Timing Rules

Question 1

Method of accounting does not determine if deductions and income are taken/included - only when

Answer 1

Commercial security bank is a good example of this. Income accrued had to be recognized even though cash basis taxpayer and deductions accrued but not paid had to be recognized even though cash basis taxpayer

Question 2

When is income included under the accrual method?

Answer 2

Income is included in the year in which the all events test is satisfied. It is helpful to remember that the goal of accrual accounting is to recognize income when earned
(for service income, that’s when service is performed; for property, it’s when delivered)

Question 3

You sell services/product for delivery in a year. Recognize income under accrual method this year or next year?

Answer 3

Recognize next year when performed/delivered

Question 4

What is the backstop for waiting to recognize income under the accrual method?

Answer 4

451(b)1 says the All Events Test will not be satisfied any later than the taxpayer takes the income into account for financial reporting purposes

Question 5

Can you use statistics to recognize income or deductions over time?

Answer 5

No. Unless you can establish how you will earn the money in the future, but recognize income immediately

Question 6

In the annual membership cases (Am. Auto Club, AAA) and dance lesson case (Schlude) what was the supreme court doing?

Answer 6

Determining when the all events test was satisfied. In all cases it said that the test was satisfied when the income was received

Question 7

When are deposits recognized as income?

Answer 7

If they are refundable or the depositor will get credit towards future services, they are not considered income

If they are nonrefundable and depositor gets no credit towards future services, they are income (Ind. Power and Light)

Question 8

When are deductions taken?

Answer 8

When the all events test is satisfied AND economic performance

461h says that the all events test is not satisfied until economic performance is complete

Question 9

When does economic performance occur…
For services/property provided to TP?
For use (but not acquisition) of property?
For provision of services/property by the TP?
For tortious activity or workers comp?

Answer 9

For services/property provided to TP: when services/property actually provided
For use (but not acquisition) of property: when property is used
For provision of services/property by the TP: when services/property actually provided
For tortious activity or workers comp: when claim is paid

Question 10

Why was the economic performance requirement added?

Answer 10

The Mooney bond and nuclear power plant situations were causing companies to fix their obligations that were certain but far in advance and take a deduction far in advance of the actual expenditure

Question 11

What are the two prongs of the all events test?

Answer 11

All events must occur to 1) fix the existence of the obligation and 2) the amount of the obligation with reasonable certainty

Question 12

A landlord leases an apartment for a year with monthly rent payments from the tenant. When does the landlord recognize the income?

Answer 12

Income recognized when the existence of the obligation and the amount of the obligation are fixed with reasonable certainty. So every month

Question 13

What was the mistake of general dynamics?

Answer 13

General Dynamics said that an expense was not recognized until the insurance claimants filed their claims. The government conceded the amount prong of the all events test (it shouldn’t have) and the court imported the amount prong into the existence prong and it doesn’t work well. court distorted the doctrine so the govt would still win. General Dynamics generally ignored

Question 14

What is the rule for recognizing income in cash method

Answer 14

All income included in the tax year in which cash/property/services constituting income are actually or constructively received

Question 15

What are the 3 methods of receipt of income under cash method?

Answer 15

Actual receipt
Constructive receipt
Economic benefit doctrine

Question 16

What is required for constructive receipt of income for income recognition under cash method?

Answer 16

Amend - TP must have unfettered access to the funds. Must have a legal right to the funds to have constructive possession

Question 17

What is required for economic benefit doctrine receipt of income for income recognition under cash method?

Answer 17

Pulsifer - funds must be irrevocably put out of the control of the payor into the hands of a third party for the taxpayer’s benefit. The taxpayer may not have any means of accessing the funds but they can still have possession under the economic benefit doctrine

Question 18

What are examples of constructive possession for income recognition under the cash method?

Answer 18

leave a check uncashed in your drawer

Payor asks you if you want the $ but you tell them to hold onto it

Question 19

What are the theoretical problems with the economic benefit doctrine?

Answer 19

Taxes are due before the funds are available to the taxpayer so the taxpayer may not have the funds to pay the taxes

Question 20

If TP gets paid by A with A’s own note, does TP recognize income under the cash method?

Can A deduct the payment under cash method?

Answer 20

No, TP does not recognize income because they aren’t actually getting anything (unless the note is secured or publicly traded)

A cannot deduct the payment made with their own note (unless the note is secured or publicly traded)

Question 21

What are the practical implications of paying with a note under cash method?

Answer 21

If I buy business supplies from staples with a Visa, I can deduct immediately upon purchase. If I buy business supplies from staples with a staples credit card, I cannot deduct until I pay the credit card bill

Question 22

When can deductions be taken under cash accounting?

Answer 22

Only when paid (no constructive payment but Commercial security bank comes close)

Question 23

What is the holding of Commercial Security Bank

Answer 23

If a cash method TP is acquired and buyer assumes liabilities, cash method TP has essentially paid liabilites by accepting a lower purchase price and can deduct the paid liabilities as expenses

Question 24

What is the holding of Thor?

Answer 24

No presumption that GAAP accounting is not an acceptable tax accounting practice. Tax system requires realization and financial accounting likes to mark to market

Question 25

What are the practical implications of Thor for publishers of books?

Answer 25

Publishers will sell excess inventory to affiliates so that they can have a realization event to take the deductions. Marking to market is not a realization event that will give you a tax deduction.

Question 26

What is the holding of North American Oil Consolidated v. Barnett?

Answer 26

Everyone operates on the cash method when it comes to contested amounts (because the all events test might not be satisfied for a long time)
If $ is received without restrictions on use-> must report income
If $ is not received but you claim it -> don’t report income until $ in your actual/constructive possession

If expense is paid -> deduct it

Question 27

What happens if I paid an expense that I don’t think I owed, I sue the person I paid, I win a recovery

Answer 27

You deducted the expense when paid even though it was contested and then you claim income for the recovery under the tax benefit rule

Question 28

Is COGS included in a 1001(a) basis calculation or deducted as an expense?

Answer 28

COGS not treated like basis under 1001(a). All receipts go in gross income and then COGS is a deduction

Question 29

What are open transactions?

Answer 29

A transaction where the amount realized is so uncertain that tax law allows you to wait until some future tax year to consider the full tax implications

Question 30

What happened in burnet v logan?

Answer 30

Open transaction - royalty payments were based on the output of a more and were uncertain so the supreme court allowed logan to deduct all of each payment from basis until the fill basis had been recovered and then all of the payment was income

Question 31

What would have happened in burnet v Logan if the court had treated the transaction as closed?

Answer 31

Would have had to recognize the full FMV of the royalty stream immediately. This estimation of FMV would have been uncertain

Question 32

When are open transactions allowed?

Answer 32

Only in rare and extraordinary circumstances, so most of the time transactions are treated as closed and estimates of FMV are taken at the time of the transaction

Question 33

Why is the vagueness of the open transaction doctrine not a big problem?

Answer 33

There is a special provision for installment sales in 453

Question 34

What is the one key area where open transactions exist even after the enactment of 453

Answer 34

Options

Question 35

Why was the government so quick to eliminate open transactions?

Answer 35

Open transactions mean free deferral, and the parties could rig their transaction to defer taxes

Question 36

One shot taxes like the estate tax leave no room for open transactions.

Answer 36

Open transactions basically allow the taxpayer to kick the can down the road and wait for certainty, but there is no “next year” in one shot taxes, so everything is estimated

Question 37

What is an installment sale?

Answer 37

A disposition of property where at least one payment is to be received in a future year (no requirement for multiple payments - a single payment next year counts)

Question 38

Are installment sale rules under 453 affected by choice of accounting method?

Answer 38

No

Question 39

Does 453 apply to both gain and loss?

Answer 39

No 453 applies only to gain

Question 40

Taxpayers can opt out of 453’s installment rules if they want to.

Answer 40

453(d)

Question 41

What kinds of transactions are excluded from 453 installment sale treatment?

Answer 41

dispositions of non-real estate inventory and dealer dispositions are excluded from 453

Question 42

What is the calculation for each year’s gain if the total value of the contract is known?

Answer 42

Calculate % of each payment that will be gain and apply to each year’s payment

Gain This Year = ((Total Gain on Sale)/(Total amount to be received under contract)) * Payments Received this year

Question 43

What is the calculation for each year’s gain if the total value of the contract is unknown?

Answer 43

Allocate basis ratably over the length of the contract

Gain This year = Payments Rec’d this year - (Total Basis/Years payments will be received)

Question 44

What is the treatment of the sale of the installment obligation itself?

Answer 44

Any of the basis that has not already been used is applied to the proceeds of the sale of the installment obligation

Question 45

What is the treatment of an installment obligation that is deemed uncollectible?

Answer 45

treated as a disposition of the installment obligation with $0 amount realized (This then allows the payee to recognize a loss for any basis that is left and it then corrects for all of the past years where they recognize too high of a % of gain)

Question 46

The deferral benefit of the 453 installment sale provisions is eliminated for large taxpayers. How is large taxpayer defined and how is the deferral benefit eliminated?

Answer 46

Large taxpayer is defined as TP who sells property on the installment method and receives installment obligations with value vale >$5M.

They are charged interest on the amount of deferral

Question 47

How are annuities taxed?

Answer 47

Calculate the exclusion ratio (Amt paid/est amt taxpayer is to receive )
Convert to the inclusion ration (1-Exclusion ration)
Multiply the inclusion ration * Payment received to get income from annuity payments

Question 48

How is the taxation of annuities adjusted for those that live longer than expected? Those that live shorter than expected?

Answer 48

Longer than expected makes the “extra” payments received fully taxable

Shorter than expected allows the unused basis to be deductible on the decedent’s final tax return

Question 49

What is income in respect of decedent?

Answer 49

any amount that would have been taxed to the decedent prior to decedent’s death of recognition was not deferred because of accounting treatment

(remember installment sales under 453 is a method of accounting)

Question 50

How is IRD taxed?

Answer 50

The recipient of IRD steps into the decedent’s shoes and is taxed as they would have been. this is incontrast to the normal rule that allows the recipient of a devise to step up their basis to FMV at time of death

Question 51

What are some good ways to defer gain on appreciated assets while still accessing their value?

Answer 51

borrow against the assets. And can also use options to hedge the risk associated with owning the asset also

Question 52

What is the risk of edging against movements in a stock price with an options collar?

Answer 52

If you get the collar too tight, then it starts to look like a constructive sale and will be taxed accordingly

Question 53

How are options taxed?

Answer 53

the cash flows from the option are essentially merged into the cash flows from exercise (if exercise happens) (it’s easier to think about what you happen if you bought the option immediately before expiration/exercise)

Remember, options are one of the rare instances where open transactions live on

Question 54

What are the pros and cons of a rabbi trust?

Answer 54

it allows the taxpayer to defer compensation and minimize the risk of the employer being unable to repay later.

Con is that the employer can’t deduct until the compensation is paid to the employee
This means a rabbi trust works well for non-profits but not so well for for profits

Question 55

How does a rabbi trust work?

Answer 55

Employer creates a spend thrift trust and names themselves as the beneficiary (to avoid Pulsifer). Employer funds the trust with deferred compensation. Employer makes the employee trustee. Funds paid to employer and then immediately paid to employee

Question 56

What are the benefits fo qualified plans?

Answer 56

employer can deduct contributions immediately and employee can still get the deferral they want

Question 57

What are the two types of employer sponsored plans?

Answer 57

Defined benefit plans and defined contribution plans

Question 58

If an employer doesn’t sponsor a pension plan, what can the employee do?

Answer 58

contribute up to $6K to an IRA or a Roth IRA

basically a build your own pension trust where the inside buildup is still tax free

Question 59

What are the 3 types of qualified plans

Answer 59

Employer sponsored plans (defined benefit/contribution) Employee funded plans (IRA/Roth IRA)
Incentive stock options

Question 60

Are all stock options part of ISOs?

Answer 60

No, ISO programs have to comply with restrictions on disposition, no grants of in the money optionsa and cap of $100K make exercisable within a year

Question 61

What are the pros and cons of ISO programs?

Answer 61

Pro: the employee is not taxed on the options when received or when exercised but only when the sell the stock that they bought with the option at capital gains rates
Con: employer can’t deduct anything

Question 62

What are non-qualified plans mainly used for?

Answer 62

To compensate company executives

Question 63

If an option given as compensation is not part of an ISO, how is it taxed?

Answer 63

Section 83 rarely applies because options are not considered property under 83e

Just treated as normal open transactions and are taxed upon exercise or sale and included as ordinary income

Question 64

What is the central rule of 83?

Answer 64

compensation is taxed when vested. If not vested, do not include in income

Question 65

When has ownership vested under 83a?

Answer 65

Vested unless BOTH 1) property is subject to substantial risk of forfeiture and 2) taxpayer cannot sell the property without restrictions continuing to apply to the buyer

Question 66

How do you opt out of section 83? what happens if you do?

Answer 66

Must make the 83(b) election within 30 days of receiving the property. You are then taxed immediately on the value of the property received as ordinary income (disregarding the possibility of forfeiture)

Question 67

What happens if you file an 83(b) election and then ent up forfeiting the property

Answer 67

Can take a deduction for the amount you PAID for the property NOT the amount you included (doesn’t make any sense theoretically)

Question 68

What are the advantages of 83(b) treatment?

Answer 68

it is better to recognize a small amount of ordinary income now if you expect the property will rapidly appreciate before you vest. That way you pay capital gains on the appreciation

It would not be smart to make an 83(b) election if you don’t think the property will appreciate or if you think there is a good chance you’ll forfeit the property

Question 69

How much can an employer deduct when it compensates someone with property?

Answer 69

They can only deduct as much as the employee includes (so the 83b election binds both employee and employer)

But most of the time (for payments that vest immediately) 83 is not a factor because it’s all included in income

Question 70

I just joined a startup that I think will be a hit. What do I want my compensation do be?

Answer 70

I want unrestricted stock. I’ll pay a small amount of ordinary income now but when the stock appreciates, I’ll get capital gains treatment

I don’t want options and then exercise immediately because then I’d have to pay in all of that strike price

I don’t wan to get stock options and then make an 83(b) election because 83 doesn’t apply to options and the whole thing would be an open transaction until exercise and then all gain would be ordinary income

Question 71

What are the 3 options for taxing options as compensation

Answer 71

1) 422 applies because it’s part of an ISO plan
2) 83 applies (exceptionally rare)
3) Neither 422 nor 83 applies and you have a normal open transaction

Question 72

Describe the two competing conceptions of the Alstores case

Answer 72

Alstores Argued: We bought a remainder interest in the property for $750K and took a basis of $750K

Commissioner Argued: They bought the property for $1M and then received $250K in prepaid rent

Question 73

How did the court resolve the two views in the Alstores case?

Answer 73

Looked to manipulable factors like who was paying the property tax and the utilities

Question 74

How should alstores have been decided

Answer 74

the two different conceptions of the transactions are the exact same economically but they are taxed differently because of Irwin v Gavitt, so the court should have just let the taxpayer pick

(if Irwin v Gavitt had given basis to the term interest, then the remainder interest would have had income as it matured)

Question 75

How do the parties game the Alstores test to get their transaction to be a sale of a remainder rather than a sale and then a lease?

Answer 75

Make sure the seller pays the utilities, pays the taxes and put in the contract that the seller bears the risk of loss if the property is condemned

Question 76

I sold a remainder interest in my property and retained a term interest. How do I recover my basis under the pure sale view or the sale lease back view?

Answer 76

These are equivalent ignoring deferral
Pure sale view:
You calculate the gain on the sale of the remainder using only part of the basis (corresponding with the value of the remainder now)

You then recover the remaining basis (associated with the term interest) at the end of the life of the term interest. It would normally be depreciable but the government won’t let you depreciate a term interest that you created yourself

Sale lease back view:
Use all of the basis for the sale price and then deduct the rent paid on the lease