Income
Tax I
Bogdanski
Fall 2012
Sample Answers to Question 1
Exam No. 3085
Reimbursement of meals and mileage
As a reimbursed 'ee, L will have ordinary income in the amount of the reimbursements she receives from XYZ for her mileage and the cost of meals on her facility visits. To the extent the expenses are deductible, she can then take an offsetting ordinary deduction above the line under 62(a)(2)(A). To the extent the expenses are not deductible, L will simply have gross income in the amount of the reimbursements from XYZ as reimbursement for her services under 83(a). Under 274(d) and Reg 1-274-5T L will have to substantiate her expenses using receipts and a travel log in order to support her deductions, unless she keeps the expenses within the allowable federal per diem amount, which seems likely, given that she is visiting hospitals and not going to fancy restaurants and events.
Under the first leg leg/last leg rule, the first and last drive of L's day will be treated as a nondeductible commuting expense under Reg. 1.262-1(b) and the Flowers case. Thus, L's drive to her office in the morning and her drive home at night will likely be treated as nondeductible expenses, so if she drives straight from the XYZ facility, to her home, that last leg may not be deductible, unless it constitutes an occasional instance of out of town travel (not likely as these visits appear to be close to her office and they are deemed "frequent"). To the extent that L is driving from the office to the facilities and back to the office, the pure transportation expenses to get to the facilities will be deductible under 162(a)(2), even though L is not sleeping or resting during these trips, because courts and the IRS are not strict about the "away from home" requirement when it comes to pure transportation. It is possible, though, that this will all be seen as commuting because she is going back and forth from XYZ facilities, rather than to client offices. Thus, it may be that every leg of every trip is actually a nondeductible commuting expense. Assuming there is some form of deduction allowed, it will be 55.5 cents per mile for gas and wear and tear on her vehicle, plus the cost of parking plus the cost of tolls.
Meals may be deductible as ordinary and necessary expenses of doing business under 162 as long as they are not occurring too frequently under Moss, where daily business lunches were deemed "too much" to be deductible. The frequency issue will be a question of fact. In terms of whether the meals are business expenses, it is likely that the meals to check on the quality of food and services will be deductible because L is performing a business function. In terms of the meals with fellow 'ees, it will depend on the character of these meals. If the 'ees are discussing business, the expenses will likely be deductible, but if they are just having personal conversations, there will be no deduction allowed. Notably, L cannot exclude the reimbursement from gross income under the theory that the meals were "furnished for the convenience of the 'er" under 119 and Benaglia because the meals were not furnished in kind, and the exceptions allowing for non-income reimbursement are not present here. The meals will not be deductible as travel expenses unless she was sleeping or resting during these trips (which it does not appear that she was) under the "away from home" rule under 162(a)(2). Under 274(n), if XYZ ultimately pays for the meals, it will be subject to the 50% deductibility limit, not L. Only the one who ultimately pays the bill is subject to that rule.
Transfer of Blackacre
from XYZ to L
Under 83(a) L may have income in the year of the transfer as compensation for her services as CEO, and under 61, it doesn't have to be cash to be income, so it doesn't matter that this is a transfer of property rather than a paycheck. However, it is likely that L does not have income in the year of the transfer because it looks like there is a substantial risk of forfeiture in that if L stops working for the company for any reason before the end of 3 years, she loses all interest in B. However, a court will likely look closely at how serious that risk of forfeiture is under Drescher, especially given that many of L's close friends are on the board of the directors--thus, a court will want to see whether this deal has been artificially constructed to allow L to defer taxation, in which case she may be deemed to have constructively received B in the year of the transfer. AT bottom, though, it is unlikely that she has income in the year of the transfer because the restriction is pretty strict.
Even if there is no income in the year of the transfer, L can still elect under 83(b) to pay the tax on the income in that first year so that she doesn't have to declare the income in the later year after it has increased in value. In that case, L will have 20,000 of ordinary income in the year of the transfer and will have a 20,000 tax basis in B. If she doesn't take the election, and if the risk of forfeiture is deemed substantial, L will not have income until year 3 when the substantial risk of forfeiture falls away; then, she will have ordinary income in the amount of the FMV of 26,000 of B in year three. She will have a tax basis in Blackacre under 1.61-2(d)(2) of 26,000.
L will not be able to take depreciation deductions against her basis because land is not depreciable, and it does not sound like B is developed. L can take a below the line deduction for local and state property taxes that she has to pay on B under 164.
Loan
L has no income when she gets the loan because a loan is not an accession to wealth under 61 because the increased spending ability comes with a corresponding obligation to repay. In year 2, L will likely have discharge of indebtedness income under 61(a)(12) and Kirby Lumber because she is getting away with only paying back 300 on a 7,200 loan. That is, unless the discharge a gift under 102(a), which would mean she would not have any income. However, even though the board said they were giving the discharge out of affection, which indicates detachment and disinterest, the fact remains that L is an 'ee of XYZ, and under 102(c) there can be no gifts to 'ees unless the 'ee is the natural object of the 'er's bounty under 1.102-1(f). This typically means a family member, not a close friend, so the fact that the board members are L's close friends doesn't really help her. L likely has ordinary income in year 2 in the amount of 7,200.
Unless L used the loan to purchase a qualified residence under 163(h)(4), or she used the loan to purchase a profit-oriented item, she likely cannot deduct any interest she paid on the loan under 163(h).
Transfer of B from L to literary society
The donation will be deductible charitable contribution under 170, deductible below the line but not subject to the 2% floor on miscellaneous deductions, so long as the organization meets the requirements under 170(c), meaning it is a domestic nonprofit charitable organization operated solely for (in this case) literary purposes, which doesn't lobby or get too involved in political campaigns. Because it is a literary society, not an educational, medical, or church org, L will probably only be able to deduct up to 30% of her AGI under 170(b)(1)(B); however, she can carryover the deduction to future years if she is in excess of the ceiling. Because B is investment real estate that she has held for over a year, she would have a capital gain if she had sold it, so it is not subject to the 170(e) rule allowing for only a deduction of the lower of the fair market value or the basis. Here, L can apply the fair market value rule, meaning she can deduct the FMV of B on the date that she transfers it. This figure will require substantiation, possibly a professional appraisal since the FMV appears to be over 5,000. However, given that the organization immediately sold B to a real estate developer for 30,000, this will likely be treated as the property's FMV (plus that's what the facts say it is). Thus, L can likely deduct 30,000 in year 5, subject to the caveats above. Notably, L does not realize any gain on the increase in the value of Blackacre; thus, it was a good move for her to transfer her appreciated property to charity.
The above is all assuming that she didn't get a substantial benefit from the organization in exchange for the transfer. If she did, she will not be able to deduct the amount of the contribution which is attributable to that benefit. That does not appear to be the case on these facts, though.
Exam No. 3487
Mileage and Meal Reimbursement
Lara's mileage is a deductible business expense because it is for purely work-related travel. If Lara ever drives home directly from one of the facilities, that trip would be considered commuting, and would not be deductible, but all the trips between Lara's office and the facilities are business travel.
The cost of the meals Lara eats at the facility cafeterias are also business expenses, since it is part of her job to check the quality of the food and service being provided in the cafeterias. The lunches Lara eats with other XYZ employees depend on the purpose of the meals. If Lara and the employees are discussing business-related issues, these are also business expenses, and deductible. If they are purely social lunches, they are not deductible.
To the extent that Lara's mileage and meal expenses are related to business, she can deduct the total amount of the reimbursement from XYZ above the line. Any amount of the reimbursement that is not for business expenses (meals for pleasure, commuting) would be included in her gross income. Since the meal expenses are reimbursed, Lara is not subject to the 50% limitation on meal deductions, but XYZ will be subject to that limitation on its deductions for reimbursing Lara.
Blackacre
Since Blackacre is transferred to Lara as a bonus from her employer, it is technically compensation for performance of services and the fair market value, $20,000, should be included in her gross income in year 1 as payment in kind income. However, since Lara's control is subject to substantial restrictions, notably that she will have to give back Blackacre if she leaves employment for any reason (including at the discretion of XYZ) before the end of year 3, Lara does not have constructive receipt of Blackacre. XYZ still maintains ultimate control over the property. Lara does not have complete control over Blackacre until the end of year 3, when her rights in Blackacre vest, and it is no longer subject to a substantial risk of forfeiture.
However, Lara can choose whether she wants to have the income in the year of receipt or in the year of vesting. If she chooses receipt, her income will be $20,000, and if she chooses the year of vesting, her income will be $26,000. XYZ must make its deduction in the same year as Lara, for the same amount. Lara's basis in Blackacre will be the amount either $20,000 or $26,000 depending on her choice.
Loan
Lara does not have any income tax consequences on receiving the loan from XYZ, as loans are not considered gross income.
When the loan is forgiven, Lara probably does have discharge of indebtedness income. Forgiveness of a loan as a gift is not considered income, and the board of directors forgave the loan "out of affection." However, in general, any transfer from an employer to an employee cannot be considered a gift for tax purposes. Even though the board of directors includes close friends of Lara, they are not making the gift to her in their personal capacity, but rather in their business capacity, specifically noting that Lara is an "excellent CEO." Even if the loan forgiveness is considered a gift, XYZ will not be able to deduct it, because the value exceeds $25.
Most likely, the loan discharge is not a gift, and Lara will have discharge of indebtedness income, since she is presumably not insolvent at the time of the loan forgiveness. She will have $7,200 of ordinary discharge income, which is the amount of remaining liability on the loan at the time of discharge.
Donation
Lara's donation of Blackacre to the national literary society will be deductible as a charitable contribution, as long as she itemizes her deductions. It will be a below-the-line itemized deduction, but not subject to the miscellaneous deduction 2% floor. The national literary society is presumably a permissible recipient , as long as it is not-for-profit and does not engage in lobbying or political campaigns. Lara will get to deduct the entire fair market value of Blackacre, $30,000, even though that is more than her basis (which may have declined due to depreciation deductions in the meantime). Her deduction might be limited by any return benefits she is receiving from the society, but based on the facts given, her donation is purely charitable. Since Blackacre is real property, it does not meet any of the exceptions to the fair market value deduction rule, so Lara does not have to worry about the fact that the society sold Blackacre shortly after her donation. Lara will also be limited in her deduction by the deduction ceilings. If the national literary society qualifies as one of the approved foundations listed in IRC § 170(b), she can deduct up to 50% of her adjusted gross income. Otherwise, she can deduct up to 30% of her AGI. Since Lara is a highly paid CEO, she probably doesn't have to worry about these caps on a deduction of $30,000.
None of these transactions involve capital gain or loss, because they do not involve IRC § 1001 disposition of property transactions.
Exam No. 3386
Per § 61 all of L's income is gross income, including property transfers ( § 83) unless the code provides an exception that says otherwise.
The money L receives in reimbursement for meals and mileage is ordinary income. If the company did not reimburse her, L could only try to deduct the costs as business expenses, but they would be below the line deductions subject to the miscellaneous floor of 2% of her AGI. Further, because meals are only deductable up to 50% under § 274n, L would only get to attempt to deduct half the cost of her meals. However, because XYZ does reimburse L, under § 62 (a)(2) she can take an above the line deduction as a reimbursed employee. (The ability to deduct meals at all depends on whether L is conducting business during the meal, in addition, the deduction of meals eaten while travelign requires that the individual be traveling overnight - however there is an argument that because eating the food is itself the business task it is still deductible by Lara. Even if it is not deductible, she must still count the reimbursement for those costs as ordinary income. The other meals eaten with XYZ employees are subject to the same limits). Further, L can deduct the whole of the cost of her meal. In regard to the mileage reimbursement, there is no overnight requirement. The reimbursement is allowed up to 55.5 cents per mile currently, and can be increased to include parkign fees or tolls. The deduction is limited by that amount - even if the reimbursement received for mileage is higher. If L is tracking her actual mileage expenses and can show documentation on her mileage and wear and tear, then she can elect to deduct up to that higher number. L would take the deduction in the year the expenses accumulated.
The transfer of Black falls under § 83 - property transferred in connection with performance of services. Normally, § 83 transfers are NOT reported as income until the right to retain is vully vested, and there is no longer a substantial risk of forfeiture or the rights become transferable. Arguably, L has a substantial risk of forfeiture until the end of the 3rd year, and thus no right to transfer, so she will not report Black until then. However, she can elect under § 83(b)(1) to include the value of Blackacre in her gross income as ordinary income in the first year of the transfer - however, if she does so she could not later take a deduction if she ended up forfeiting Black. The value of Black is determined in the year that it is included in income - if L had elected to include in income the first year, her income would have been $20,000 ( the amount employee paid subtracted from the FMV). Because L did not elect to include, the value is calculated once the property rights vest - so in the 3rd year, Black has a value of $26,000 (FMV) and that is the same amount of income that L must claim as ordinary income. L's basis in Black would normally be the cost, since she did not purchase it outright, the basis is the amount includable in her gross income - so $20,000 if she had elected, and $26,000 in vested at the end fo the 3rd year.
Discharge of indebtedness is considered to be income under § 61(a)(12). L will have to claim $7200 as ordinary income in year 2 unless she can show that the forgiveness of debt was a gift under § 102. However, § 102(c) specifically states that a transfer from an employer to an employee is not a gift. The exception is if the employee is your child and you can show that the transfer is not related to work (Rev. 1.102-1). L is not a child of the employers though, and there is evidence that the gift was neither detached and disinterested, nor without regard to services provided. Because the note referred to L as a "most excellent CEO" the transfer was almost certainly in regard to L's performance and services at work. Even if gifting by employer to employee was allowed, this example would probably not pass the Duberstein "detached and disinterested" intent of the giver test - this was related to work. Further, there is no likelihood of passing the forgiveness off as some kind of § 74c employee achievement award, and even if that was possible, then there is a limit on the maximum. LIke Kirby Lumber, L paid back less than she had promised to pay - the difference - the $7,200, is ordinary income at the time of the discharge, so in year 2.
Charitable donations are allowed under § 170. Such
are eligible for below the line deductions, so L could only potentially deduct
if she is itemizing her deductions. There is a limit on the maximum amount of
such donations. Property can be donated under § 170(f)(16).
Any deduction for such is limited to a maximum percentage of AGI, and the
applicable percentage is affected by the type of receiver. Here, if a National
literary society qualifeis under § 170(b)(1)(A), then the deduction is allowed up to 50% of L's agi for the year, if identified in (1)(B) tehn only 30%. There are only 5 kinds of organizations that
L can donate to - 1) a state or political subdivision, 2) a corporation, trust,
community chest or foudnation, 3) a veterans group,
4) a domestic fraternal roganziation operating unde rhte ldoge
system, or 5) a cemetery company. It seems the most likely option is to see if
the charity falls under 2) corpoartion, trust,
community chest, or foundation. The 4-part test requires that the entity be in the