Structure Analysis: Federal Income Tax on Individuals IPM 39-40

I. Structure
1. GROSS INCOME
a. Determine GROSS INCOME
 §61 – all income from whatever sources derived – add up all of the items
under §61
 If it is not in §61 then apply Glenshow Glass factors
 Accession to wealth
 Realized
 TP had complete dominion
 §71-90 describes items specifically included in gross income
 §101-150 describe items specifically excluded from gross income
b. Determine adjusted gross income (AGI)- by subtracting above the line deductions
 Subtract from gross income above-the-line deductions
 DEFINITION – above the line: taken after calculating gross income and
before calculating adjusted gross income (reduce gross to adjusted gross
income)
 To know if above look at §62(a)
 Or 1040 form lines 23-37
 §62(a)(1) employee business expenses above the line BUT other trade
expenses get reported on Schedule C which is reported on line 12 of
1040
 trade or business expenses regardless of whether they elect the
standard or itemized deduction, gets deducted.
 §62(a)(10) alimony – report on 1040 line 31a
c. Determine taxable income – subtract below the line deductions
 A TP is allowed to either take a standard deduction (which is the 57,000) or
itemize deduction. Whichever # is bigger, that is the one the TP should chose
 Standard deduction – the sum of the basic standard deduction and any
additional standard deduction
 Standard deduction is adjusted for inflation by §63(c)(4)
 Either standard deduction + personal exemption or itemized deduction +
personal exemption
 To get the most, bunch the itemized deduction in one year, and take the other
year the standard deduction
 Itemized deductions – made for people with high AGI
 For individuals and corps §161-199
 For individuals only §§211-222
 For corps only §§241-249
 LIMITATIONS on below the line deductions
 §67(b) subject ot 2% limitation if not on this list. Miscellaneous itemized
deductions are deductible to extent they are above 2% of the AGI. – only
affects the miscellaneous deductions
  Only the miscellaneous ones (it is not listed in (b))
 §68 limits on itemized deduction based on adjusted gross income
 §68 is a phase out of itemized deductions as a TP’s AGI gets too
high
 Section 67 & 88 – appear on Schedule A (68 is on line 29, 67 is on line
26)
 Discrepancy between the form and code- the 100,000 is adjusted
for inflation (68(b)(2))
 personal exemptions are described in §§151-153
2. REALIZATION
a. Realization – an event that significantly alters the form of the TP’s wealth
b. The realization requirement provides the TP with a tax deferral, not an exemption.
Eventually, the TP will realize and pay tax on that gain
 Tax deferred is taxed reduced
c. Lock and effect – a taxpayer is unlikely to sell and reallocate their investments
because they will realize a gain and will consequently be taxed on it
 Inefficient- ties up the flow of capital in the marketplace
 Delay/Deferment- you will be taxed, just not now right away
d. Cottage Savings- an exchange of property gives rise to a realization event under
1001 only if the properties exchanges are materially different (legally distinct
entitlements)
 Substance over forum – the TP can decide when to have the realization
3. DISCHARGE OF LOANS AND DEBTS
a. Loans are not taxable – the receipts are offset by debt so the TP has no gain
 Loans do not accession to wealth or increase the TP’s net worth b/c the loan
proceeds are accompanied by an equal and offsetting liability
 Repayment does not result in deductible expense
b. However, if the creditor forgives debt, taxpayer must claim the forgiven amount as
income even though the forgiveness provides no cash to pay the tax
c. If a loan is discharged for less than the amount owed, the borrower must include in
income the amount of the discount (§61)
d. James v. U.S. → a TP has income when the TP acquires earning, lawfully or
unlawfully, without the consensual recognition of an obligation to repay and no
restriction on disposition
e. U.S. v Kirby Lumber → IPM 50( discharged debt is an accession to income)
 Debts are often forgiven when TPs are in financial trouble; §§108, 1017
provide that TPs who otherwise had taxable income when a debt was
forgiven could usually defer tax on the discharge of indebtedness
 If the TP is relieved of nonrecourse debt, the debt relief is included in the
TP’s amount realized for the purpose of computing her gain/loss realized in
the property transaction (§1001)
f. §108 exclusion – discharged debt is gross income unless:
 (a)(1)(A) the discharge occurs in a title 11 case (BK)
 (a)(2)(B) the discharge occurs when the taxpayer is insolvent
 (a)(3)(C) farm issues
  (a)(4)(D) the discharge is from qualified real property business indebtedness
– TP other than C corporation
g. §108(b)- if 108(a) exclusion apply, may need to be repaid by reduction of other good
things available to TP
h. Adjustment to basis §108(b)(2)(D) – Capital Loss carryovers (may result in reduction
in basis)
4. PROPERTY DISPOSITION & BASIS
a. Basis affect the amount of gross income on sales or other property income
b. §61(a)(3) gross income “gains derived from dealings in property”
 What is a gain? § 1001
 1001 formula is Amount realized – adjusted basis = gain or loss
 gain is the excess of the amount realized over the unrecovered cost
(adjusted basis” or other basis for the property sold or exchanged
 Amount Realized equals the money received plus the fair market value
of any other property §1001(b)
 Adjusted Basis (unrecovered cost) § 1011
 §1011(a) adjusted basis is equal to the basis as determined under
§1012 (or other appropriate section) adjusted as provided in §1016
 §1016 requires a TP to adjust her basis to reflect recovery of
investment or any additional investments
i. Ex. A buys a home for $100,000 and subsequently added a
room to the home at a cost of 50,000. The original basis in
the home was 100,000, the amount A paid for the home she
must adjust the basis in her home to reflect the additional
investment which the new room represents. Therefore A’s
adjusted basis is 150,000.
 Formula becomes Amount realized – Adjusted basis (original basis in
the property §§1012, 1014, 1015 plus or minus adjustments §1016) =
gain or loss
 Ex. A purchases a share of stock in XYZ Corp for $80.00. After 12
years, A sold the stock for 200. How much is gross income? – amount
realized (200) – adjusted basis (80) = gain / income (120).
 Basis prevents dollars that have already been taxed from being
taxed a second time.
 However if A receives $10 dividend from XYZ Corp, that
divident would not constitute a tax-free return of capital which
must be reflected by a downward adjustment of A’s basis in the
stock.
i. Dividend would constitute profit form A’s investment in
XYZ and would be treated as gross income. Viewed as
earnings on a profit from one’s investment much the way
rent represents earnings on one’s property or interest.
c. How a person acquires the property
 §1012 by purchase – the original basis is cost (what the TP spend to get the
property), except as otherwise provided [for capital gains and losses].
  The Cost of property shall not include any amount in respect of property
taxes
 Acquisition of property by PURCHASE – original basis is COST
 Acquisition of property as substitute for income – original basis as
FMV
i. Fair Market Value “FMV” – price at which property would
exchange hands b/w reasonable buyer and reasonable seller
when both have full/reasonable knowledge of relevant facts
and neither is under distress to deal
 Loss is computed the same way as gain under the §1001 formula (AR –
B)
 If the property is used for income production, the loss is deductible no
matter the cause; if personal, only casualty losses are deductible under
§165
 §1014(a)(1) received from Decedent
 Basis of property acquired from a decedent – except as otherwise
provided, the basis shall be FMV of the property at the date of
decedent’s death (if not sold, exchanged, or otherwise disposed of before
the decedent’s death by such person)
 When basis goes up from the original owner to the new owner that
got the property from the decedent, the revenue deplete
i. Economic effects of the step up code -> dispose the asset
before death
ii. Lock in effect of §1014- TP holds the property instead of
selling it so that it will pass on to their heirs and have a
higher adjusted tax basis
1. Inefficient for the markert
2. Loss of revenue for the IRS
iii. Why keep it? Provides an estate tax basis
1. Administraility - Too difficult to determine what the
decedent’s FMV was at the time of purchase
2. Intergration of tax basis and estate tax – IPM 53 (will
not be on the test)
 §1014(e) it is in the code to prevent anti-abuse IPM 47
 Carryover basis §1015