Income Tax for Bar Exam

Federal Income taxation –MN Essay

Might see it combined with other issues. typically

· Estates and trusts or

· Family law

It will be straightforward issues and round #’s.

Steps to determining tax liability.

1. determine gross income GI
2. subtract “above the line”deductions and exemptions to determine, adjusted gross income or AGI.
3. subtract the standard deduction or itemized deductions to determine taxable income TI.
4. Multiply by tax rate= tentative tax liability
5. subtract any available credits= final tax liability

There are four tax issues.

1. WHAT is income?

2. to WHOM is it income?

3. WHEN is it income?

4. What is the character of the income?

1. WHAT is income?
1. When in doubt it is probably taxable.
2. General

i. Includes any economic benefits or clearly realized profit to your wealth.

ii. A change in the value of asset is not counted until sale or disposition of asset.

iii. Non cash is income if fair market value of any serices.

iv. CLAIM OF RIGHT- when received without restriction of use/disposition must be reported even if might have to return it later.

1. If give back later, then deduct the taxes paid on earlier return (if did).

v. Tax benefit rule. If deduct then recover only the extent of the prior deduction NOT fair market value (if has risen during time).

3. Federal taxes are NOT deductible.
4. State taxes are deductible.
5. Alimony

i. Must be

1. in writing

2. not living together

3. cease at or before death of receiving spouse

4. in cash

ii. then it is taxable to receiving spouse and

1. deductible to giving spouse.

2. Unless otherwise provided

6. Child support

i. NOT taxable

ii. NOT deductible

iii. Is

1. designated in court agreement and

2. specified as “child support” or

3. if payment is reduced upon a contingency relating to a child

a. then the amount of reduction is child support.

7. Child support v. alimony

i. When total payments for alimony and child support falls short. Payments are considered first to meet child support obligation.

8. Prizes and awards

i. Includes winning, treasure trove, etc.

ii. Is income

iii. Taxable EVEN if keep (not sell). If later sell, then get credit for the value paid on taxes.

iv. Bargain purchase rule- taxable at rate of payment (not fair market value)

v. Borrower does not have to include in gross income,

1. but if debt is cancelled or discharged later for less then amount owed, then the difference is taxable.

2. exceptions (RIG)

a. renegotiation/reduction in purchase price (with goods) involves more facts “shouldn’t have been that high”.

b. If Insolvency/bankruptcy ≠ income

c. Gift, ≠ income if lender gives real gift. (usually family)

9. Stock distributions

i. Shareholders taxable on dividends on earnings and profits.

10. EXCLUSIONS

i. Life insurance proceeds-if because of death

ii. Inheritances

iii. Gift – detached, disinterested generosity

iv. Tort awards

1. not if personal injury (not emotional)

2. but punative awards are taxable

v. improvements by lessee

1. unless intended in lieu of rent.

vi. Employee

1. life insurance through EMPLOYER

a. first 50,000

b. value is what costs employer

2. receipts from health and accident insurance

a. premiums employer pays for employee

b. reimbursement

c. coverage

3. meals and lodging

a. excluded if for convenience of EMPLOYER and

b. for in-kind and

c. on employer’s premises

4. other

a. de minimus OK

b. no additional cost to EMPLOYER

c. qualified employee discounts

d. contributions to qualified pension plans

e. employee safety/length of service award.

i. Ceremony and less then 400 bucks.

11. DEDUCTIONS

i. Above the line- ALL

1. ordinary and necessary business expenses

a. Not illegal bribes and kickbacks

2. business interest

3. business taxes

4. business bad debts

5. depreciation

a. for business assets

b. instead spread deduction ove time.

6. capital loss

a. net loss in capital assets,

b. up to 3,000/yr

c. can carry

7. alimony

8. moving expenses (limited)

9. business legal fees

10. legal fees for tax advice

11.

ii. below the line

1. standard or

2. itemized

a. home mortgage interest

i. up to 1,000,000 total

ii. home equity loan up to 100,000

b. state and local taxes

i. not sales tax

c. unreimbursed casualty losses

i. if loss greater then 100

ii. sudden and unexpected

iii. only for amount above 10%.

d. Unreimbursed medical expenses

i. For over 7.5%

e. Charitable contributions

i. Fair market value of stuff and cahs

ii. To qualified charities

iii. NOT SERVICES

iv. NOT TIME

v. Subtract anything in return.

vi. NOT quid pro quo

f. Misc

i. If exceed 2%

1. educational expenses necessary for current trade

2. unreimbursed employee business expense.

ii. Investment fee/expenses necessary to produce taxable income

1. broker fees

2. advertisement expenses

3. settlement expenses

3. exemptions

a. 1 for themselves

b. 1 for each dependent

i. Part of household and more then 50% of financial support.

ii. After divorce, custodial parent (or agreement)

2. to WHOM is it income?
1. Earned income

i. Taxed to who earns (assignment of income rule- CAN”T)

2. Contingent fees/civil litigation

i. Taxable to P (if would have gone through P and then P paid)

ii. Taxable to lawyer as compensation

3. Investment income

i. Taxed to s/he who owns it.

3. WHEN is it income? Accounting
1. CASH

i. Moment of payment

ii. Writing check (date written)

iii. Charge on credit card

2. Constructive receipt

i. Even if no actual receipt still taxable if

1. credited to her account, set apart or

2. otherwise made available so you could draw upon them.

3. Accrual

i. Taxable When all events have occurred to fix right to receive and amount can be determined.

ii. Deduction when all events have occurred to establish fact of liability and when amount can be determined.

4. Gains and losses on disposition of property

i. WHEN sold

ii. WHAT?

1. realization and (amount gotten)

2. recognition (amount reported)

3. Take amount realized – adjusted basis =gain/loss

4. amount realized is what got from sale and

5. adjusted basis is the previously paid taxable amount

a. cost basis rule- basis is acquired by purchase= money paid and borrowing incurred.

iii. Divorce property settlement

1. exception to realized. NOT TAXABLE

2. same basis also transfers. (substituted basis)

3. as if no sale.

4. so appreciation taxed solely to spouse who got it.

iv. Gift

1. same basis is also substituted.

a. Loss exception- if lost, then donor pays fair market value.

v. Inherited property

1. fair market value at death. (stepped up basis)

vi. like-kind exchanges

1. RULE- no gain/no loss when business/investment property swapped.

2. not highly liquid, rather like real estate.

3. basis? Same as old property=substituted.

vii. Involuntary conversion

1. fire, theft, seizure

2. Not gain or loss if converted to similar thing within 2 years.

3. still HAVE realized gain, just no recognition.

viii. Sale of principal residence

1. up to 250 or 500 (if joint) exclude if use and owned as principal for 2 years during last 5.

4. What is the character of the income?
1. Ordinary income

i. Top tax rate is 35%

1. rent

2. salary

3. interest

4. royalties

ii. capital gain top tax is 15%

1. must have held more then one year

2. sale of capital asset

3. investment

4. real estate

5. stock

6. u.s. dividends.

7.