Income Tax I

Bogdanski

Fall 2000

Sample Answers to Question 2

Exam No. 3005

Section 61 defines gross income as all income from whatever source deferred. If, in connection with the performance of services, property is transferred to any person other than the person for whom services are performed, the FMV of the property shall be included in the gross income of the person performing the service in the first taxable year the goods are transferred, § 83. While Tammi would like to have the purchase discounts at XYZ.com to be excluded as a fringe benefit under 132(c)’s qualified employee discount fringe benefits exclusion, the in-cash offer is not permissible and Tammi will realize $600 in additional income. XYZ.com’s new provision is not a permissible employee cafeteria plan but rather gives constructive receipt immediately of the $500 savings. Tammi may claim that her income was increased only $500 and that the $600 in discounts did not result in an additional $100 in income. This argument will, however, likely fail. The new, non-discriminatory plan gives employees ordinary income of at least $500.

Tammi’s $14,000 in interest and $5,000 in property tax will be deductible upon her 2000 taxes. Code section 163 gives taxpayers who own their own home a powerful from-AGI deduction for qualified residence interest. § 163(h)(3). Interest is deductible as long as the acquisition indebtedness does not exceed $1,000,000 for single individuals. Here, the mortgage is $200,000, so the $14,000 is deductible. § 163(h)(3)(C) allows for a deduction for home equity indebtedness up to $100,000 in equity indebtedness. Tammi’s 1999 home equity loan interest may be deducted in full so long as this second loan does not exceed 100K. Property taxes may be deducted under § 164 in an amount of $5,000.

Tammi’s gift of appreciated property to a religious order is deductible up to her basis in the gift. Here, Tammi will be able to deduct $1,000, her cost basis in the collection because the charitable organization will not be using the collection in its ordinary operations. § 170 provides for this charitable deduction from AGI. Must have verification to get deduction!

Tammi takes other XYZ.com co-workers to lunch for two months straight when the company faces a crisis. The co-workers spend lunch talking about work and business, and Tammi changes the lunch upon her credit card. XYZ.com then pays Tammi for these charges of $2,100. Tammi’s lunch outings do not provide any tax effect in 2000. All ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business are deductible. The issue is if these are fairly ordinary and necessary business expenses or f they are § 262 personal living expenses.

Meals may be deducted if you are doing business over the meal. While Moss v. Commissioner shows that you may not take this deduction too for and get away with it, XYZ.com may still be OK deducting these expenses. While meals are generally subject to a 50% limit, 274(n), this 50% rule will not affect Tammi as she is not the entity ultimately paying the bill and trying to deduct these meals. If Tammi is working under an expense reimbursement program, the $2,100 should have no effect upon her tax liability as it will not be income or a deductible expense. XYZ.com will then worry about the deduction. This analysis assumes that the meals were not lavish or extravagant under the circumstances.

Home Loan - If the home equity portion is > 100K, then only 100K in interest charges may be deductible. If the home equity loan in 2000 is 200K, then only $7,000 in interest may be deducted.

Tammi met the substantiation requirements of § 274 by writing on the receipt.

The 500 in lieu of option will increase Tammi’s gross income while the donation and home equity interest and tax payments will be deductible. The lunches should have no tax effect.

Exam No. 3044

Tammy has $600 of income pursuant to the new plan. In order to avoid the income, the benefits in the new plan would have to qualify as a cafeteria plan under § 125. 125(a) excludes from gross income benefits received under a cafeteria plan. A cafeteria plan is one which provides employees with a choice between a group of qualified benefits. Qualified benefits are those excluded from income by the code, except, among others, § 132 fringe benefits. The presence of any benefit that does not fit the definition of a qualified benefit precludes the employee from taking advantage of the tax benefits of a cafeteria plan.

The discount program here is a § 132(c) qualified employee discount. XYZ sells its goods, offered for sale to customers in ordinary course of its business, to employees at cost. This qualifies under 132(c), which kicks the “new plan” out of § 125 and makes any benefits received under it includable in gross income unless otherwise excluded. Absent 132(c), Tammi would have ordinary income in the amount of $600, the difference between her purchase price and the FMV of the goods.

Regarding Tammi’s home-related expenses, she may take a deduction for the property tax she pays, if she itemizes her deductions. State and local property taxes are deductible under § 164, which is a below-the-line deduction (not listed in § 62). However, it is not a miscellaneous deduction, so is not subject to the 2% AGI floor found in § 67. Tammi is also entitled to deduct a portion of the interest paid on her home equity indebtedness. § 163(h)(3)(C). Home equity indebtedness is simply a loan secured by a qualified residence, which itself means the principal residence of the taxpayer, here, Tammi. The limit on deductible interest on home equity indebtedness is $100,000. For 2000, Tammi has $200,000 in home equity indebtedness. Thus, Tammi may only deduct half of her interest payments in 2000, or $7,000. It does not matter that Tammi spent part of the money on paying off her consumer debt. Only acquisition indebtedness is required to be spent on your house in order to get the deduction. To the extent that Tammi put some of the money into her house, it will increase her basis.

Tammi’s charitable contributions are also deductible. Tammi donated tangible personal property with a basis of $1000 but with a FMV at the time of the donation of $4500. As long as the religious organization to which Tammi donated her goods is organized in the US, does not lobby, and no part of its net earnings goes to benefit a private individual, the deduction will be allowed. A religious organization such as a church is an acceptable target of a charitable donation. 170(c)(2)(B). Assuming that Tammi’s donation does not exceed 30% of her AGI, her deduction will be as follows: Typically, donors are entitled to deduct the FMV of what they give to charity, rather than your basis. If that rule applied here, Tammi would get a deduction, in the year of the donation, of $4500. Because the religious organization used the donation for a purpose unrelated to their exempt status (selling the goods at auction instead of using them), Tammi may only deduct her basis of $1000. 170(e)(1)(B). Tammi will need a receipt to verify the amount of her donation.

The lunch expenses recall the Moss case. There, the attorneys in a Chicago firm ate lunch out every day because they were too busy to meet at any other time. The court said you just can’t do it everyday; at a certain point it becomes a personal expense, which is not deductible under § 262. The question in Moss was whether the firm could deduct the everyday lunch expenses. The question here is whether the reimbursement of the $2100 Tammi spent on the lunches is income for her.

The meals don’t qualify for a § 119 exclusion from income. While they may be for the convenience of the employer, they are not served on the business premises. Additionally, the fact that Tammi is reimbursed, rather than XYZ furnishing the meals, takes this amount outside § 119.

Although the circumstances were out of the ordinary, there is nothing that compelled Tammi to foot the bill for these lunches. Tammi was not in a supervisory position; she just picked up the check when she went out with her co-workers. Even though she kept meticulous records, she must still include the $2100 as ordinary income in 2000. Tammi was not required by her company to take the crew out to lunch, much less pick up the tab. Accordingly, the $2100 reimbursement is an undeniable accession to wealth, clearly realized, over which the taxpayer has complete dominion. Glenshaw Glass.

Exam No. 3135

Prior to the company change in the rule allowing employees to purchase goods at a discount, this was a qualified employee discount fringe benefit under § 132. The products were the type sold to the public and the discount was only down to the company cost. With the change in the plan providing the option to receive $500 cash, instead of the benefit, it can be argued that the benefit is constructively received, at least up to $500, if not the entire $600 benefit that Tammi received. This is set up like a cafeteria plan, but it is not qualified, because the benefit offered does not meet the definition of a qualified plan. Since Tammi only has to elect to receive the $500, it is constructively received and should count as gross income. The additional $100 benefit that Tammi received may still be counted as a qualified fringe benefit, or it may be tainted as well.

If Tammi itemizes her deductions (and she should), she can take a $7,000 deduction for the interest paid on her home equity loan. This is only $7,000 instead of $14,000, because the cap on qualified home equity indebtedness is 100K, and her home equity loan is for 200K. If this was an acquisition loan all 14K would be deductible, but it is clearly a home equity loan, since it was mainly used to pay off personal debt.

The property tax for $5,000 is all deductible, under § 164. The property tax and the interest are ordinary deductions.

Tammi can take a deduction for the charitable donations, but she can only deduct $1,000, because this property fit the exception in §170 (e)(3)(A). It is tangible property and the church did not use it for its exempt function, so Tammi can only deduct her basis in the property. If she had donated it to a library, this would have fit the exempt function and she could have deducted the FMV (probably $4,500) of the donation. The $1,000 is an ordinary deduction.

The reimbursement for the lunches raises several issues but it probably has little or no effect on Tammi. Business lunches are deductible, when business is discussed, but they will be questioned if they are taken on an everyday basis. See Moss v. Comm’r (where an attorney was deducting his lunch every day because they were working lunches). However, Tammi’s case she is not claiming a deduction for the lunches; XYZ.com will claim the deduction and they will face the tax consequences if this is deemed to be to excessive. XYZ will only be able to deduct 50% of the cost of the meals, § 274 (n), but this does not concern Tammi, because she is on an expense account.

Tammi is receiving a benefit from the lunches, the money is exchanged is a wash, but she is personally getting a free lunch four days a week, for two months. This is the same as a chit, and at some point it is no longer a de minimis fringe benefit. It may be counted as a working condition fringe, since it would be deductible as a business expense, if she were paying for it herself. In that case the 50% rule may apply, because only 50% would be deductible if she were paying herself. Under the circumstances, she probably does not need to claim any income from these business lunches, but if this were to occur throughout an entire year, it would cross the line and Moss v. Comm’r would apply.

She is complying with the code by keeping a record of who ate and what was discussed. This is necessary for XYZ to take the 50% deduction, and if she is questioned abut the benefit, this will help her prove that it was a working condition fringe.

Created by: bojack@lclark.edu

Updated: 02 Sep 04

Expires: 31 Aug 05