Income Tax I
Bogdanski
Fall 2008
Sample Answers to Question 1
Exam No. 9140
For the tuition reimbursement, under § 127 Erika can exclude $5,250 of the employer-provided tuition assistance, meaning that of the $12,250 reimbursed to her, only $7,000 will be currently income. Under § 25A, Erika is eligible for a lifetime learning credit of $2,000, thereby reducing any tax liability she has for the year by $2,000. Alternatively, under § 222, Erika can elect to deduct all of her qualified tuition and related expenses, limited to an amount set out in § 222(b) that depends on how much her adjusted gross income is. The credit will likely produce a better result.
Erika may also be able to deduct her out-of-pocket expense as a business expense under Reg. § 1.162-5, as the education relates to her career as a broadcaster and thus likely maintains or improves required skills in her trade or business, and is not entry-level education for her existing trade or business. However, if the classes somehow qualify her for a new trade or business, say as a video editor, regardless of whether she intends to enter that new trade or business, she will not be able to take the education as a business expense deduction. Note that in any event the income will be ordinary and not capital, as it is not a gain from a sale or exchange of a capital asset under § 1222.
The plan offered by her employer qualifies as a cafeteria plan under § 125 because it includes the choice of two or more benefits consisting of cash and qualified benefits. The health insurance premiums and child care expenses are both employee benefits that are not includable in income because excluded by the IRC, and are not set out in § 125(f) as benefits that destroy a cafeteria plan. Therefore, the fact that she could have chosen $6,000 of cash instead will not bring a claim for constructive receipt of $6,000, because § 125(a) insulates against such a claim. Thus, Erika will have no income at any time from this $6,000.
The sale of her house will not generate any income from the sale, assuming she also lived in the house all those years she owned it. Under § 121, gross income doesn’t include any gain from the sale of property if, during the 5 year period ending on the date of the sale, the property was owned and used by the taxpayer as her principal residence for periods aggregating two years or more. Unless she was living in a cardboard box under a bridge, one can likely assume that she was living in the home she owned, and thus lived in it as her principal residence for the correct period of time. However, if she made more than $250,000 profit on the sale, the amount over that will be taxed under § 121(b). That will be a capital gain, if it exists, because it is not listed in § 1221(a); everything NOT listed there IS a capital asset. Thus, it will be subject to preferential treatment (i.e., taxed at a lower rate, 15%) than if it were ordinary income.
As to the property taxes, under § 164(a)(1) property taxes on a personal residence are deductible. Assuming she has already paid her federal income taxes for the prior year, and that she deducted these property taxes, under the tax benefit rule and Alice Phelan Sullivan, she will have income in the year of sale in the amount of the deduction. This is because she would have deducted the full amount of property taxes, but repayment of a prorated amount by the buyer is fundamentally inconsistent w/ the basic premise of that deduction. She cannot open the prior year because annual accounting periods are treated as separate compartments unless Congress says otherwise; they haven’t here. However, under § 111(a), if the deduction in the prior year didn’t give her any tax benefit at all, she will not have to include the recovered amount in income this year. However, it’s unlikely that her taxable income was already at $0 in that prior year, and thus the prorated income taxes will be includable as ordinary income this tax year.
As to the rental of the townhouse, the amount her employer pays in rent will be taxable income. Under § 61(a)(1), gross income means all income, unless there’s a provision exempting it. Here, the only possible provision is § 119; but the lodging, while arguably for the employer’s convenience, is only excludable if the employee is required to accept lodging on business premises as a condition of employment. The townhouse, 200 miles away, clearly does not qualify. Further, Erika cannot deduct the rent as a travel expense under § 162(a)(2). Under § 162(a)’s flush language, if you go away on business and stay more than one year, “home” for tax purposes changes and deductions are completely disallowed. Because she was there for 16 months, she is no longer “away from home” and cannot deduct her lodging expense.
As to the transportation costs, the moving expenses are deductible under § 217 because she moved more than 50 miles away. Because her employer reimbursed her, she can for tax purposes ignore that transaction. Her transportation costs to Polis for staff meetings will not be deductible. This is because her home is now the capital; and travel from home to work is just considered commuting, no matter how long the commute is. Flowers, Reg. § 1.262-1(b)(5). Commuting is too personal to be deducted. Thus, while her reimbursement for moving expenses can be ignored, her reimbursement for transportation between cities must be treated as ordinary income, taxable now.
As to any other costs associated with these trips, she should be able to deduct them under § 162 as long as the trip’s primary purpose is for business, not fun. Rudolph, Reg. § 1.162(b). However, if she does have too much fun (like her primary purpose is just to see friends and relatives) they will not be deductible, and if reimbursed will be includible in gross income.
Exam No. 9901
Erika will have various federal income tax consequences based on the various transactions between her and her employer. Erika will likely be able to exclude part of the money that she receives from her employer under IRC §127. Under that section gross income of an employee does not include amounts paid by the employer for education assistance to the employee. The only amounts that can be deducted are tuition and fees, which it appears that is what NewsChannel is covering. However, the maximum amount of exclusion that Erika may take is 5,250. The result is that Erika will still have gross income of 7000. There is a nondiscriminatory requirement but it appears that the station meets that requirement. The nondiscriminatory applies to favoring highly compensated employees. The 5,250 that Erika receives will mean that she is not allowed to take a deduction on that amount as well.
Erika may be able to offset some of the remaining 7000 in ordinary gross income with an education deduction. Under Reg 1.162-5(a) an individual can deduct education expenses if the education maintains or improves skills required by existing business. However it can’t qualify a taxpayer for a new trade or business. Erika already works at the station so one could argue that she is just maintaining or improve skills that are required by her job as a reported which could include video editing. It doesn’t appear that this is minimum entry level education because she already is a reporter. There is the argument that by learning how to edit the video she may qualify for a new job. However, it doesn’t appear that she will be able to sit for an examination or certification so this argument will likely fail. To obtain this deduction Erika will need to itemize her deductions
Finally Erika may qualify for a lifetime learning credit under §25A where she would receive a nonrefundable credit up to 2,000 per year. However, because it is unclear if she is taking at least ½ the normal full time workload it appears that she will be ineligible. This seems likely because she is working full time. Additionally, she may not qualify because there is a phase-out based on adjusted gross income.
The offer by NewsChannel of cash, insurance premiums or day care expenses should qualify as a cafeteria plan under §125. Under this section a plan in which an employee may choose among a variety of noncash nontaxabable benefits or may choose cash is not gross income. Again there is a non-discrimination requirement, which it appears the station fulfills. To be a cafeteria plan the benefits must qualify as non-taxable. For the child care an employee may qualify for in-kind or reimbursement from her employer under §129 up to 5000. So this is a qualified non-taxable benefit. In the case of the health insurance premiums, this benefit qualifies under §106(a) which excludes from gross income employer-provided coverage under an accident or health plan. Because this plan appears to qualify there will be no taxable income for Erika for the 6,000 in medicl insurance premiums.
In the selling of Erika’s home it is unlikely that she will
have to pay taxes on the sale under §121.
While she did sell it for a great deal more, for her to have to pay
taxes she would need to make a gain of $250,000 to pay taxes. All that Erika will be required to show is
that this house was her principal residence aggregating 2 years out of the past
5. If she were to pay taxes this would
likely be a capital gain because she is not a dealer of real estate and instead
this is a personal use asset. The
prorating of taxes is a common part of a sale of property. For the reimbursement there is some question
if Erika will have to include this as ordinary gross income or not. The argument can be made that someone is
paying her taxes for her thus she is getting a benefit and should pay taxes on
this accession to wealth. On the other
hand if Erika didn’t deduct the amount of property taxes she did not receive
any extra benefit for overpayment.
Instead, this is just like recovery of taxes improperly assessed much as
like what happened in
The money that Erika received for her move and living expenses in the state capital will be deductible in part. The part that will be deductible will be the moving expenses under §217. However, because Erika moved down to the state capitol and lived in a townhouse she will not be able to get a rent reimbursed. She is gone for 16 months and thus does not qualify as a temporary transfer, which, under §162 requires that an individual not stay for more than one year. Clearly she stays over one year so the entire cost is ordinary gross income.
There are some questions about taking a deduction for the cost of Erika’s transportation between the state capitol and Polis at various times during her assignment. The argument can be made that her principal place of business is still at Polis and thus she is commuting between her home and office when she drives to Polis. She moved because of “exigencies of the business.” This commuting expense is not something that can be reimbursed and thus would be ordinary gross income. However, it appears that instead Erika is actually traveling “away from home.” Having established that it is not a temporary transfer Erica’s home is at the state capitol. Thus when she went to Polis to attend staff meetings it could be argued that she is away from home attending a bona fide business meeting under §274(e)(5) and thus her travel expenses should not be included as ordinary gross income.
There is some question however, when she attends retreats and visits with her friends and family. In order for her travel to be deducted the primary purpose of the travel must be business. If she travels to Polis for primarily for business and while there happens to visit family and friends, the travel will still be deductible. The retreats are likely not deductible and instead probably ordinary gross income. If the NewChannel retreats are like most retreats there is limited business and instead more of a focus on relaxation and fun much the retreat was in Rudolph. However, this argument is weakened a little with the requirement that entertainment only directly precedes or follow a “substantial and bona fide business discussion” under§274(a). Thus, Erika will likely only be able to deduct a part of her travel to Polis, when the primary purpose was for business.
Exam No. 9599
Courses taken & tuition paid
Under §127, the tuition assistance that E’s employer gives her is not included in E’s gross income for that year up to a max of $5250 per year. The assistance which NewsChannel offers complies with the requirements for §127 because it applies to employees, covers grad and undergrad, and does not discriminate in favor of highly paid employees (§127(b)(2)). However because NewsChannel reimburses E for $12,250, E will have gross income in the amount of $7000 in the year in which she received the money (§127(a)(2)). This income is ordinary income. However, under Reg 1.162-5, E may be entitled to a deduction for her the $7000 in education expenses if they (1) maintain or improve required skills in her existing trade or business, (2) are not entry level education for existing trade or business, and (3) don’t qualify her for a new trade or business. Although E is a news reporter, it is likely that the classes in video editing will not be seen as qualifying her for a new trade or business or entry level education for an existing trade or business – but they might so that is something to think about.
Note also that E may be entitled to some credits under §25A. The Hope Credit allows for a $1500 max per student credit for the first two years of college, and the Lifetime Learning Credit allows for a $2000/taxpayer credit and is good forever. Because these are college courses in video editing (undergraduate courses) then she would probably be entitled to both credits (cannot take them both at the same time but she might choose to take the Hope Credit now and use the Lifetime Learning Credit later when and if she goes to grad school). Alternatively, under §222, E could take an above the line deduction for “higher education expenses” (rather than credits).
Medial Insurance
Under §125, Cafeteria Plans, such as the one described here, are not considered to be gross income to the recipient. Therefore, E has no gross income for the $6000 that her employer pays in medical insurance premiums. Under §125 this plan must comply with antidiscrimination rules and must only include “qualified benefits.”
Under §121 the gain that E realized on the sale of her residence is not recognized as long as the home was E’s principal residence for 2 of the past 5 years and she did not make more than $250K on the sale. If she did make more than $250K, then only the first $250K would not be recognized, and the rest would be considered a capital gain in the year of the sale. For there to be a capital gain, there must be (1) a realizing event, and (2) the asset sold must be capital. Here, the “sale” was a realizing event, and her home (a personal use asset) is a capital asset under §1221(a). Note that if she had realized a loss on the sale of her home it would not be deductible b/c personal use assets losses are too personal (and therefore not deductible under §262). Any capital gain she realized would enjoy a preferential tax rate of 15% if she had held the asset for more than 1 year (as required by §1222(11).
Under §217, E may be able to take a deduction for the moving expenses she incurred since her new job site is more than 50 miles away.
Additionally, under the tax benefit rule, if a taxpayer takes a deduction, and then something fundamentally inconsistent with the premise of the deduction occurs, then in the current tax year, the taxpayer is required to include as gross income the amount of the previously taken deduction. Here E surely deducted the property takes that she paid on her home under §164 (below the line) in the year before the sale. When she was reimbursed for a prorated share of those taxes, then that was fundamentally inconsistent with the deduction she had taken and she will need to include the amount she received in her gross income in the year received (as ordinary income). UNLESS, the deduction taken in the previous year did not result in any tax savings for E (this is the exception to the tax benefit rule). If the deduction that E took in the previous year did not result in any tax savings, then the tax benefit rule does not apply and E would not have to include the $$ in her income.
Assignment in State Capital
Under §162, NewsChannel is going to want to take deductions for E’s rented townhouse for the time that she is in the capital, however, lodging is only deductible under §162(a)(2) if the employee is “away from home” – i.e. away from her principal place of work. However, when an employee is away from home for more than 1 year, then the new location becomes the employee’s home for the purpose of the deduction. Here, because E is on assignment in the capital for 16 months, the capital becomes her new home and so her employer cannot deduct ANY of the expenses for E’s lodging while in the capital. Consequently, the reimbursements from her employer for these expenses would be ordinary income to E. Note that this would not be considered lodging for the convenience of her employer under §119 (or Benaglia) b/c the townhouse rented is not furnished nor is it on the business premises.
Under §132(g), the moving expenses reimbursed by E’s employer would not be gross income to E b/c the moving expenses would have been deductible by E under §217 if she had paid for them herself (more than 50 miles away).
Under §132(f) up to $115 for vanpool or mass transit and $220 for parking are not considered income to the employee, but are rather an excluded fringe benefit. If the transportation costs mentioned in the problem fall under this section they will not be gross income up to the amounts stated – any amount reimbursed over these amounts would be ordinary income to E in the year received.
Reimbursed expenses to employees are deductible by the employee above the line (b/c in theory, the employee paid for these expense out of dollars which had already been taxed and so they shouldn’t be taxed again as income when the employee gets reimbursed for them).
The reimbursement of transportation expenses E’s trips back to Polis to visit her family and friends are ordinary income to E (and not deductible because they are personal §262). However, depending on the frequency of the trips and whether they were considered to be ordinary commuting, the transportation expenses for E to attend NewsChannel staff meetings and retreats may or may not be income to E. If the trips into Polis for staff meetings and retreats are commuting, then they are not deductible under Reg 1.262-1(b)(5) and Flowers and the reimbursements to E would be considered ordinary income to her. However, it is unlikely that those trips are commuting. If they are not considered commuting, then they are not income E because they are merely reimbursements for her ordinary and necessary business expenses under §162 (and therefore deductible by her employer too).
Exam No. 9459
Lucky for Erika, she has a job with many benefits.
First, her tuition reimbursement. If the tuition reimbursement plan stands on its own, instead of being included with the medical expenses mentioned later, then the reimbursement for her tuition is not included in her gross income, up to $5,250. § 127(a)(2). If the tuition reimbursement were a part of the other plan it would be it included in her gross income, as tuition reimbursement plans are not included in cafeteria plans. § 125(f), § 127(b)(4).
The remaining amount of income, which is ordinary income, the $7000 (12,250-5250) can be deducted as a business expense under § 162. Business expenses are above-the-line deductions, so even if Erika doesn’t itemize, she’ll still benefit. As in Carroll v. Commissioner, Reg. § 1.162-5 creates a test to evaluate whether or not the education can be deducted as a business expense. First, the education must maintain or improve required skills in existing trade/business. Here, Erika is a news reporting and is learning about video editing. NewsChannel only reimburses the tuition that is related to broadcasting, so the fact that they did reimburse her helps weigh on the side that the education maintains/improves skills in her business. Second, the education can’t be entry-level education for the existing trade or business. Here, if Erika took entry level courses regarding video editing, the cost of those classes might not be deductible. Otherwise, she is okay. Finally, the classes can’t qualify taxpayer for a new trade or business. Given Erika is already in the news broadcasting business, she is okay on this ground. The deductions would take place in the years the reimbursements were received.
Anything education expense that is not deductible is going to be considered “an inseparable aggregate of personal and capital expenditures.” Reg. § 1.162-5. However, Erika won’t get to depreciate that amount. Also, Erika, if she has non-deductible income, might be able to utilize some of the education credits in § 25A, depending on whether her income is within the phaseout range.
Cafeteria plan. Cafeteria plans are governed by § 125, which states that the tuition reimbursement mentioned above is not allowed to be a part of the plan. If the plan meets the standards set out in the code, all the benefits are tax free. If Erika didn’t receive any benefits, instead choosing to take the money as part of her salary, it would definitely be taxed. Here, the cafeteria plan appears legit, because both medical benefits and child care plans are often included in a cafeteria plan. Under § 105, medical insurance premiums paid by employers are excluded from gross income. And under § 125(g), 100% of the premiums can be paid. So the $6,000 of ordinary income received for medical insurance premiums is not included in Erika’s gross income.
New residence, moving expenses. Erika can deduct the reimbursement for her moving expenses under § 217, because it is more than 50 miles away from Polis. Moving expenses include the cost of moving, as well as the cost of transportation to the new residence. However, only that first trip to the new residence will be allowed to be deducted. Also, she is a full time employee during the 12 month period following the move. This will be deductible in the taxable year in which the moving expenses occurred. Moving expenses are an above-the-line deduction, meaning she doesn’t have to itemize to take advantage of NewsChannel’s generosity.
The rent, and
commuting costs. The rent paid by
NewsChannel will be ordinary income to Erika.
Under § 119, an employer is allowed to provide for lodging only if the
lodging was provided for the convenience of the employer, generally showing by
the employee being on call. Also, the
lodging provided needs to be on the business premises. While the business premises might include
more than just where NewsChannel is located , Lindeman v. Commissioner,
Commissioner v.
Erika will not be able to deduct the transportation or lodging costs under § 162 as business travel expenses. These can only be deducted if 3 requirements are met, which Erika does not meet. The expenses are reasonable and appropriate, the expenses are incurred while the taxpayer is away from home. However, because Erika has moved away from Polis, she cannot be considered away from home. Additionally, even if she had kept her residence in Polis, the assignment lasts more than a year, and the taxpayer is not allowed to have a business trip that lasts longer than a year.
Her transportation costs back to NewsChannel for meetings can also not be considered deductible, since they are commuting expenses, from her home to her place of work. Commuting expenses are considered to be part of the choice the taxpayer makes on where to live and are never deductible. Commissioner v. Flowers. Rev. Rul. 99-7 applies to temporary job sites, which this might qualify for, but the extended period of time seems to exclude that. Additionally, whenever she comes back to visit friends, that is a personal expense and won’t be deductible at all.
All in all, even though some of it is ordinary income to Erika, she gets a pretty sweet deal from NewsChannel.