Introduction and Income

Question 1

What is Basis?

Answer 1

The amount originally paid for an item. Subtracted from the FMV to find the “gain”.

Question 2

What is the status of cancellation of debt in Bankruptcy?

Answer 2

Cancellation of debt in bankruptcy is NOT considered income for tax purposes.

Question 3

What are the four types of Tax Work?

Answer 3

• Tax Compliance
• Tax Planning
• Tax Controversies
• Tax Evasion

Question 4

What is tax incidence?

Answer 4

Who bears the burden of the tax.

Question 5

What is the IRS’s role in regard to tax laws?

Answer 5

The IRS does not make tax laws. The IRS only interprets the law and provides an opinion on what the law means.

Question 6

What are taxpayer confidence levels and the “ballpark” percentages?

Answer 6

• The taxpayer has a “reasonable basis” for the position (15-30 percent change of prevailing)
• The taxpayers position is supported by “substantial authority” (30-50 percent)
• The taxpayer is “more likely than not” to prevail if the position is challenged (more than 50 percent)
• The taxpayer “should” prevail if the position is challenged in litigation (probably at least 70 percent)

Question 7

What is a progressive tax system?

Answer 7

The amount of tax you pay increases with the amount of taxable income and the percentage you pay is within each bracket.

E.g. - up to $30k you pay 15%, from $30k to $50k you pay 19 percent on that amount, above $50k you pay 19% (on all income above that $50k).

Question 8

What is the marginal tax rate?

Answer 8

The final percentage the individual is taxed at, the rate at which they would pay taxes on one more dollar of income.

If $70,000 taxable income, marginal tax rate is 28%.

Question 9

What is effective tax rate?

Answer 9

The percentage of total income that you paid in taxes.

Question 10

What is tax planning?

Answer 10

Structuring what you do (during the year) in such a way as to minimize your taxes or provide the greatest benefit over the long term.

Must look at the advantages and disadvantages of certain actions or structuring deals/transactions in certain ways.

Question 11

What is Imputed Income?

Answer 11

benefit (accession to wealth) that a person received from doing a service themselves, instead of paying someone to do it (avoiding having to pay someone else to do it).

Not included in Gross Income.

Benefit you derive from performing your own services and the benefit you derive from the use of your own property.

Question 12

What is economic income?

Answer 12

the change in value of assets, including realized and unrealized gains. Change in market value rather than cash received.

Includes the change in net worth

Question 13

What is ordinary income?

Answer 13

regular income earned from things such as work.

Question 14

What are capital gains?

Answer 14

generally gains from investment (e.g. - profit made from selling a house or stocks), taxed lower than ordinary income

Question 15

What is Income?

Answer 15

many definitions.
• Whatever the Tax Code says it is.
○ § 61 - All income from any source derived.
• Includes things such as compensation, interest, dividends, etc.
• Many things that would normally be considered income are exempted due to political considerations.
• Derived from capital, labor, or both.

Question 16

What is the major issue regarding timing in most tax issues?

Answer 16

The time-value of money and when the tax must be paid.

• Taxpayer is often not fighting about the amount of taxes that must be paid, but the timing of when it must be paid. The taxpayer usually wants to pay later, and take deductions sooner.

Question 17

How are meals and lodging treated in regards to income?

Answer 17

meals and lodging (§ 119) provided to the employee for the benefit of the employer are excluded from gross income.

A fringe benefit

Question 18

What are types of fringe benefits?

Answer 18

§ 132

1. No-additional-cost service.
2. Qualified employee discount
3. Working condition fringe
4. De minimus fringe
5. Qualified transportation fringe
6. Qualified moving expenses reimbursement
7. Qualified retirement planning services.

Question 19

How is the worth of a fringe benefit determined?

Answer 19

Valuation

• Basic valuation rule is Fair Market Value (FMV) - the amount a willing buyer will buy, and a willing seller will sale, while fully understanding of all relevant facts.
• Safe Harbor valuation areas - if you do what the code says under a particular methodology, the IRS will not challenge it.

Question 20

What is the difference between Realization and Recognition?

Answer 20

• Realization - when the transaction/event occurs
• Recognition - if you realize the gain, but do you have to recognize it (report it) on your tax report.
• Some realized gains do not have to be recognized (e.g. - 1031 exchange - selling a property/business for a profit then using that money to purchase a new investment, that is a realized gain that does not have to be recognized)

Question 21

What is imputed income?

Answer 21

Benefit (accession to wealth) that a person received from doing a service themselves, instead of paying someone to do it (avoiding having to pay someone else to do it). Not included in Gross Income.

Benefit you derive from performing your own services and the benefit you derive from the use of your own property.

Question 22

What is the rule for bartering of services?

Answer 22

Revenue Ruling 79-24
• Barter of services must be included in gross income at the fair market value of the services exchanged.
○ Lawyer provided Legal services to a house painter in exchange for the painting of the lawyer’s residence.

Question 23

What is a de minimus exception?

Answer 23

often exceptions for low amounts of certain transactions because reporting and enforcement of these small amounts would not be economically beneficial.

Question 24

Does Punative Damages awards have to be reported as income?

Answer 24

Yes - Commissioner v. Glenshaw Glass Co. (1955)
• Glenshaw awarded compensatory damages and punitive damages. Did not report the punitive damages as income. The recovery was reported as income.
• Court said punitive damages must be reported as income.
• Court should not be the one to say what the law should be, court only says what the law is.

Question 25

Are gifts taxable?

Answer 25

Gifts are generally excluded from taxable income under § 102.
• “Gross income does not include the value of property acquired by gift, behest, devise or inheritance.”
○ Gift is not taxable, but any income earned from that gift (such as interest) is taxable.
○ Exception - Gifts from an Employer to an employee generally must be included in gross income.
§ Employee performance awards can be excluded from gross income.
§ Numerous other exclusions.

Question 26

How do you know if a transaction is a gift?

Answer 26

detached and disinterested generosity of the Donor.
• Duberstein
○ A transfer of property is a gift if the transferor acted out of a detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses.
○ It is income if it is the result of the constraining force of any moral or legal duty, constitutes a reward for services rendered, or proceeds from the incentive of anticipated benefit of an economic nature.

Question 27

What determines whether a transaction is a gift?

Answer 27

The intent of the donor. (U.S. v. Harris)

Question 28

What is the rule regarding Gift Taxes and who must pay?

Answer 28

Donor is required to pay taxes on all gifts given over the exclusion amount.
• during the life, a person can give an annual exclusion amount (currently $14,000 per person) that does not need to be reported and is not taxed (total value of the gift must be under that amount).
• $5,450,000 is the annual exclusion amount which applies to both gift and estates. This amount can be combined with the $14,000 to make more gifts without paying tax, but this must be reported.
• Unlimited number of gifts under $14,000 can be given to any number of people without having to report it. This does not count against the $5.45 million.
• No gift tax if the parties are married (only applies to U.S. citizen spouses).

Question 29

What is the income reporting requirement for Scholarships and Fellowships?

Answer 29

Scholarships and Fellowships that are used to pay tuition, fees, and books are not required to be reported as income (excluded for income).

If a condition is to work at a campus office, then it is required to be reported as income (no exclusion for scholarships that represents payment for teaching, research, or other services).

Question 30

What is the basis of a gift?

Answer 30

Basis of a gift transfers to the donee.
• Policy reason is the donor never paid taxes on gains and this would avoid paying taxes on an unrealized gain, donated to a donee, then realized.

Question 31

How is life insurance taxed?

Answer 31

Amounts received under a life insurance contract are not included in gross income if such amounts are paid by reason of the death of the insured. §101(a)

Question 32

What is the “exclusion ratio” for annuities?

Answer 32

The investment in the contract divided by the total expected return is treated as the nontaxable recovery of investment. The remainder would be treated as income.

If the person lives longer than the expected term of the annuity, then all future payments are considered income.

Question 33

How is gambling taxed?

Answer 33

All gains are taxable, but losses are deductible only to the extent of gains from the same taxable year. § 165(d)

Cannot use gambling losses to offset non-gambling income.

Question 34

How are damages awards taxed?

• Loss of property?
• Personal injury?
• Punitive damages?

Answer 34

Damages awarded in a lawsuit are taxed as income in the year they were received (taxed as profit for a business).

Damages awarded for the loss of property are taxed based on the amount received minus the basis in the property. Gain can be deferred if immediately invested into a like property as the property lost.

Damages for a personal injury are tax free.

Punitive damages are taxable in full.

Question 35

How are taxes paid in deferred payments and structured settlements?

Answer 35

Recovery for personal injury remains nontaxable, to include interest.
-Provides a benefit to the awardee as they are receiving interest that they do not have to pay tax on, where if they received the entire amount owed immediately, then invested it, they would pay tax on the interest.