Income
Tax I
Bogdanski
Fall 2010
Sample Answers to Question 2
Exam No. 6359
The fact that Jenny owns her own home may mean that she can deduct qualified residence interest if she has a mortgage secured by the home. She can also deduct her property taxes on her federal tax return.
Jenny’s Mom
Jenny cannot use her mother as a dependent on her tax return despite the fact that she provides more than half her mother’s support. Marie is not Jenny’s qualifying child because she is not Jenny’s child, sibling, niece or nephew, or grandchild. Marie is not Jenny’s qualifying relative because she has gross income exceeding $3650 for the year. If Marie did not make more than $3650 per year and she was not someone else’s qualifying child, Jenny could use her as a dependent qualifying relative on her return.
Because Marie is not Jenny’s dependent, Jenny cannot take the dependent care credit either.
Jenny’s basis in the ring is $800. When Gail died, her grandson Floyd got the stepped up basis of the ring’s fair market value at the time of Gail’s death. When Marie then received the ring as a gift, she got Floyd’s carryover basis of $800. When Jenny received the ring as a gift, she got Marie’s carryover basis of $800. When Jenny sold the ring, she had a gain of $1050, which is capital gain and taxed at favorable rates.
If the ring was not given first to Marie and then to Jenny out of detached and disinterested generosity, the analysis is different. If neither transaction was motivated by detached and disinterested generosity, Jenny had income when Marie transferred the ring to her, and the income was $2000, the fair market value of the ring. In that case, she had a loss of $150 when she sold the ring, and it was capital loss, which sucks because she can only deduct capital losses against capital gain and $3000 of ordinary income. If the transfer to Marie was not detached and disinterested but the transfer to Jenny was, Jenny had a basis of $1200 (Marie’s carryover basis) in the ring. Then Jenny’s gain was $650 capital gain.
Jenny’s Son
Jenny’s son Scott is her dependent, and she can take a personal exemption for him on her tax return. Even though she does not provide at least half or his support, she can claim him as a dependent because he is her qualifying child. He is her son, he’s younger than her, he lives with her when he’s not at school, he doesn’t provide more than half his own support. Oscar does not get to claim him as a dependent unless Jenny signs a release each year saying he can because Jenny has greater custody of Scott.
Because Scott is younger than 17, Jenny can also take the child tax credit under IRC Section 24. This is a $1000 credit. But if Jenny makes more than a certain amount, she cannot take the credit because it is phased out for upper income taxpayers.
Trust
The income from the trust is income to Jenny because the trust is irrevocable and Brook has not retained any kind of interest in the trust. Although the bank can change the beneficial enjoyment of the trust, Brook cannot, so it is not his income under the grantor trust rules. This is ordinary income to Jenny.
Under Irwin v. Gavit, Jenny does not have a basis in the trust because she only gets the income, not the corpus. If Scott and Jenny decided to sell both their interests, Jenny would have some basis from the $90,000 carryover basis from her brother. She would probably only have a very small amount of basis though. She would not have any basis if she sold just her interest, though, and she has no basis to exclude from her income from the trust.
Lottery Winnings
The prize winnings are income under IRC Section 74. Jenny constructively received the winnings when the winning numbers were announced on the internet. Because the money was available to her when the winning numbers were announced, she constructively received the income in October. Even though she did not collect the winnings until the next year, she received the winnings as income the year the winners were announced. This is ordinary income.
We might be able to analyze this as gambling winnings, in which case Jenny could deduct the cost of her lottery ticket (assuming she kept the receipt) against her winnings, but there’s probably not much point to that because it’d be a really small deduction and probably does not exceed the 2% floor.
If she was seeking tax advice from her accountant (which it looks like she was), she can deduct the cost of the accountant’s services under IRC 212(3).
Exam No. 6469
a. Ring
The
ring had a basis of 800 in Floyd’s hands because the basis was stepped up to
fair market value at the time of Gail’s death per 1014. Maybe Floyd gave it to Marie out of detached
and disinterested generosity, in which case it is a gift and gets a carryover
basis of 1200 in Marie’s hands per 1015.
On the other hand, maybe Floyd gave it to Marie in exchange for her
promise to marry him or in exchange for waiver of her marital rights (though we
don’t have any evidence about a waiver).
If that was the case, Marie would have a cost basis in the ring of 1200,
determined through the barter equivalence presumption of the
The second question is whether Marie gave Jenny the ring out of detached and disinterested generosity, in which case it would have a carryover basis of 800 or 1200, depending on the answer to question 1. Alternately, she could also have given Jenny the ring in exchange for Jenny’s support, in which case Jenny would have a cost basis of 2000 using the barter equivalence doctrine. However, all this speculation is somewhat moot because the burden is on Jenny to show whatever basis she chooses, so she’ll have to be ready to prove, for a 2000 basis, that she and her mother made a deal about the ring, or that (even more difficult) her mother and her father made a deal about the ring (rather than it ever being given as a gift).
When she sells it for 1850, Jenny will realize and recognize a capital gain of either 1050 (basis 800), 650 (basis 1200), or a capital loss of 150 (basis 2000), which she could apply against ordinary income up to 3k, and after that would only be deductible against capital gains.
b. Dependents
Jenny will file as a head of household and be taxed at those rates, which are better than the rates for single filers but not quite as good as those for married filing jointly. Unfortunately, it appears that she cannot take a dependent exemption for Marie under section 151. Marie would qualify as a qualifying relative under 152(d) except that her income is more than the threshold amount of 3650 per year (for 2009). She is a relative and Jenny provides more than half of her support (I think it also goes without saying that she is not someone else’s qualifying child).
She can take an exemption for Scott, however, as a qualifying child under 152(c), which will result in a deduction (essentially, the 0% bracket) of 3650. This is the strange deduction that is neither above nor below the line, precisely. She will get it regardless of whether she itemizes her deductions, but it is not taken into account in calculating adjusted gross income. Scott is her child, and although he doesn’t live with her for more than ½ the year because he is often away at boarding school, her house is surely his principal place of abode because school doesn’t create residency. We know he does not live with his father. He is younger than the taxpayer, under age 24 (he’s a full time student), and probably does not provide more than half his own support. Jenny does not have to support him under the requirements of 152(c). In addition, under the divorced parents tie breaker rules, Jenny can take his exemption because she has more custody during the year than Oscar. If, however, Jenny and Oscar have agreed by contract that Oscar will take the exemption or part of it, that controls (152(e)(2)).
In addition, Jenny can take a 1000 tax credit for Scott under section 24 because he is her dependant child under 152. This is phased out for adjusted gross incomes above 75k, and it sounds like Jenny might qualify. This credit is refundable under some circumstances, so she should look into it further. Boarding school, however, will not qualify her for the child care credit because that only covers household services (and we don’t know if boarding school allows Jenny to work, and Scott is over 13).
c. Trust Fund
Jenny’s life interest in the trust income is ordinary income and she will never be able to apply any of the basis of the property to it, under Irwin v. Gavit. Upon her death and the dissolution of the trust, Scott will get the property with its 90k basis intact. If he sells it then, he’ll realize capital gain, but until then all income is ordinary. If Brooke’s goal was to split his income by providing some to Jenny and Scott, he has succeeded, because he appears not to have any prohibited control over the trust. The trustee may shift the income between Jenny and Scott, but Brooke has avoided the grantor trust rules of sections 671-78 by (1) not carving out any interest for himself (just for Scott), (2) not retaining any right to control beneficial enjoyment of the trust income (the trustee can shift the beneficiary, but Brooke can’t) and (3) not retaining any other economic interest (i.e., it isn’t revocable, that we know of). As a result, the trust income will be taxed to Jenny for her lifetime. Because Jenny is an adult, the Kiddie Tax, section 1(g), also does not apply; it would if Brooke had made Scott the recipient of the income from the trust (and it will apply if the trustee shifts the income before Scott is 18/24 if a student).
d. Lottery
As soon as the numbers were published on the internet, Jenny had the right to collect the lottery winnings, so she’ll be taxed on them this year despite waiting until next year to claim them. She constructively received them as soon as they were set apart for her and she had the legal right to receive them. Although the lottery people did not know her name, she had the winning ticket, which is enough to identify the winning with her.
In addition, they are income under Glenshaw Glass, as a windfall. They are ordinary income.
Exam No. 6618
The Dependents
Marie
would be a “qualified relative” of Jenny’s and thus her dependent under section
152(d), but because she makes over $3650 per year (at least $4800). Marie meets the other requirements for a
qualifying relative, however, because Jenny provides more than half her
support, she is a member of Jenny’s household, and apparently no one else can
claim her as a dependent.
By
contrast, Scott is Jenny’s dependent because he is a qualifying child under
section 152(c). He is Jenny’s son; he has the same principal place of abode as
Jenny for more than half the year, because his absences just to attend school
don’t count; he is younger than Jenny and younger than age 19; he has not
provided more than half of his own support (Oscar supplies most of his
support); and apparently he is not filing a joint return with someone else.
Because
she is a Head of household with dependents, Jenny can take a standard deduction
of $8500 if she is not itemizing her deductions. She can also take the $3650
personal exemption for both herself and for Scott. She may be able to take a child credit for
Scott in the amount of $1000, reduced by $50 for each $1000 over $75,000 her
income is. If she makes more than $90,000 the credit is eliminated completely. When she was married to Oscar, the threshold
income for their joint return was $110,000.
The Gift
When
Floyd gave the ring to Marie, they were not married, so their transfer is not
treated like a gift for tax purposes under 1041. Instead, Marie had income in the amount of
the FMV of the ring, so $1,200. However,
if this was a gift made with detached and disinterested generosity, and not
pursuant to a premarital agreement or enforceable promise of some sort, it
could still be counted as a gift under section 102. This is likely the case, considering that this
was an engagement ring. In that case,
Marie’s basis in the ring would be $800, as Floyd’s basis carries over to her.
Floyd got that basis because gifts made at death get a basis equal to the fair
market value at the time of death (or six months later if the estate chooses to
value at that point). When Marie gives
it Jenny, Jenny gets her basis, or $800.
When Marie sells the ring for $1850, she must recognize 1,050 of gain (FMV
of ring 1850-basis of 800). This is the
sale of a personal asset, so it will be taxed at capital gain rate of 15%.
The Trust
Here,
Brook has successfully reduced his income by setting up an irrevocable trust—he
will not have to pay tax on the income on the property because he has
relinquished all rights to control it.
This is not a grantor trust under section 673, in which Brook would keep
a reversion in the property; nor a revocable trust under section 676, in which
Brook would retain the power to revoke the trust; nor a case in which Brook
retains the power to control beneficial enjoyment under section 674—instead, he
has made a third party, the bank, the trustee who has the power to control who
gets the income from the property. When
the trust is transferred to Scott, he will have a basis in the property of
$90,000, carried over from Brook pursuant to this gift. This corpus of the trust will not be taxable
to Scott, but the income from the bond paid to Jenny throughout her life will
be taxable as gross income, and as ordinary income. Further, if she sells her life interest, her
basis in it is zero, while Scott retains the full amount of the basis. This is the situation from Irwin v. Gavit, codified in sections 102b and 273. The only way Jenny can get around this very
non-beneficial treatment of her life interest is if she and Scott were to sell
their interest and the trust at the exact same time, under 273e3, they would
share the basis in the property between them.
Further, after Jenny’s death, income from the trust will then be taxable
to Scott.
The Prize
Under
Glenshaw Glass, even a windfall such a prize is considered gross income—it is
an accession to wealth, clearly realized, over which Jenny has complete
dominion. The income will be ordinary
income as well, as it is not derived from any type of sale of a capital
asset. The question is when Jenny will
pay tax on that income.
When
Jenny sees that she has the winning number by checking the state lottery’s
internet site, she knows that she will have access to the money. However, from the perspective of the lottery,
no one has yet come forward to claim the money.
Under Reg. 1.451-2, the money has not be credited to Jenny’s account or
set aside for her specifically, though it has been set aside for a winner. Since it will not be paid unless a winner
comes forward, it does not seem that Jenny has constructively received the
income at that point.
However,
when Jenny turns in her ticket on December 15, she is likely in constructive
receipt of the prize. At that point, the money has been specifically set aside
for Jenny. Even though she does not have
the ability to have the money in her hand until thirty days later, as in Pulsifer v. Comm, she has an
“absolute right to income.” In that case, the court specified that the prize
money was “beyond the reach of the payor’s
creditors.” While the lottery may go
bankrupt and be pursued by creditors who will take Jenny’s prize money before
she gets it, this seems very unlikely.
Jenny might not want to pay tax on the income until January 14—that
seems to be the goal of her waiting until January 15 on the advice of her
accountant (whose tax preparation fees will be deductible above a 2% floor as
miscellaneous below-the-line deductions under section 67). So she will argue that because there is a
substantial restriction place on the money—she can’t get it for a full
month—she should not be taxed in the current year for constructive receipt. As in Amend, she is not colluding with the
lottery to postpone her tax—this is an arms-length transaction, and the lottery
has no idea why she is waiting until December 15 to come forward.
Exam No. 6831
Marie, Jenny's mother, does not qualify as a “qualifying relative” under 152(d) because her income is greater than 3.65k. Therefore, Jenny receives no deduction for taking care of her mother, but her mother will receive the personal exemption of 3.65k on her own tax return, for herself.
Qualified retirement plan
The engagement ring received the fair market value basis of $800 when it was transfered to Floyd as a result of Gail's death. The gifting of the ring to marie preserved this basis as a carryover basis and was not income to marie, and not deductible by floyd. The gifting to Jenny similarly is neither deductible nor income and the basis remains at $800. Therefore, when Jenny sells the ring, she has a capital gain of $1050. If Jenny is a dealer in rings, this property might qualify as inventory, and the profits from her business as pordinary income. If Jenny is a dealer, she can elect to have this income be ordinary income.
Scott could qulify as Jenny's dependant, permitting jenny to take a expemtion deduction of 3.65k. It is irrelevant that oscar pays more than half of Scott's support. Scott qualifies bc he is a full time student under 24 years of age, he doesn't provide more than half of his support, is a child of Jenny, and spends half or more of the year with her (time at school counts for her). This is all fine unless Oscar has a claim to scott's dependancy.
If there was a written agreement, releasing the rt to claim Scott by the custodial parent, Jenny to Oscar, then this trumps everything else. Since Jenny has more custody, she would win the tie-breaker if the dispute went furhter.
IF Scott is a qualifying child, under 152(C), and here the residence is an issue again, Jenny might qualify for the $1000 child tax credit, which would count directly against her tax wihtheld for each year. There is a shase-out for this credit. For every thousand dollars of AGI over the threshold, $50 is reduced from the $1000 credit.
The trust set up by Brook seems to qualify as “splitting income”. There will be a carryover basis that scott will be able to use upon receipt of the trust value, assuming he doesn't sell his interest before then.
Jenny will not be able to use the basis against her income unless she and Scott get together to sell their interests as a whole (IVWIN V GRANT). In that situation, the basis will be apportioned.
Jenny will receive a passive income, ordinary interest income, from the trust while she is alive. If she sells her interest, this will be capital gain in the year that she sells it.
Jenny's prize is certainly income, gambling income which is ordinary. The issue of when she recieves the income is tricky. A court will likely require for the rules of the competition to be satisfies, which here mean that she must hand in the ticket, like performance under a contract. Also under the rules, payments are made 30 days after such performance. Jenny will probably slide by in this case, as she had no legal right to the $ before she got it in January and did not actually receive the $ until january (AMEND). She is avoiding tax, not evading tax. Her attorney probably told her to do this for tax purposes. She will have no income from the prize in the first year, all in the second year. Jenny will be able to deduct whatever she spent on the lottery ticket from the gain she recieves as gambling gains are deductible against gambling outlays and losses.