they were actually indeed engaged in for profit and gross income in recent years exceeds deductions, they can take the deduction.

Question 42

What factors will a court use to determine if an activity was engaged in for profit?

Answer 42

1. Financial status of the TP
2. Elements of personal pleasure/recreation
3. Manner in which the TP carries on the activity
4. Expertise of the TP or their advisors
5. Expectation of assets appreciating
6. Success in carrying on similar activities
7. History of income/loss
8. Amount of occasional profits
9. Time and effort expended by TP

Question 43

What interest qualifies for the qualified residential interest exception?

Answer 43

Interest paid on “acquisition indebtedness” with respect to their “qualified interest.”

Question 44

What is acquisition indebtedness, and what is the limit?

Answer 44

Any indebtedness which is secured by the residence and incurred in acquiring/constructing/substantially improving the residence. The limit is $750,000. ($1 million if before the year 2018)

Question 45

What is home equity interest, and what is it’s limit?

Answer 45

Any interest which is not acquisition indebtedness, and is secured by a qualified residence. Limit is $100,000.

Question 46

How is “qualified residence” defined for the residential interest exception?

Answer 46

The TP’s principal residence, or if they rent it, as long as they use it for more than 14 days in a year.

Question 47

What state/local taxes can you deduct?

Answer 47

You can deduct EITHER income or sales tax, not both. Can also deduct real or personal property tax if from a trade or business.

Question 48

What was the result in Cramer, where the TP tried to deduct property tax he paid for his mother while she was in hospital and he was taking care of her property?

Answer 48

TP lost because the tax was not levied against him. You can only deduct state/local taxes if they are levied against you.

Question 49

Can you deduct taxes as part of acquiring property?

Answer 49

No. These are just added to the basis (cost) in the property.

Question 50

How do you allocate property taxes between seller and buyer?

Answer 50

It’s based on how many days spent in the property. So if A sells to B in April, A will pay 1/4 of the tax and B will pay 3/4 (as A only lived there for 1/4 of the taxable year). This determines how much each side may deduct.

Question 51

What is the limit on a TP’s deduction for SALT?

Answer 51

$10,000, or $5,000 for married TP’s filing separately.