Solution Manual for Prentice Hall's Federal Taxation 2013 Individuals, 26th Edition
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C:1-1
Chapter C:1
Tax Research
Discussion Questions
C:1-1 In a closed-fact situation, the facts have occurred, and the tax advisor’s task is to analyze
them to determine the appropriate tax treatment. In an open-fact situation, by contrast, the facts have
not yet occurred, and the tax advisor’s task is to plan for them or shape them so as to produce a
favorable tax result. p. C:1-2.
C:1-2 According to the AICPA’s Statements on Standards for Tax Services, the tax practitioner
owes the client the following duties: (1) to inform the client of (a) the potential adverse
consequences of a tax return position, (b) how the client can avoid a penalty through disclosure,
(c) errors in a previously filed tax return, and (d) corrective measures to be taken; (2) to inquire of
the client (a) when the client must satisfy conditions to take a deduction and (b) when information
provided by him or her appears incorrect, incomplete, or inconsistent on its face; and (3) not to
disclose tax-related errors without the client’s consent. pp. C:1-32 through C:1-35.
C:1-3 When tax advisors speak about “tax law,” they refer to the IRC as elaborated by Treasury
Regulations and administrative pronouncements and as interpreted by federal courts. The term also
includes the meaning conveyed by committee reports. p. C:1-7.
C:1-4 Committee reports concerning tax legislation explain the purpose behind Congress’
proposing the legislation. Transcripts of hearings reproduce the testimonies of the persons who
spoke for or against the proposed legislation before the Congressional committees. Committee
reports are sometimes used to interpret the statute. p. C:1-7.
C:1-5 Committee reports can help resolve ambiguities in statutory language by revealing
Congressional intent. They are indicative of this intent. pp. C:1-7 and C:1-8.
C:1-6 The Internal Revenue Code of 1986 is updated for every statutory change to Title 26
subsequent to 1986. Therefore, it includes the post-1986 tax law changes enacted by Congress and
today reflects the current state of the law. p. C:1-8.
C:1-7 No. Title 26 deals with all taxation matters, not just income taxation. It covers estate tax,
gift tax, employment tax, alcohol and tobacco tax, and excise tax matters. p. C:1-8.
C:1-8 a. Subsection (c). It discusses the tax treatment of property distributions in general
(e.g., amount taxable, amount applied against basis, and amount exceeding basis).
b. Because Sec. 301 applies to the entire chapter, one should look throughout that entire
chapter (Chapter 1 of the IRC – which covers Sec. 1 through Sec. 1400U-3) for any exceptions. One
special rule – Sec. 301(e) – is found in Sec. 301. This special rule explains the tax treatment of
dividends received by a 20% corporate taxpayer. Section 301(f) indicates some of the important
special rules found in other IRC sections.
Chapter C:1
Tax Research
Discussion Questions
C:1-1 In a closed-fact situation, the facts have occurred, and the tax advisor’s task is to analyze
them to determine the appropriate tax treatment. In an open-fact situation, by contrast, the facts have
not yet occurred, and the tax advisor’s task is to plan for them or shape them so as to produce a
favorable tax result. p. C:1-2.
C:1-2 According to the AICPA’s Statements on Standards for Tax Services, the tax practitioner
owes the client the following duties: (1) to inform the client of (a) the potential adverse
consequences of a tax return position, (b) how the client can avoid a penalty through disclosure,
(c) errors in a previously filed tax return, and (d) corrective measures to be taken; (2) to inquire of
the client (a) when the client must satisfy conditions to take a deduction and (b) when information
provided by him or her appears incorrect, incomplete, or inconsistent on its face; and (3) not to
disclose tax-related errors without the client’s consent. pp. C:1-32 through C:1-35.
C:1-3 When tax advisors speak about “tax law,” they refer to the IRC as elaborated by Treasury
Regulations and administrative pronouncements and as interpreted by federal courts. The term also
includes the meaning conveyed by committee reports. p. C:1-7.
C:1-4 Committee reports concerning tax legislation explain the purpose behind Congress’
proposing the legislation. Transcripts of hearings reproduce the testimonies of the persons who
spoke for or against the proposed legislation before the Congressional committees. Committee
reports are sometimes used to interpret the statute. p. C:1-7.
C:1-5 Committee reports can help resolve ambiguities in statutory language by revealing
Congressional intent. They are indicative of this intent. pp. C:1-7 and C:1-8.
C:1-6 The Internal Revenue Code of 1986 is updated for every statutory change to Title 26
subsequent to 1986. Therefore, it includes the post-1986 tax law changes enacted by Congress and
today reflects the current state of the law. p. C:1-8.
C:1-7 No. Title 26 deals with all taxation matters, not just income taxation. It covers estate tax,
gift tax, employment tax, alcohol and tobacco tax, and excise tax matters. p. C:1-8.
C:1-8 a. Subsection (c). It discusses the tax treatment of property distributions in general
(e.g., amount taxable, amount applied against basis, and amount exceeding basis).
b. Because Sec. 301 applies to the entire chapter, one should look throughout that entire
chapter (Chapter 1 of the IRC – which covers Sec. 1 through Sec. 1400U-3) for any exceptions. One
special rule – Sec. 301(e) – is found in Sec. 301. This special rule explains the tax treatment of
dividends received by a 20% corporate taxpayer. Section 301(f) indicates some of the important
special rules found in other IRC sections.
C:1-1
Chapter C:1
Tax Research
Discussion Questions
C:1-1 In a closed-fact situation, the facts have occurred, and the tax advisor’s task is to analyze
them to determine the appropriate tax treatment. In an open-fact situation, by contrast, the facts have
not yet occurred, and the tax advisor’s task is to plan for them or shape them so as to produce a
favorable tax result. p. C:1-2.
C:1-2 According to the AICPA’s Statements on Standards for Tax Services, the tax practitioner
owes the client the following duties: (1) to inform the client of (a) the potential adverse
consequences of a tax return position, (b) how the client can avoid a penalty through disclosure,
(c) errors in a previously filed tax return, and (d) corrective measures to be taken; (2) to inquire of
the client (a) when the client must satisfy conditions to take a deduction and (b) when information
provided by him or her appears incorrect, incomplete, or inconsistent on its face; and (3) not to
disclose tax-related errors without the client’s consent. pp. C:1-32 through C:1-35.
C:1-3 When tax advisors speak about “tax law,” they refer to the IRC as elaborated by Treasury
Regulations and administrative pronouncements and as interpreted by federal courts. The term also
includes the meaning conveyed by committee reports. p. C:1-7.
C:1-4 Committee reports concerning tax legislation explain the purpose behind Congress’
proposing the legislation. Transcripts of hearings reproduce the testimonies of the persons who
spoke for or against the proposed legislation before the Congressional committees. Committee
reports are sometimes used to interpret the statute. p. C:1-7.
C:1-5 Committee reports can help resolve ambiguities in statutory language by revealing
Congressional intent. They are indicative of this intent. pp. C:1-7 and C:1-8.
C:1-6 The Internal Revenue Code of 1986 is updated for every statutory change to Title 26
subsequent to 1986. Therefore, it includes the post-1986 tax law changes enacted by Congress and
today reflects the current state of the law. p. C:1-8.
C:1-7 No. Title 26 deals with all taxation matters, not just income taxation. It covers estate tax,
gift tax, employment tax, alcohol and tobacco tax, and excise tax matters. p. C:1-8.
C:1-8 a. Subsection (c). It discusses the tax treatment of property distributions in general
(e.g., amount taxable, amount applied against basis, and amount exceeding basis).
b. Because Sec. 301 applies to the entire chapter, one should look throughout that entire
chapter (Chapter 1 of the IRC – which covers Sec. 1 through Sec. 1400U-3) for any exceptions. One
special rule – Sec. 301(e) – is found in Sec. 301. This special rule explains the tax treatment of
dividends received by a 20% corporate taxpayer. Section 301(f) indicates some of the important
special rules found in other IRC sections.
Chapter C:1
Tax Research
Discussion Questions
C:1-1 In a closed-fact situation, the facts have occurred, and the tax advisor’s task is to analyze
them to determine the appropriate tax treatment. In an open-fact situation, by contrast, the facts have
not yet occurred, and the tax advisor’s task is to plan for them or shape them so as to produce a
favorable tax result. p. C:1-2.
C:1-2 According to the AICPA’s Statements on Standards for Tax Services, the tax practitioner
owes the client the following duties: (1) to inform the client of (a) the potential adverse
consequences of a tax return position, (b) how the client can avoid a penalty through disclosure,
(c) errors in a previously filed tax return, and (d) corrective measures to be taken; (2) to inquire of
the client (a) when the client must satisfy conditions to take a deduction and (b) when information
provided by him or her appears incorrect, incomplete, or inconsistent on its face; and (3) not to
disclose tax-related errors without the client’s consent. pp. C:1-32 through C:1-35.
C:1-3 When tax advisors speak about “tax law,” they refer to the IRC as elaborated by Treasury
Regulations and administrative pronouncements and as interpreted by federal courts. The term also
includes the meaning conveyed by committee reports. p. C:1-7.
C:1-4 Committee reports concerning tax legislation explain the purpose behind Congress’
proposing the legislation. Transcripts of hearings reproduce the testimonies of the persons who
spoke for or against the proposed legislation before the Congressional committees. Committee
reports are sometimes used to interpret the statute. p. C:1-7.
C:1-5 Committee reports can help resolve ambiguities in statutory language by revealing
Congressional intent. They are indicative of this intent. pp. C:1-7 and C:1-8.
C:1-6 The Internal Revenue Code of 1986 is updated for every statutory change to Title 26
subsequent to 1986. Therefore, it includes the post-1986 tax law changes enacted by Congress and
today reflects the current state of the law. p. C:1-8.
C:1-7 No. Title 26 deals with all taxation matters, not just income taxation. It covers estate tax,
gift tax, employment tax, alcohol and tobacco tax, and excise tax matters. p. C:1-8.
C:1-8 a. Subsection (c). It discusses the tax treatment of property distributions in general
(e.g., amount taxable, amount applied against basis, and amount exceeding basis).
b. Because Sec. 301 applies to the entire chapter, one should look throughout that entire
chapter (Chapter 1 of the IRC – which covers Sec. 1 through Sec. 1400U-3) for any exceptions. One
special rule – Sec. 301(e) – is found in Sec. 301. This special rule explains the tax treatment of
dividends received by a 20% corporate taxpayer. Section 301(f) indicates some of the important
special rules found in other IRC sections.
C:1-2
c. Legislative. Section 301(e)(4) authorizes the issuance of Treasury Regulations as
may be necessary to carry out the purposes of the subsection. pp. C:1-9 through C:1-10.
C:1-9 Researchers should note the date on which a Treasury Regulation was adopted because the
IRC may have been revised subsequent to that date. That is, the regulation may not interpret
the current version of the IRC. Discrepancies between the IRC and the regulation occur when the
Treasury Department has not updated the regulation to reflect the statute as amended. p. C:1-9.
C:1-10 a. Proposed regulations are not authoritative, but they do provide guidance concerning
how the Treasury Department interprets the IRC. Temporary regulations, which are binding on the
taxpayer, often are issued after recent revisions to the IRC so that taxpayers and tax advisers will
have guidance concerning procedural and/or computational matters. Final regulations, which are
issued after the public has had time to comment on proposed regulations, are considered to be
somewhat more authoritative than temporary regulations. pp. C:1-9 and C:1-10.
b. Interpretative regulations make the IRC’s statutory language easier to understand and
apply. They also often provide computational illustrations. In the case of legislative regulations,
Congress has delegated the rulemaking on a specific topic (either narrow or broad) to the Treasury
Department. However, after the Mayo Foundation case, both types of regulations will have the same
authoritative weight. p. C:1-10.
C:1-11 Legislative. In the past, it was more difficult for a taxpayer to successfully challenge this type
of regulation because Congress has delegated its rulemaking authority to the Treasury Department.
However, after the Mayo Foundation case, both types of regulations will have the same authoritative
weight. p. C:1-10.
C:1-12 Under the legislative reenactment doctrine, a Treasury Regulation is deemed to have been
endorsed by Congress if the regulation was finalized before a related IRC provision was enacted and
in the interim, Congress did not amend the statutory provision to which the regulation relates.
p. C:1-10.
C:1-13 a. Revenue rulings are not as authoritative as court opinions, Treasury Regulations, or
the IRC. They represent interpretations by an interested party, the IRS. p. C:1-12.
b. If the IRS audits the taxpayer’s return, the IRS likely will contend that the taxpayer
should have followed the ruling and, therefore, owes a deficiency. p. C:1-12.
C:1-14 a. The Tax Court, the U.S. Court of Federal Claims, or the U.S. district court for the
taxpayer’s jurisdiction. p. C:1-14.
b. The taxpayer might consider the precedent, if any, existing within each jurisdiction.
The taxpayer might prefer to avoid expending cash to pay the proposed deficiency. If so, the
taxpayer would want to litigate in the Tax Court. If the taxpayer would like to have a jury trial
address questions of fact, he or she should opt for the U.S. district court. pp. C:1-14 through C:1-19,
p. C:1-21, and p. C:1-23.
c. Appeals from Tax Court and U.S. district court decisions are made to the circuit court
of appeals for the taxpayer’s geographical jurisdiction. U.S. Court of Federal Claims decisions are
appealable to the Court of Appeals for the Federal Circuit. Appeals from any of the circuit courts of
appeals may be brought to the U. S. Supreme Court. pp. C:1-20 through C:1-21.
c. Legislative. Section 301(e)(4) authorizes the issuance of Treasury Regulations as
may be necessary to carry out the purposes of the subsection. pp. C:1-9 through C:1-10.
C:1-9 Researchers should note the date on which a Treasury Regulation was adopted because the
IRC may have been revised subsequent to that date. That is, the regulation may not interpret
the current version of the IRC. Discrepancies between the IRC and the regulation occur when the
Treasury Department has not updated the regulation to reflect the statute as amended. p. C:1-9.
C:1-10 a. Proposed regulations are not authoritative, but they do provide guidance concerning
how the Treasury Department interprets the IRC. Temporary regulations, which are binding on the
taxpayer, often are issued after recent revisions to the IRC so that taxpayers and tax advisers will
have guidance concerning procedural and/or computational matters. Final regulations, which are
issued after the public has had time to comment on proposed regulations, are considered to be
somewhat more authoritative than temporary regulations. pp. C:1-9 and C:1-10.
b. Interpretative regulations make the IRC’s statutory language easier to understand and
apply. They also often provide computational illustrations. In the case of legislative regulations,
Congress has delegated the rulemaking on a specific topic (either narrow or broad) to the Treasury
Department. However, after the Mayo Foundation case, both types of regulations will have the same
authoritative weight. p. C:1-10.
C:1-11 Legislative. In the past, it was more difficult for a taxpayer to successfully challenge this type
of regulation because Congress has delegated its rulemaking authority to the Treasury Department.
However, after the Mayo Foundation case, both types of regulations will have the same authoritative
weight. p. C:1-10.
C:1-12 Under the legislative reenactment doctrine, a Treasury Regulation is deemed to have been
endorsed by Congress if the regulation was finalized before a related IRC provision was enacted and
in the interim, Congress did not amend the statutory provision to which the regulation relates.
p. C:1-10.
C:1-13 a. Revenue rulings are not as authoritative as court opinions, Treasury Regulations, or
the IRC. They represent interpretations by an interested party, the IRS. p. C:1-12.
b. If the IRS audits the taxpayer’s return, the IRS likely will contend that the taxpayer
should have followed the ruling and, therefore, owes a deficiency. p. C:1-12.
C:1-14 a. The Tax Court, the U.S. Court of Federal Claims, or the U.S. district court for the
taxpayer’s jurisdiction. p. C:1-14.
b. The taxpayer might consider the precedent, if any, existing within each jurisdiction.
The taxpayer might prefer to avoid expending cash to pay the proposed deficiency. If so, the
taxpayer would want to litigate in the Tax Court. If the taxpayer would like to have a jury trial
address questions of fact, he or she should opt for the U.S. district court. pp. C:1-14 through C:1-19,
p. C:1-21, and p. C:1-23.
c. Appeals from Tax Court and U.S. district court decisions are made to the circuit court
of appeals for the taxpayer’s geographical jurisdiction. U.S. Court of Federal Claims decisions are
appealable to the Court of Appeals for the Federal Circuit. Appeals from any of the circuit courts of
appeals may be brought to the U. S. Supreme Court. pp. C:1-20 through C:1-21.
C:1-2
c. Legislative. Section 301(e)(4) authorizes the issuance of Treasury Regulations as
may be necessary to carry out the purposes of the subsection. pp. C:1-9 through C:1-10.
C:1-9 Researchers should note the date on which a Treasury Regulation was adopted because the
IRC may have been revised subsequent to that date. That is, the regulation may not interpret
the current version of the IRC. Discrepancies between the IRC and the regulation occur when the
Treasury Department has not updated the regulation to reflect the statute as amended. p. C:1-9.
C:1-10 a. Proposed regulations are not authoritative, but they do provide guidance concerning
how the Treasury Department interprets the IRC. Temporary regulations, which are binding on the
taxpayer, often are issued after recent revisions to the IRC so that taxpayers and tax advisers will
have guidance concerning procedural and/or computational matters. Final regulations, which are
issued after the public has had time to comment on proposed regulations, are considered to be
somewhat more authoritative than temporary regulations. pp. C:1-9 and C:1-10.
b. Interpretative regulations make the IRC’s statutory language easier to understand and
apply. They also often provide computational illustrations. In the case of legislative regulations,
Congress has delegated the rulemaking on a specific topic (either narrow or broad) to the Treasury
Department. However, after the Mayo Foundation case, both types of regulations will have the same
authoritative weight. p. C:1-10.
C:1-11 Legislative. In the past, it was more difficult for a taxpayer to successfully challenge this type
of regulation because Congress has delegated its rulemaking authority to the Treasury Department.
However, after the Mayo Foundation case, both types of regulations will have the same authoritative
weight. p. C:1-10.
C:1-12 Under the legislative reenactment doctrine, a Treasury Regulation is deemed to have been
endorsed by Congress if the regulation was finalized before a related IRC provision was enacted and
in the interim, Congress did not amend the statutory provision to which the regulation relates.
p. C:1-10.
C:1-13 a. Revenue rulings are not as authoritative as court opinions, Treasury Regulations, or
the IRC. They represent interpretations by an interested party, the IRS. p. C:1-12.
b. If the IRS audits the taxpayer’s return, the IRS likely will contend that the taxpayer
should have followed the ruling and, therefore, owes a deficiency. p. C:1-12.
C:1-14 a. The Tax Court, the U.S. Court of Federal Claims, or the U.S. district court for the
taxpayer’s jurisdiction. p. C:1-14.
b. The taxpayer might consider the precedent, if any, existing within each jurisdiction.
The taxpayer might prefer to avoid expending cash to pay the proposed deficiency. If so, the
taxpayer would want to litigate in the Tax Court. If the taxpayer would like to have a jury trial
address questions of fact, he or she should opt for the U.S. district court. pp. C:1-14 through C:1-19,
p. C:1-21, and p. C:1-23.
c. Appeals from Tax Court and U.S. district court decisions are made to the circuit court
of appeals for the taxpayer’s geographical jurisdiction. U.S. Court of Federal Claims decisions are
appealable to the Court of Appeals for the Federal Circuit. Appeals from any of the circuit courts of
appeals may be brought to the U. S. Supreme Court. pp. C:1-20 through C:1-21.
c. Legislative. Section 301(e)(4) authorizes the issuance of Treasury Regulations as
may be necessary to carry out the purposes of the subsection. pp. C:1-9 through C:1-10.
C:1-9 Researchers should note the date on which a Treasury Regulation was adopted because the
IRC may have been revised subsequent to that date. That is, the regulation may not interpret
the current version of the IRC. Discrepancies between the IRC and the regulation occur when the
Treasury Department has not updated the regulation to reflect the statute as amended. p. C:1-9.
C:1-10 a. Proposed regulations are not authoritative, but they do provide guidance concerning
how the Treasury Department interprets the IRC. Temporary regulations, which are binding on the
taxpayer, often are issued after recent revisions to the IRC so that taxpayers and tax advisers will
have guidance concerning procedural and/or computational matters. Final regulations, which are
issued after the public has had time to comment on proposed regulations, are considered to be
somewhat more authoritative than temporary regulations. pp. C:1-9 and C:1-10.
b. Interpretative regulations make the IRC’s statutory language easier to understand and
apply. They also often provide computational illustrations. In the case of legislative regulations,
Congress has delegated the rulemaking on a specific topic (either narrow or broad) to the Treasury
Department. However, after the Mayo Foundation case, both types of regulations will have the same
authoritative weight. p. C:1-10.
C:1-11 Legislative. In the past, it was more difficult for a taxpayer to successfully challenge this type
of regulation because Congress has delegated its rulemaking authority to the Treasury Department.
However, after the Mayo Foundation case, both types of regulations will have the same authoritative
weight. p. C:1-10.
C:1-12 Under the legislative reenactment doctrine, a Treasury Regulation is deemed to have been
endorsed by Congress if the regulation was finalized before a related IRC provision was enacted and
in the interim, Congress did not amend the statutory provision to which the regulation relates.
p. C:1-10.
C:1-13 a. Revenue rulings are not as authoritative as court opinions, Treasury Regulations, or
the IRC. They represent interpretations by an interested party, the IRS. p. C:1-12.
b. If the IRS audits the taxpayer’s return, the IRS likely will contend that the taxpayer
should have followed the ruling and, therefore, owes a deficiency. p. C:1-12.
C:1-14 a. The Tax Court, the U.S. Court of Federal Claims, or the U.S. district court for the
taxpayer’s jurisdiction. p. C:1-14.
b. The taxpayer might consider the precedent, if any, existing within each jurisdiction.
The taxpayer might prefer to avoid expending cash to pay the proposed deficiency. If so, the
taxpayer would want to litigate in the Tax Court. If the taxpayer would like to have a jury trial
address questions of fact, he or she should opt for the U.S. district court. pp. C:1-14 through C:1-19,
p. C:1-21, and p. C:1-23.
c. Appeals from Tax Court and U.S. district court decisions are made to the circuit court
of appeals for the taxpayer’s geographical jurisdiction. U.S. Court of Federal Claims decisions are
appealable to the Court of Appeals for the Federal Circuit. Appeals from any of the circuit courts of
appeals may be brought to the U. S. Supreme Court. pp. C:1-20 through C:1-21.
C:1-3
C:1-15 No. A taxpayer may not appeal a case litigated under the Tax Court’s Small Cases
Procedure. p. C:1-17.
C:1-16 Tax Court regular and memo decisions have about the same precedential value. Decisions
issued under the Small Cases Procedure of the Tax Court have little or no precedential value.
pp. C:1-15 and C:1-17.
C:1-17 Yes. The IRS can acquiesce (or nonacquiesce) in any federal court decision that is adverse to
the IRS if the IRS decides to do so. In many cases the IRS does not acquiesce or nonacquiesce.
p. C:1-17.
C:1-18 In both the AFTR and USTC: decisions of U.S. district courts, U.S. bankruptcy courts, U.S.
Court of Federal Claims, circuit courts of appeal, and the U.S. Supreme Court. Tax Court decisions
are reported in neither of the two reporters. pp. C:1-16 and C:1-17 through C:1-22.
C:1-19 When first issued, revenue rulings appear in the weekly Internal Revenue Bulletin (I.R.B.).
Twice each year, the decisions published in the I.R.B. are bound together and published in the
Cumulative Bulletin (C.B.). The I.R.B. citation is appropriate only until the ruling is published in
the C.B. p. C:1-12.
C:1-20 According to the Golsen Rule, the Tax Court will not follow a decision it made earlier, but
rather will follow a decision of the circuit court of appeals to which the case under consideration is
appealable. As an example, assume that the Tax Court, in a case involving a First Circuit taxpayer,
ruled for the taxpayer. The issue had not been litigated earlier. Then, a U.S. district court in Georgia
decided a case involving the same issue in favor of another taxpayer. The Eleventh Circuit,
however, reversed the decision. Now a taxpayer from the Eleventh Circuit litigates the same issue in
the Tax Court. Under the Golsen Rule, the Tax Court will follow the Eleventh Circuit’s decision
favoring the government. The Tax Court need not follow an appeals court decision if a case was
litigated by a taxpayer whose appeal would have been made to any circuit other than the Eleventh.
p. C:1-21.
C:1-21 a. The precedent binding upon a California taxpayer would be the Tax Court case.
The Tax Court has national jurisdiction. pp. C:1-21 and C:1-23.
b. Under the Golsen Rule, the Tax Court will depart from its earlier decision and follow
the Fifth Circuit’s decision favoring the government. p. C:1-21.
C:1-22 a. Congressional Record
b. Internal Revenue Bulletin
c. Tax Court of the United States Reports
d. Federal Register, Internal Revenue Bulletin, and/or Cumulative Bulletin
e. Federal Supplement, American Federal Tax Reports (only tax-related), United States
Tax Cases (only tax-related).
f. Not found in an “official” publication; published by tax services
pp. C:1-7, C:1-12 through C:1-14, and C:1-17 through C:1-19.
C:1-15 No. A taxpayer may not appeal a case litigated under the Tax Court’s Small Cases
Procedure. p. C:1-17.
C:1-16 Tax Court regular and memo decisions have about the same precedential value. Decisions
issued under the Small Cases Procedure of the Tax Court have little or no precedential value.
pp. C:1-15 and C:1-17.
C:1-17 Yes. The IRS can acquiesce (or nonacquiesce) in any federal court decision that is adverse to
the IRS if the IRS decides to do so. In many cases the IRS does not acquiesce or nonacquiesce.
p. C:1-17.
C:1-18 In both the AFTR and USTC: decisions of U.S. district courts, U.S. bankruptcy courts, U.S.
Court of Federal Claims, circuit courts of appeal, and the U.S. Supreme Court. Tax Court decisions
are reported in neither of the two reporters. pp. C:1-16 and C:1-17 through C:1-22.
C:1-19 When first issued, revenue rulings appear in the weekly Internal Revenue Bulletin (I.R.B.).
Twice each year, the decisions published in the I.R.B. are bound together and published in the
Cumulative Bulletin (C.B.). The I.R.B. citation is appropriate only until the ruling is published in
the C.B. p. C:1-12.
C:1-20 According to the Golsen Rule, the Tax Court will not follow a decision it made earlier, but
rather will follow a decision of the circuit court of appeals to which the case under consideration is
appealable. As an example, assume that the Tax Court, in a case involving a First Circuit taxpayer,
ruled for the taxpayer. The issue had not been litigated earlier. Then, a U.S. district court in Georgia
decided a case involving the same issue in favor of another taxpayer. The Eleventh Circuit,
however, reversed the decision. Now a taxpayer from the Eleventh Circuit litigates the same issue in
the Tax Court. Under the Golsen Rule, the Tax Court will follow the Eleventh Circuit’s decision
favoring the government. The Tax Court need not follow an appeals court decision if a case was
litigated by a taxpayer whose appeal would have been made to any circuit other than the Eleventh.
p. C:1-21.
C:1-21 a. The precedent binding upon a California taxpayer would be the Tax Court case.
The Tax Court has national jurisdiction. pp. C:1-21 and C:1-23.
b. Under the Golsen Rule, the Tax Court will depart from its earlier decision and follow
the Fifth Circuit’s decision favoring the government. p. C:1-21.
C:1-22 a. Congressional Record
b. Internal Revenue Bulletin
c. Tax Court of the United States Reports
d. Federal Register, Internal Revenue Bulletin, and/or Cumulative Bulletin
e. Federal Supplement, American Federal Tax Reports (only tax-related), United States
Tax Cases (only tax-related).
f. Not found in an “official” publication; published by tax services
pp. C:1-7, C:1-12 through C:1-14, and C:1-17 through C:1-19.
C:1-4
C:1-23 A tax advisor might find the provisions of a tax treaty useful where a U.S. taxpayer engages
in transactions in a foreign country. The United States has tax treaties with over 55 countries.
p. C:1-24.
C:1-24 Citators (1) trace the history of the case in question and (2) list other authorities that have
cited such case. p. C:1-30.
C:1-25 First, CHECKPOINT lists all citing cases and not just those that the editors believe will serve
as precedent. Second, CHECKPOINT indicates how the case in question was cited (favorably,
unfavorably, distinguished, etc.). p. C:1-30.
C:1-26 Keyword, index, citation, or content are the four ways to search in CHECKPOINT and
INTELLICONNECT databases. p. C:1-27.
C:1-27 a. The principal primary sources found in both INTELLICONNECT and
CHECKPOINT are as follows:
• IRC
• Treasury Regulations
• Court opinions
• Revenue rulings and procedures
• Letter rulings
• Committee reports
• Tax treaties
b. The principal secondary sources found in INTELLICONNECT are as follows:
• Standard Federal Income Tax Reporter
• Federal Estate and Gift Tax Reporter
• Federal Excise Tax Reporter
• Tax Treaties Reporter
• Master Tax Guide
The principal secondary sources found in CHECKPOINT are as follows:
• Federal Tax Coordinator
• United States Tax Reporter
• RIA Federal Tax Handbook
• Warren, Gorham & Lamont journals and treatises
pp. C:1-26 through C:1-29.
C:1-28 The features (i.e., icons, templates, and command buttons) will vary depending upon the
particular tax service/Internet site accessed. Just about all commercial tax databases can be searched
by keyword and citation. Some can be searched by table of contents and topic. Most
noncommercial tax databases can be searched by keyword. Some can be searched by citation and
table of contents.
The advantages of using a commercial tax service (as opposed to a noncommercial service)
are broader database scope, greater historical coverage, and more efficient search engines. The
principal disadvantage is cost.
C:1-23 A tax advisor might find the provisions of a tax treaty useful where a U.S. taxpayer engages
in transactions in a foreign country. The United States has tax treaties with over 55 countries.
p. C:1-24.
C:1-24 Citators (1) trace the history of the case in question and (2) list other authorities that have
cited such case. p. C:1-30.
C:1-25 First, CHECKPOINT lists all citing cases and not just those that the editors believe will serve
as precedent. Second, CHECKPOINT indicates how the case in question was cited (favorably,
unfavorably, distinguished, etc.). p. C:1-30.
C:1-26 Keyword, index, citation, or content are the four ways to search in CHECKPOINT and
INTELLICONNECT databases. p. C:1-27.
C:1-27 a. The principal primary sources found in both INTELLICONNECT and
CHECKPOINT are as follows:
• IRC
• Treasury Regulations
• Court opinions
• Revenue rulings and procedures
• Letter rulings
• Committee reports
• Tax treaties
b. The principal secondary sources found in INTELLICONNECT are as follows:
• Standard Federal Income Tax Reporter
• Federal Estate and Gift Tax Reporter
• Federal Excise Tax Reporter
• Tax Treaties Reporter
• Master Tax Guide
The principal secondary sources found in CHECKPOINT are as follows:
• Federal Tax Coordinator
• United States Tax Reporter
• RIA Federal Tax Handbook
• Warren, Gorham & Lamont journals and treatises
pp. C:1-26 through C:1-29.
C:1-28 The features (i.e., icons, templates, and command buttons) will vary depending upon the
particular tax service/Internet site accessed. Just about all commercial tax databases can be searched
by keyword and citation. Some can be searched by table of contents and topic. Most
noncommercial tax databases can be searched by keyword. Some can be searched by citation and
table of contents.
The advantages of using a commercial tax service (as opposed to a noncommercial service)
are broader database scope, greater historical coverage, and more efficient search engines. The
principal disadvantage is cost.
C:1-5
Because of their relative disadvantages, the noncommercial sites should not be regarded as a
substitute for a commercial tax service. Access is non-uniform. The scope and breadth of their
databases are limited. pp. C:1-26 through C:1-28.
C:1-29 The CPA should have a good faith belief that his or her position has a realistic possibility of
being sustained administratively or judicially on its merits if challenged. p. C:1-33.
C:1-30 Under the AICPA’s Statements on Standards for Tax Services (SSTSs), a tax preparer is not
obligated (1) to verify client provided information if the information is not suspicious on its face and
(2) to update professional advice based on developments following its original conveyance. pp. C:1-
33 and C:1-34.
C:1-31 The two primary classifications of written advice under Circular 230 are (1) covered opinions
and (2) other written advice. A covered opinion refers to tax advice rendered on a tax shelter type
transaction the IRS has identified (listed) as having a tax avoidance purpose. The Treasury
Department proposed changes to these rules in 2012. C:1-32.
C:1-32 Circular 230 is a government issued document that dictates rules for practicing before the
IRS. The Statements on Standards for Tax Services (SSTSs) are ethical standards issued by the
AICPA aimed at tax practitioners. Circular 230 applies only to federal tax issues, and the SSTSs
apply to both federal and state issues. Circular 230 only applies to income taxes, and the SSTSs
apply to all types of taxes. Finally, Circular 230 does not provide the same depth of ethical guidance
found in the SSTSs. p. C:1-32.
Problems
C:1-33 a. Yes. According to Secs. 71(a) and (b), the wife includes $25,000 per year. Also, the
divorce agreement must explicitly state that the husband has no liability to make payments after the
wife’s death. See Sec. 71(b)(1)(D) and Temp. Reg. Sec. 1.71-1T(b), Q-11.
b. Yes. The husband deducts $25,000 per year according to Secs. 215(a) and
(b). According to Sec. 62(a)(10), the alimony is deductible for AGI. pp. C:1-8 and C:1-26 through
C:1-29.
C:1-34 a. Legislative. According to Sec. 385(a), “The Secretary is authorized to prescribe such
regulations as may be necessary or appropriate. . . .”
b. Yes. Section 385(a) states that the regulations will be applicable “for purposes of this
title.” “This title” is Title 26 of the federal statutes. Because Title 26 encompasses all tax statutes,
the regulations would be relevant for estate tax purposes. pp. C:1-8 through C:1-10 and C:1-26
through C:1-29.
C:1-35 a. Both rulings hold that contributions to a fund formed to acquire a portrait of a former
judge and donated to a governmental agency are deductible under Sec. 170. p. C:1-29.
b. Private letter rulings cannot be cited as precedence and apply only to the taxpayer for
whom the IRS issued the ruling. pp. C:1-12 and C:1-13.
c. Revenue rulings can be cited as precedence, and they are relied on by both taxpayers
and the IRS for guidance in particular factual situations. pp. C:1-12 and C:1-13.
Because of their relative disadvantages, the noncommercial sites should not be regarded as a
substitute for a commercial tax service. Access is non-uniform. The scope and breadth of their
databases are limited. pp. C:1-26 through C:1-28.
C:1-29 The CPA should have a good faith belief that his or her position has a realistic possibility of
being sustained administratively or judicially on its merits if challenged. p. C:1-33.
C:1-30 Under the AICPA’s Statements on Standards for Tax Services (SSTSs), a tax preparer is not
obligated (1) to verify client provided information if the information is not suspicious on its face and
(2) to update professional advice based on developments following its original conveyance. pp. C:1-
33 and C:1-34.
C:1-31 The two primary classifications of written advice under Circular 230 are (1) covered opinions
and (2) other written advice. A covered opinion refers to tax advice rendered on a tax shelter type
transaction the IRS has identified (listed) as having a tax avoidance purpose. The Treasury
Department proposed changes to these rules in 2012. C:1-32.
C:1-32 Circular 230 is a government issued document that dictates rules for practicing before the
IRS. The Statements on Standards for Tax Services (SSTSs) are ethical standards issued by the
AICPA aimed at tax practitioners. Circular 230 applies only to federal tax issues, and the SSTSs
apply to both federal and state issues. Circular 230 only applies to income taxes, and the SSTSs
apply to all types of taxes. Finally, Circular 230 does not provide the same depth of ethical guidance
found in the SSTSs. p. C:1-32.
Problems
C:1-33 a. Yes. According to Secs. 71(a) and (b), the wife includes $25,000 per year. Also, the
divorce agreement must explicitly state that the husband has no liability to make payments after the
wife’s death. See Sec. 71(b)(1)(D) and Temp. Reg. Sec. 1.71-1T(b), Q-11.
b. Yes. The husband deducts $25,000 per year according to Secs. 215(a) and
(b). According to Sec. 62(a)(10), the alimony is deductible for AGI. pp. C:1-8 and C:1-26 through
C:1-29.
C:1-34 a. Legislative. According to Sec. 385(a), “The Secretary is authorized to prescribe such
regulations as may be necessary or appropriate. . . .”
b. Yes. Section 385(a) states that the regulations will be applicable “for purposes of this
title.” “This title” is Title 26 of the federal statutes. Because Title 26 encompasses all tax statutes,
the regulations would be relevant for estate tax purposes. pp. C:1-8 through C:1-10 and C:1-26
through C:1-29.
C:1-35 a. Both rulings hold that contributions to a fund formed to acquire a portrait of a former
judge and donated to a governmental agency are deductible under Sec. 170. p. C:1-29.
b. Private letter rulings cannot be cited as precedence and apply only to the taxpayer for
whom the IRS issued the ruling. pp. C:1-12 and C:1-13.
c. Revenue rulings can be cited as precedence, and they are relied on by both taxpayers
and the IRS for guidance in particular factual situations. pp. C:1-12 and C:1-13.
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C:1-6
C:1-36 Sections 355 and 856. The official IRS publication is the Internal Revenue Bulletin, which
eventually is incorporated into the Cumulative Bulletin. pp. C:1-12 and C:1-29.
C:1-37 Results might vary as the service adds or deleted documents, but as of this writing:
a. 54.
b. 25.
c. 14.
d. The program default presents results sorted by IRC section, and in this case those
results listed first are not on point. However, when sorted by relevance, the very first result
addresses expenses related to a home office deduction. The effect is similar to using Boolean
connectors. pp. C:1-26 through C:1-28.
C:1-38 Results might vary as the service adds or deleted documents, but as of this writing:
a. 50.
b. 1.
c. In Part a, the search engine uses the thesaurus to include in the search other terms for
home. Because most tax documents do not use the term home, limiting the search results to only
those documents including “home sale” is not ideal. The researcher will not see the majority of
documents relevant to the search question. The one result is fortunate, and provides a general
answer, but if the student needs clarification, those documents are not presented.
d. Principle residence. pp. C:1-26 through C:1-28.
C:1-39 a. Acquiescence. See AOD 1986-030, 1986-1 C.B. 1.
b. No. The acquiescence was only with respect to whether a transfer to the taxpayer’s
spouse is a taxable disposition. pp. C:1-17 and C:1-29.
C:1-40 a. Acquiescence. See 1953-1 C.B. 6.
b. Partial. It dealt with sales taxes.
c. Yes. In 1981, he withdrew the acquiescence on the issue of sales tax deduction and
nonacquiesced (see AOD 1981-184, 1981-2 C.B. 3). pp. C:1-17 and C:1-29.
C:1-41 a. Nonacquiescence. See AOD 1988-014, 1988-2 C.B.1.
b. Yes. In 2003, the Commissioner withdrew the 1988 AOD and acquiesced. See AOD
2003-001, 2003-2 I.R.B.
C:1-42 a. Yes. The case was reviewed by the court. No. It was not a unanimous decision.
Judges Korner, Swift, and Gerber did not participate. Judge Simpson dissented. pp. C:1-26 through
C:1-29.
b. Yes. The decision was entered under Rule 155. p. C:1-17.
c. Yes. The case was reviewed by the Sixth Circuit Court of Appeals. pp. C:1-30 and
C:1-31.
C:1-43 a. Yes. The case was reviewed by the court. The decision was not unanimous. Judge
Quealy dissented. Judge Tannenwald issued a concurring opinion with which five judges agreed.
Judge Chabot issued a dissenting opinion with which three judges agreed, and Judge Nims issued a
dissenting opinion with which three judges agreed. pp. C:1-26 through C:1-29.
C:1-36 Sections 355 and 856. The official IRS publication is the Internal Revenue Bulletin, which
eventually is incorporated into the Cumulative Bulletin. pp. C:1-12 and C:1-29.
C:1-37 Results might vary as the service adds or deleted documents, but as of this writing:
a. 54.
b. 25.
c. 14.
d. The program default presents results sorted by IRC section, and in this case those
results listed first are not on point. However, when sorted by relevance, the very first result
addresses expenses related to a home office deduction. The effect is similar to using Boolean
connectors. pp. C:1-26 through C:1-28.
C:1-38 Results might vary as the service adds or deleted documents, but as of this writing:
a. 50.
b. 1.
c. In Part a, the search engine uses the thesaurus to include in the search other terms for
home. Because most tax documents do not use the term home, limiting the search results to only
those documents including “home sale” is not ideal. The researcher will not see the majority of
documents relevant to the search question. The one result is fortunate, and provides a general
answer, but if the student needs clarification, those documents are not presented.
d. Principle residence. pp. C:1-26 through C:1-28.
C:1-39 a. Acquiescence. See AOD 1986-030, 1986-1 C.B. 1.
b. No. The acquiescence was only with respect to whether a transfer to the taxpayer’s
spouse is a taxable disposition. pp. C:1-17 and C:1-29.
C:1-40 a. Acquiescence. See 1953-1 C.B. 6.
b. Partial. It dealt with sales taxes.
c. Yes. In 1981, he withdrew the acquiescence on the issue of sales tax deduction and
nonacquiesced (see AOD 1981-184, 1981-2 C.B. 3). pp. C:1-17 and C:1-29.
C:1-41 a. Nonacquiescence. See AOD 1988-014, 1988-2 C.B.1.
b. Yes. In 2003, the Commissioner withdrew the 1988 AOD and acquiesced. See AOD
2003-001, 2003-2 I.R.B.
C:1-42 a. Yes. The case was reviewed by the court. No. It was not a unanimous decision.
Judges Korner, Swift, and Gerber did not participate. Judge Simpson dissented. pp. C:1-26 through
C:1-29.
b. Yes. The decision was entered under Rule 155. p. C:1-17.
c. Yes. The case was reviewed by the Sixth Circuit Court of Appeals. pp. C:1-30 and
C:1-31.
C:1-43 a. Yes. The case was reviewed by the court. The decision was not unanimous. Judge
Quealy dissented. Judge Tannenwald issued a concurring opinion with which five judges agreed.
Judge Chabot issued a dissenting opinion with which three judges agreed, and Judge Nims issued a
dissenting opinion with which three judges agreed. pp. C:1-26 through C:1-29.
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C:1-7
b. No. The decision was not entered under Rule 155. p. C:1-17.
c. Yes. The case was reviewed by the Sixth Circuit Court of Appeals in 1982. pp. C:1-30
and C:1-31.
C:1-44 a. National Cash Register Co. v. U.S., 400 F.2d 820, 22 AFTR 2d 5562, 68-2 USTC
¶9576 (6th Cir., 1968).
b. Thomas M. Dragoun, 1984 RIA T.C. Memo ¶84,094 (T.C. Memo 1984-94), 47 TCM
1176.
c. U.S. v. John M. Grabinski, 558 F. Supp. 1324, 52 AFTR 2d 83-5169, 83-2 USTC
¶9460 (DC MN, 1983).
d. U.S. v. John M. Grabinski, 727 F.2d 681, 53 AFTR 2d 84-710, 84-1 USTC ¶9201
(8th Cir., 1984).
e. Rebekah Harkness v. U.S., 469 F.2d 310, 30 AFTR 2d 72-5754, 72-2 USTC ¶9740
(Ct. Cl., 1972). Note that during this period, Court of Claims decisions were published in the
Federal Reporter, Second Series. Alternatively, you could give the citation 199 Ct. Cls. 721, which
references the Court of Claims Reporter. In the RIA citator the name of the case is simply Harkness.
f. Hillsboro National Bank v. CIR, 460 U.S. 370, 51 AFTR 2d 83-874, 83-1 USTC
¶9229 (USSC, 1983).
g. Rev. Rul. 78-129, 1978-1 C.B. 67. pp. C:1-17 through C:1-22.
C:1-45 a. Rev. Rul. 99-7, 1999-1 C.B. 361.
b. Frank H. Sullivan, 1 B.T.A. 93 (1924).
c. Tate & Lyle, Inc., 103 T.C. 656 (1994).
d. Ralph L. Rogers v. U.S., 539 F. Supp. 104, 49 AFTR 2d 82-1160, 82-1 USTC ¶9246
(DC OH, 1982).
e. Norman Rodman v. CIR, 542 F.2d 845, 38 AFTR 2d 76-5840, 76-2 USTC ¶9710
(2nd Cir., 1976). pp. C:1-17 through C:1-22.
C:1-46 a. Circuit Court of Appeals for the Ninth Circuit; page 1198 of Volume 648 of the
Federal Reporter, Second Series and page 81-5353 of Volume 48 of the American Federal Tax
Reports, Second Series.
b. U. S. Court of Federal Claims; page 455 of Volume 14 of the Claims Court Reporter
and paragraph (not page) 9231 of Volume 1 of the 1988 U. S. Tax Cases.
c. Supreme Court; page 13 of Volume 309 of the United States Supreme Court Reports
and page 816 of Volume 23 of the American Federal Tax Reports.
d. A U.S. District Court in Texas; page 76 of Volume 441 of the Federal Supplement
and page 78-335 of Volume 41 of the American Federal Tax Reports, Second Series.
e. Not a court decision; page 72 of Volume 1 of the 1983 Cumulative Bulletin.
f. Circuit Court of Appeals for Sixth Circuit; page 474 of Volume 568 of the Federal
Reporter, Second Series and paragraph (not page) 9199 of Volume 1 of the 1978 U.S. Tax Cases.
pp. C:1-16 and C:1-22.
b. No. The decision was not entered under Rule 155. p. C:1-17.
c. Yes. The case was reviewed by the Sixth Circuit Court of Appeals in 1982. pp. C:1-30
and C:1-31.
C:1-44 a. National Cash Register Co. v. U.S., 400 F.2d 820, 22 AFTR 2d 5562, 68-2 USTC
¶9576 (6th Cir., 1968).
b. Thomas M. Dragoun, 1984 RIA T.C. Memo ¶84,094 (T.C. Memo 1984-94), 47 TCM
1176.
c. U.S. v. John M. Grabinski, 558 F. Supp. 1324, 52 AFTR 2d 83-5169, 83-2 USTC
¶9460 (DC MN, 1983).
d. U.S. v. John M. Grabinski, 727 F.2d 681, 53 AFTR 2d 84-710, 84-1 USTC ¶9201
(8th Cir., 1984).
e. Rebekah Harkness v. U.S., 469 F.2d 310, 30 AFTR 2d 72-5754, 72-2 USTC ¶9740
(Ct. Cl., 1972). Note that during this period, Court of Claims decisions were published in the
Federal Reporter, Second Series. Alternatively, you could give the citation 199 Ct. Cls. 721, which
references the Court of Claims Reporter. In the RIA citator the name of the case is simply Harkness.
f. Hillsboro National Bank v. CIR, 460 U.S. 370, 51 AFTR 2d 83-874, 83-1 USTC
¶9229 (USSC, 1983).
g. Rev. Rul. 78-129, 1978-1 C.B. 67. pp. C:1-17 through C:1-22.
C:1-45 a. Rev. Rul. 99-7, 1999-1 C.B. 361.
b. Frank H. Sullivan, 1 B.T.A. 93 (1924).
c. Tate & Lyle, Inc., 103 T.C. 656 (1994).
d. Ralph L. Rogers v. U.S., 539 F. Supp. 104, 49 AFTR 2d 82-1160, 82-1 USTC ¶9246
(DC OH, 1982).
e. Norman Rodman v. CIR, 542 F.2d 845, 38 AFTR 2d 76-5840, 76-2 USTC ¶9710
(2nd Cir., 1976). pp. C:1-17 through C:1-22.
C:1-46 a. Circuit Court of Appeals for the Ninth Circuit; page 1198 of Volume 648 of the
Federal Reporter, Second Series and page 81-5353 of Volume 48 of the American Federal Tax
Reports, Second Series.
b. U. S. Court of Federal Claims; page 455 of Volume 14 of the Claims Court Reporter
and paragraph (not page) 9231 of Volume 1 of the 1988 U. S. Tax Cases.
c. Supreme Court; page 13 of Volume 309 of the United States Supreme Court Reports
and page 816 of Volume 23 of the American Federal Tax Reports.
d. A U.S. District Court in Texas; page 76 of Volume 441 of the Federal Supplement
and page 78-335 of Volume 41 of the American Federal Tax Reports, Second Series.
e. Not a court decision; page 72 of Volume 1 of the 1983 Cumulative Bulletin.
f. Circuit Court of Appeals for Sixth Circuit; page 474 of Volume 568 of the Federal
Reporter, Second Series and paragraph (not page) 9199 of Volume 1 of the 1978 U.S. Tax Cases.
pp. C:1-16 and C:1-22.
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C:1-8
C:1-47 a. “Medical expenses, cosmetic surgery” is discussed at ¶2134.04 and 2135.05(42) and
cosmetic surgery costs is discussed at ¶2134.04.
b. Section 213(d)(9) is referred to in ¶2135.04. Rev. Rul 76-332, 1976-2 C.B. 81 and
Rev. Rul. 2003-57, 2003-1 C.B. 959 are discussed at ¶2135.05(42).
c. Generally no. Section 213(d)(9) (effective for tax years beginning after 1990)
provides that the cost of cosmetic surgery is not deductible except in certain narrow circumstances.
pp. C:1-28 and C:1-29.
C:1-48 No. The regulation does not reflect the amendments to Sec. 302 made in 1996, 1997, and
1998. A caution to this effect appears at the beginning of the regulation of both services, although
INTELLICONNECT does not refer to the 1998 amendments. pp. C:1-26 through C:1-29.
C:1-49 a. “Casualty losses for invasion by” is discussed at ¶10,005.029 and at ¶¶10,005.671 -
10,005.68.
b. Authorities include: Rev. Rul. 63-232, 1963-2 C.B. 97; Henry L. Sutherland, 1966
PH T.C. Memo ¶66,155, 25 TCM 822; and Martin A. Rosenberg v. CIR, 42 AFTR 2d 303, 52-2
USTC ¶9377 (8th Cir., 1952). The first two authorities denied a deduction and the third allowed a
deduction. pp. C:1-28 and C:1-29.
C:1-50 a. More than 35% of the excess of the value of the decedent’s gross estate over the sum
of allowable Sec. 2053 and 2054 deductions. (CCH ¶15,350.)
b. No. The regulation indicates the test is more than (1) 35% of the gross estate or
(2) 50% of the taxable estate. It does not reflect the P.L. 94-455 or P.L. 97-34 amendments to the IRC.
A caution to this effect appears before the beginning of the reprint of the regulations.
pp. C:1-26 through C:1-29.
C:1-51 a. 645.
b. 572-3rd - Accounting Methods – Adoptions and Changes.
570- 2nd - Accounting Methods – General Principles.
c. 568-4th..
d. 367.
e. 523-2nd.
p. C:1-25.
C:1-52 “Clergy, work clothes, deductibility” is discussed at ¶L-3806. The authority dealing with this
topic is J.W. Ratcliff, 1983 PH T.C. Memo ¶83,636. This heading is listed in the topical index under
“clergy.” pp. C:1-28 through C1-29.
C:1-53 a. 7 (4 in 1954-1977 volume; 1 in 1978-1989 volume; 2 in 1990-1996 volume; 0 in the
1997-2002 cumulative supplement; and 0 in the 2003-2007 cumulative supplements). All seven
citations have been integrated into one listing on CHECKPOINT.
b. 12 issues, but 13 issues are listed in the findings of fact.
c. Yes. The Fourth Circuit reviewed the case.
d. None.
e. INTELLICONNECT does not list headnote numbers. (INTELLICONNECT
indicates 11 cases, and two rulings cite Biltmore.) pp. C:1-30 and C:1-31.
C:1-47 a. “Medical expenses, cosmetic surgery” is discussed at ¶2134.04 and 2135.05(42) and
cosmetic surgery costs is discussed at ¶2134.04.
b. Section 213(d)(9) is referred to in ¶2135.04. Rev. Rul 76-332, 1976-2 C.B. 81 and
Rev. Rul. 2003-57, 2003-1 C.B. 959 are discussed at ¶2135.05(42).
c. Generally no. Section 213(d)(9) (effective for tax years beginning after 1990)
provides that the cost of cosmetic surgery is not deductible except in certain narrow circumstances.
pp. C:1-28 and C:1-29.
C:1-48 No. The regulation does not reflect the amendments to Sec. 302 made in 1996, 1997, and
1998. A caution to this effect appears at the beginning of the regulation of both services, although
INTELLICONNECT does not refer to the 1998 amendments. pp. C:1-26 through C:1-29.
C:1-49 a. “Casualty losses for invasion by” is discussed at ¶10,005.029 and at ¶¶10,005.671 -
10,005.68.
b. Authorities include: Rev. Rul. 63-232, 1963-2 C.B. 97; Henry L. Sutherland, 1966
PH T.C. Memo ¶66,155, 25 TCM 822; and Martin A. Rosenberg v. CIR, 42 AFTR 2d 303, 52-2
USTC ¶9377 (8th Cir., 1952). The first two authorities denied a deduction and the third allowed a
deduction. pp. C:1-28 and C:1-29.
C:1-50 a. More than 35% of the excess of the value of the decedent’s gross estate over the sum
of allowable Sec. 2053 and 2054 deductions. (CCH ¶15,350.)
b. No. The regulation indicates the test is more than (1) 35% of the gross estate or
(2) 50% of the taxable estate. It does not reflect the P.L. 94-455 or P.L. 97-34 amendments to the IRC.
A caution to this effect appears before the beginning of the reprint of the regulations.
pp. C:1-26 through C:1-29.
C:1-51 a. 645.
b. 572-3rd - Accounting Methods – Adoptions and Changes.
570- 2nd - Accounting Methods – General Principles.
c. 568-4th..
d. 367.
e. 523-2nd.
p. C:1-25.
C:1-52 “Clergy, work clothes, deductibility” is discussed at ¶L-3806. The authority dealing with this
topic is J.W. Ratcliff, 1983 PH T.C. Memo ¶83,636. This heading is listed in the topical index under
“clergy.” pp. C:1-28 through C1-29.
C:1-53 a. 7 (4 in 1954-1977 volume; 1 in 1978-1989 volume; 2 in 1990-1996 volume; 0 in the
1997-2002 cumulative supplement; and 0 in the 2003-2007 cumulative supplements). All seven
citations have been integrated into one listing on CHECKPOINT.
b. 12 issues, but 13 issues are listed in the findings of fact.
c. Yes. The Fourth Circuit reviewed the case.
d. None.
e. INTELLICONNECT does not list headnote numbers. (INTELLICONNECT
indicates 11 cases, and two rulings cite Biltmore.) pp. C:1-30 and C:1-31.
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C:1-9
C:1-54 a. 23.
b. No. According to the headnote to the opinion, the decision dealt with one issue,
deductions.
c. No. The decision has not been cited unfavorably although the point made in
Headnote No. 1 has been distinguished in a number of cases and limited in one case.
d. 13.
e. Indeterminable. There is one cite to the Tax Court decision, but the
INTELLICONNECT citator does not indicate headnote numbers. pp. C:1-30 through C:1-31.
C:1-55 a. 1972.
b. The deductibility of the cost of a customer list under Sec. 162.
c. The government. The cost was not currently deductible.
d. No. The decision was not reviewed at the trial level.
e. Yes. The decision was appealed to the Sixth Circuit Court of Appeals.
f. Yes. The RIA citator and the CCH citator list eight citations to the decision. pp. C:1-26
through C:1-31.
C:1-56 a. To file a tax return electronically, one must (1) purchase the requisite software from a
commercial vendor or download it from a designated Internet site; (2) obtain a Personal
Identification Number (PIN) from the IRS; (3) either prepare a tax return offline and upload, or
prepare the return online; and (4) transmit the return to the IRS.
b. The taxpayer can transmit funds electronically in one of three ways: (1) by
authorizing an electronic funds withdrawal from a checking or savings account; (2) by authorizing
payment by credit card; or (3) by mailing to the IRS a check or money order using a payment
voucher.
c. Electronic filing (1) allows the taxpayer to file a return from any personal computer;
(2) is more accurate than manual filing; (3) offers the safety and security of direct deposit; (4) offers
the convenience of filing a tax return early and delaying payment up to the due date, and (5) allows
one to file federal and state tax returns simultaneously. pp. C:1-29 and C:1-30.
C:1-57 a. “Request for Copy of Tax Return.”
b. “Corporation Claim for Deduction for Consent Dividends.”
c. “Excise Tax on Greenmail.”
pp. C:1-29 and C:1-30.
C:1-58 a. “Request for Copy of Tax Return.”
b. “Credit for Tax Paid to Other States.”
c. “New York Consolidated Franchise Tax Return.”
pp. C:1-29 and C:1-30.
C:1-59 The latest data as of this writing was for 2010.
a. 7 (Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming).
b. 2 (New Hampshire and Tennessee).
c. 11%.
d. Illinois, 3%.
pp. C:1-29 and C:1-30.
C:1-54 a. 23.
b. No. According to the headnote to the opinion, the decision dealt with one issue,
deductions.
c. No. The decision has not been cited unfavorably although the point made in
Headnote No. 1 has been distinguished in a number of cases and limited in one case.
d. 13.
e. Indeterminable. There is one cite to the Tax Court decision, but the
INTELLICONNECT citator does not indicate headnote numbers. pp. C:1-30 through C:1-31.
C:1-55 a. 1972.
b. The deductibility of the cost of a customer list under Sec. 162.
c. The government. The cost was not currently deductible.
d. No. The decision was not reviewed at the trial level.
e. Yes. The decision was appealed to the Sixth Circuit Court of Appeals.
f. Yes. The RIA citator and the CCH citator list eight citations to the decision. pp. C:1-26
through C:1-31.
C:1-56 a. To file a tax return electronically, one must (1) purchase the requisite software from a
commercial vendor or download it from a designated Internet site; (2) obtain a Personal
Identification Number (PIN) from the IRS; (3) either prepare a tax return offline and upload, or
prepare the return online; and (4) transmit the return to the IRS.
b. The taxpayer can transmit funds electronically in one of three ways: (1) by
authorizing an electronic funds withdrawal from a checking or savings account; (2) by authorizing
payment by credit card; or (3) by mailing to the IRS a check or money order using a payment
voucher.
c. Electronic filing (1) allows the taxpayer to file a return from any personal computer;
(2) is more accurate than manual filing; (3) offers the safety and security of direct deposit; (4) offers
the convenience of filing a tax return early and delaying payment up to the due date, and (5) allows
one to file federal and state tax returns simultaneously. pp. C:1-29 and C:1-30.
C:1-57 a. “Request for Copy of Tax Return.”
b. “Corporation Claim for Deduction for Consent Dividends.”
c. “Excise Tax on Greenmail.”
pp. C:1-29 and C:1-30.
C:1-58 a. “Request for Copy of Tax Return.”
b. “Credit for Tax Paid to Other States.”
c. “New York Consolidated Franchise Tax Return.”
pp. C:1-29 and C:1-30.
C:1-59 The latest data as of this writing was for 2010.
a. 7 (Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming).
b. 2 (New Hampshire and Tennessee).
c. 11%.
d. Illinois, 3%.
pp. C:1-29 and C:1-30.
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C:1-10
Comprehensive Problem
C:1-60 STEP ONE: In searching INTELLICONNECT’s Standard Federal Tax Reporter (SFTR),
you would consult the topical index under “Yachts” or “Advertising, expenses for.” In searching
CHECKPOINT’s United States Tax Reporter (USTR), you would consult the topical index under
“Advertising – special or unusual forms of.” In searching SFTR on INTELLICONNECT or USTR
on CHECKPOINT, you would use the keyword “Yacht.” Either way, in SFTR you would likely
find an annotation at ¶8851.1327; in USTR you would likely find an annotation at ¶1625.356(13).
STEP TWO: In print research, you would leave the tax service reporter volume to look up
the case on page 879, Volume 36 of Tax Court of the United States Reports. In computerized
research, you would remain in the service and click on the hyperlinked citation. Either way, you
would find the text of R.L. Henry, 36 T.C. 879. This case involved an attorney/accountant who tried
to deduct the costs of insuring and maintaining a yacht on which he flew a pennant with the
numerals “1040.” It is analogous to your client’s case.
STEP THREE: In print research, to check the status of the case, you would leave Tax Court
of the United States Reports to consult a citator. In computerized research, you would remain in the
service and click on the citator command button. Either way, you would discover a listing of cases
that cite R.L. Henry. You also would discover that the case is still “good law.”
STEP FOUR: In both print and computerized research, based on the ruling in R.L. Henry,
you likely would conclude that the costs of maintaining and insuring the physician’s yacht are not
deductible as ordinary and necessary business expenses. pp. C:1-26 through C:1-29.
Tax Strategy Problem
C:1-61 Choose Alternative 2; file the lawsuit in the Tax Court. HPU is likely to lose a lawsuit filed
in the U. S. district court (Alternative 1) because that court is bound by district court precedent
adverse to the taxpayer. Likewise, HPU is likely to lose a lawsuit filed in the Court of Federal
Claims (Alternative 3) because that court is bound by circuit court precedent adverse to the
taxpayer. On the other hand, in the Tax Court (Alternative 2) the tax return position taken by HPU
has a realistic possibility of being sustained on its merits. In a case involving HPU, the Tax Court
would not be bound by the other circuit court’s precedent, which is adverse to the taxpayer because
of the Golsen Rule. Rather, the Tax Court would be bound by HPU’s own circuit court precedent,
which, based on the specific facts of the problem, is nonexistent because HPU’s circuit court has
merely offered dictum, which is not binding. However, if the Tax Court issues a ruling consistent
with the circuit court’s second proposition, namely, that by opening the home improvement center,
HPU is merely “improving customer access to its existing products,” HPU will win the lawsuit, and
its deduction will be sustained. pp. C:1-21 and C:1-23.
Comprehensive Problem
C:1-60 STEP ONE: In searching INTELLICONNECT’s Standard Federal Tax Reporter (SFTR),
you would consult the topical index under “Yachts” or “Advertising, expenses for.” In searching
CHECKPOINT’s United States Tax Reporter (USTR), you would consult the topical index under
“Advertising – special or unusual forms of.” In searching SFTR on INTELLICONNECT or USTR
on CHECKPOINT, you would use the keyword “Yacht.” Either way, in SFTR you would likely
find an annotation at ¶8851.1327; in USTR you would likely find an annotation at ¶1625.356(13).
STEP TWO: In print research, you would leave the tax service reporter volume to look up
the case on page 879, Volume 36 of Tax Court of the United States Reports. In computerized
research, you would remain in the service and click on the hyperlinked citation. Either way, you
would find the text of R.L. Henry, 36 T.C. 879. This case involved an attorney/accountant who tried
to deduct the costs of insuring and maintaining a yacht on which he flew a pennant with the
numerals “1040.” It is analogous to your client’s case.
STEP THREE: In print research, to check the status of the case, you would leave Tax Court
of the United States Reports to consult a citator. In computerized research, you would remain in the
service and click on the citator command button. Either way, you would discover a listing of cases
that cite R.L. Henry. You also would discover that the case is still “good law.”
STEP FOUR: In both print and computerized research, based on the ruling in R.L. Henry,
you likely would conclude that the costs of maintaining and insuring the physician’s yacht are not
deductible as ordinary and necessary business expenses. pp. C:1-26 through C:1-29.
Tax Strategy Problem
C:1-61 Choose Alternative 2; file the lawsuit in the Tax Court. HPU is likely to lose a lawsuit filed
in the U. S. district court (Alternative 1) because that court is bound by district court precedent
adverse to the taxpayer. Likewise, HPU is likely to lose a lawsuit filed in the Court of Federal
Claims (Alternative 3) because that court is bound by circuit court precedent adverse to the
taxpayer. On the other hand, in the Tax Court (Alternative 2) the tax return position taken by HPU
has a realistic possibility of being sustained on its merits. In a case involving HPU, the Tax Court
would not be bound by the other circuit court’s precedent, which is adverse to the taxpayer because
of the Golsen Rule. Rather, the Tax Court would be bound by HPU’s own circuit court precedent,
which, based on the specific facts of the problem, is nonexistent because HPU’s circuit court has
merely offered dictum, which is not binding. However, if the Tax Court issues a ruling consistent
with the circuit court’s second proposition, namely, that by opening the home improvement center,
HPU is merely “improving customer access to its existing products,” HPU will win the lawsuit, and
its deduction will be sustained. pp. C:1-21 and C:1-23.
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Case Study Problem
C:1-62 Statements on Standards for Tax Services (SSTS) No. 3 states that a CPA “may in good faith
rely, without verification, on information furnished by the taxpayer or by third parties” (Para. 2,
reproduced in Appendix E of the text). Thus, you may accept Mal’s information at face value. His
increase in AGI of over $30,000 may explain his increase in charitable contributions of
approximately $10,000. In the second scenario the provision from SSTS No. 3 that a CPA “should
make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or
inconsistent either on its face or on the basis of other facts known to a member” would be pertinent.
Recently, the IRS audited Mal’s return, and Mal lacked substantiation for about 75 percent of the
charitable contributions he had claimed. (He may have made the contributions, but he could not
prove that he did.) Further, the round amount ($25,000) reported by Mal suggests that Mal may be
estimating what he contributed. You probably should request to see substantiation (canceled checks,
etc.) for the contribution(s) claimed. For charitable contributions of $250 or greater made after
December 31, 1993, no deduction is allowed unless the donee organization substantiates the
contribution with a contemporaneous, written acknowledgement. Mal needs to be made aware of
this rule for his current year’s return. All cash contributions, regardless of amount, must be
documented with a bank record or written communication from the charity. The communication
must include the name of the charity, date, and amount. p. C:1-33.
Tax Research Problems
C:1-63 a. The primary issue is whether the amounts Thomas A. Curtis, M.D. Inc. paid to Ellen
Curtis as compensation during fiscal years 1988 and 1989 were reasonable.
b. Neither party was totally victorious. In fiscal year 1988, Ellen Curtis was paid
$410,500. The amount held to be reasonable compensation by the Tax Court for 1988 was $227,000.
In fiscal year 1989, Ellen Curtis was paid $510,500. The amount held to be reasonable
compensation by the Tax Court for 1989 was $239,000. The amount held to be compensation,
however, is more than the $100,000 and $105,000 the IRS asserted was reasonable compensation.
c. The plaintiff is the corporation because it is the party that claimed a deduction for the
compensation. The IRS is attempting to disallow the corporation’s deduction for part of the
compensation paid. The disallowance of the deduction will have little effect on the two individuals
since the amounts received will be either salary or dividends depending on the outcome of the case.
d. Ellen Barnert married Dr. Thomas Curtis in 1984.
e. Ms. Curtis worked approximately 60 to 70 hours supervising all departments set up
within the corporation and the independent contractors, including scheduling and staffing of all the
corporation’s offices. Ms. Curtis was a registered nurse. She had a bachelor’s degree in science and
took worker’s compensation courses at the University of Southern California Law School. She had
worked as a nurse for a number of years and managed an ambulatory hospital system.
f. In fiscal year 1989, Ellen Curtis was paid $510,500. The Tax Court held $239,000 to
be reasonable compensation in 1989.
g. The corporation paid no dividends in either fiscal year.
h. The case is appealable to the Ninth Circuit.
i. The five factors mentioned in determining reasonable compensation according to
Elliott’s are: (1) the employee’s role in the company, (2) external comparison of the employee’s
salary with those paid by similar companies for similar services, (3) character and condition of the
Case Study Problem
C:1-62 Statements on Standards for Tax Services (SSTS) No. 3 states that a CPA “may in good faith
rely, without verification, on information furnished by the taxpayer or by third parties” (Para. 2,
reproduced in Appendix E of the text). Thus, you may accept Mal’s information at face value. His
increase in AGI of over $30,000 may explain his increase in charitable contributions of
approximately $10,000. In the second scenario the provision from SSTS No. 3 that a CPA “should
make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or
inconsistent either on its face or on the basis of other facts known to a member” would be pertinent.
Recently, the IRS audited Mal’s return, and Mal lacked substantiation for about 75 percent of the
charitable contributions he had claimed. (He may have made the contributions, but he could not
prove that he did.) Further, the round amount ($25,000) reported by Mal suggests that Mal may be
estimating what he contributed. You probably should request to see substantiation (canceled checks,
etc.) for the contribution(s) claimed. For charitable contributions of $250 or greater made after
December 31, 1993, no deduction is allowed unless the donee organization substantiates the
contribution with a contemporaneous, written acknowledgement. Mal needs to be made aware of
this rule for his current year’s return. All cash contributions, regardless of amount, must be
documented with a bank record or written communication from the charity. The communication
must include the name of the charity, date, and amount. p. C:1-33.
Tax Research Problems
C:1-63 a. The primary issue is whether the amounts Thomas A. Curtis, M.D. Inc. paid to Ellen
Curtis as compensation during fiscal years 1988 and 1989 were reasonable.
b. Neither party was totally victorious. In fiscal year 1988, Ellen Curtis was paid
$410,500. The amount held to be reasonable compensation by the Tax Court for 1988 was $227,000.
In fiscal year 1989, Ellen Curtis was paid $510,500. The amount held to be reasonable
compensation by the Tax Court for 1989 was $239,000. The amount held to be compensation,
however, is more than the $100,000 and $105,000 the IRS asserted was reasonable compensation.
c. The plaintiff is the corporation because it is the party that claimed a deduction for the
compensation. The IRS is attempting to disallow the corporation’s deduction for part of the
compensation paid. The disallowance of the deduction will have little effect on the two individuals
since the amounts received will be either salary or dividends depending on the outcome of the case.
d. Ellen Barnert married Dr. Thomas Curtis in 1984.
e. Ms. Curtis worked approximately 60 to 70 hours supervising all departments set up
within the corporation and the independent contractors, including scheduling and staffing of all the
corporation’s offices. Ms. Curtis was a registered nurse. She had a bachelor’s degree in science and
took worker’s compensation courses at the University of Southern California Law School. She had
worked as a nurse for a number of years and managed an ambulatory hospital system.
f. In fiscal year 1989, Ellen Curtis was paid $510,500. The Tax Court held $239,000 to
be reasonable compensation in 1989.
g. The corporation paid no dividends in either fiscal year.
h. The case is appealable to the Ninth Circuit.
i. The five factors mentioned in determining reasonable compensation according to
Elliott’s are: (1) the employee’s role in the company, (2) external comparison of the employee’s
salary with those paid by similar companies for similar services, (3) character and condition of the
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C:1-12
company, (4) conflict of interest in the employee’s relationship to the corporation, and (5) the
internal consistency in the company’s treatment of payments to employees.
C:1-64 Judicial authority exists to exclude the Medicare payments from the amount the mother is
treated as having provided for her own support. The IRS agrees with this authority; therefore, if the
IRS audits the client’s return, the IRS will not argue that Josh’s mother provided the majority of her
own support. (This information should be included in the client letter.)
The work papers should include a discussion of the authorities summarized below. Section
152(a) provides that one of the tests for claiming another as a dependent is to provide over one-half
of such person’s support. (Note: Josh’s mother’s gross income of $2,000 is not too high in the
current year for her to be claimed his dependent assuming all other requirements are met.) If he
provides over one-half of her support, he also may deduct any medical expenses he pays on her
behalf. Section 152 does not define “support.” Regulation Sec. 1.152-1(a)(2) states that support
includes “food, shelter, clothing, medical and dental care, education, and the like.” It also provides
that in determining the amount an individual contributes to his own support, one must count the cost
of support items paid for from “income, which is ordinarily excludable from gross income, such as
benefits received under the Social Security Act.”
In Alfred H. Turecamo v. CIR, 39 AFTR 2d 77-1487, 77-1 USTC ¶9415 (2nd Cir., 1977), the
court held that hospital costs paid by Basic Medicare do not constitute support the ill person
furnishes for himself or herself. After studying the legislative history of the Medicare statute, the
court could find no valid basis “for distinguishing between hospital benefits received under Part A of
Medicare [Basic Medicare] and either private insurance proceeds or supplemental benefits received
under Part B [of Medicare].”
In Rev. Rul. 70-341, 1970-2 C.B. 31, the IRS ruled that Basic Medicare payments on a
person’s behalf must be treated as contributions by such person toward his own support. Such
treatment was in contrast to that of Supplemental Medicare, which the IRS viewed as in the nature of
insurance proceeds, and not self-support. Revenue Ruling 64-223, 1964-2 C.B. 50, held that
amounts paid by an insurance company for medical costs are disregarded in the support test.
In Rev. Rul. 79-173, 1979-1 C.B. 86, the IRS revoked Rev. Rul. 70-341. Thus, the IRS
currently treats Basic Medicare payments consistently with Supplemental Medicare and ignores
amounts received from either source for purposes of the support test. In Archer v. Comm. 73 T.C.
963 (1980), the court held that both medicare and medicaid are disregarded in the support test.
C:1-65 In determining whether the property is used “too much” for personal purposes so that
Sec. 280A applies, use of the residence by Amy or by family members constitutes personal use, as
does use by persons who pay less than fair rental value (Sec. 280A(d)(2)). Use by Amy when
performing repairs and maintenance full-time is totally disregarded (Sec. 280A(d)(2)). For purposes
of allocating the expenses attributable to rental use, however, all the days on which the property is
rented for fair rental value are considered, even if the property is rented to family members on some
of these days (Prop. Reg. Sec. 1.280A-3(c)).
company, (4) conflict of interest in the employee’s relationship to the corporation, and (5) the
internal consistency in the company’s treatment of payments to employees.
C:1-64 Judicial authority exists to exclude the Medicare payments from the amount the mother is
treated as having provided for her own support. The IRS agrees with this authority; therefore, if the
IRS audits the client’s return, the IRS will not argue that Josh’s mother provided the majority of her
own support. (This information should be included in the client letter.)
The work papers should include a discussion of the authorities summarized below. Section
152(a) provides that one of the tests for claiming another as a dependent is to provide over one-half
of such person’s support. (Note: Josh’s mother’s gross income of $2,000 is not too high in the
current year for her to be claimed his dependent assuming all other requirements are met.) If he
provides over one-half of her support, he also may deduct any medical expenses he pays on her
behalf. Section 152 does not define “support.” Regulation Sec. 1.152-1(a)(2) states that support
includes “food, shelter, clothing, medical and dental care, education, and the like.” It also provides
that in determining the amount an individual contributes to his own support, one must count the cost
of support items paid for from “income, which is ordinarily excludable from gross income, such as
benefits received under the Social Security Act.”
In Alfred H. Turecamo v. CIR, 39 AFTR 2d 77-1487, 77-1 USTC ¶9415 (2nd Cir., 1977), the
court held that hospital costs paid by Basic Medicare do not constitute support the ill person
furnishes for himself or herself. After studying the legislative history of the Medicare statute, the
court could find no valid basis “for distinguishing between hospital benefits received under Part A of
Medicare [Basic Medicare] and either private insurance proceeds or supplemental benefits received
under Part B [of Medicare].”
In Rev. Rul. 70-341, 1970-2 C.B. 31, the IRS ruled that Basic Medicare payments on a
person’s behalf must be treated as contributions by such person toward his own support. Such
treatment was in contrast to that of Supplemental Medicare, which the IRS viewed as in the nature of
insurance proceeds, and not self-support. Revenue Ruling 64-223, 1964-2 C.B. 50, held that
amounts paid by an insurance company for medical costs are disregarded in the support test.
In Rev. Rul. 79-173, 1979-1 C.B. 86, the IRS revoked Rev. Rul. 70-341. Thus, the IRS
currently treats Basic Medicare payments consistently with Supplemental Medicare and ignores
amounts received from either source for purposes of the support test. In Archer v. Comm. 73 T.C.
963 (1980), the court held that both medicare and medicaid are disregarded in the support test.
C:1-65 In determining whether the property is used “too much” for personal purposes so that
Sec. 280A applies, use of the residence by Amy or by family members constitutes personal use, as
does use by persons who pay less than fair rental value (Sec. 280A(d)(2)). Use by Amy when
performing repairs and maintenance full-time is totally disregarded (Sec. 280A(d)(2)). For purposes
of allocating the expenses attributable to rental use, however, all the days on which the property is
rented for fair rental value are considered, even if the property is rented to family members on some
of these days (Prop. Reg. Sec. 1.280A-3(c)).
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C:1-13
The total number of days rented at fair rental value – the numerator of the fraction used in the
allocation – is determined as follows:
Days rented to sister 8
Days rented to cousin 4
Days rented to three families 120
Total 132
The denominator for allocating interest and taxes is in dispute. Per Prop. Reg. Sec. 1.280
A-3(d)(3), the denominator is the total number of days of actual use (exclusive of use by the owner
for performing repairs). Thus, the denominator would be 146 (12 + 8 + 4 + 2 + 120). Case law
supports using as the denominator the number of days in the year, or 365 days in this case for
allocating interest and taxes. Dorrance D. Bolton v. CIR 51 AFTR 2d 83-305, 82-2 USTC ¶9,699,
(9th Cir., 1982), affirming 77 T.C. 104 (1981), and Edith G. McKinney v. CIR 52 AFTR 2d
83-6281, 83-2 USTC ¶9,665 (10th Cir., 1983).
No dispute exists over the fraction to use for allocating repairs, insurance, and depreciation.
It is the number of days rented at fair rental value divided by the total number of days of actual use,
or 132/148 (Sec. 280A(e)(1)). Note: The denominator is 148 instead of 146 (as above) because,
here, it includes the two days of use for repairs.
C:1-66 a. The principal issue in both cases was whether the corporation could deduct amounts
paid as compensation to the spouse (ex-spouse) of a sole shareholder. This issue, in turn, depended
on whether such compensation was “reasonable” under the circumstances.
b. The Tax Court considered a number of factors, including (1) the employee’s
qualifications and training, (2) the nature, extent, and scope of her duties, (3) responsibilities and
hours involved, (4) the size and complexity of the business, (5) the results of the employee’s efforts,
(6) the prevailing rates for comparable employees in comparable businesses, (7) the scarcity of other
qualified employees, (8) the ratio of compensation to the gross and net income of the business,
(9) the salary policy of the employer to other employees, and (10) the amount of compensation paid
to the employee in prior years.
c. The facts of these cases are similar in the following respect: in both cases, the
taxpayers were corporations that claimed a deduction for payments made to the spouse or ex-spouse
of a sole shareholder. The facts are different in these respects: (1) In Summit the IRS contended
that only a portion of the salary payments were nondeductible; in J.B.S., it argued that none of the
salary payments were deductible. (2) In Summit, the spouse performed extensive services for the
firm; in J.B.S., the ex-spouse appears to have performed no services. (3) In Summit, the court took
into consideration the corporation’s rising profits; in J.B.S., the court did not. (In fact, the latter
opinion does not mention the firm’s profits or loss position). (4) In Summit, the payments did not
appear to be motivated by tax avoidance. (Because the corporation paid substantial dividends to its
sole shareholder, the payments to the spouse did not appear to be “disguised dividends”). In J.B.S.,
the payments did appear to be motivated by tax avoidance. (Testimony indicated that some tax
positions had been taken to minimize the corporation’s tax liability).
The total number of days rented at fair rental value – the numerator of the fraction used in the
allocation – is determined as follows:
Days rented to sister 8
Days rented to cousin 4
Days rented to three families 120
Total 132
The denominator for allocating interest and taxes is in dispute. Per Prop. Reg. Sec. 1.280
A-3(d)(3), the denominator is the total number of days of actual use (exclusive of use by the owner
for performing repairs). Thus, the denominator would be 146 (12 + 8 + 4 + 2 + 120). Case law
supports using as the denominator the number of days in the year, or 365 days in this case for
allocating interest and taxes. Dorrance D. Bolton v. CIR 51 AFTR 2d 83-305, 82-2 USTC ¶9,699,
(9th Cir., 1982), affirming 77 T.C. 104 (1981), and Edith G. McKinney v. CIR 52 AFTR 2d
83-6281, 83-2 USTC ¶9,665 (10th Cir., 1983).
No dispute exists over the fraction to use for allocating repairs, insurance, and depreciation.
It is the number of days rented at fair rental value divided by the total number of days of actual use,
or 132/148 (Sec. 280A(e)(1)). Note: The denominator is 148 instead of 146 (as above) because,
here, it includes the two days of use for repairs.
C:1-66 a. The principal issue in both cases was whether the corporation could deduct amounts
paid as compensation to the spouse (ex-spouse) of a sole shareholder. This issue, in turn, depended
on whether such compensation was “reasonable” under the circumstances.
b. The Tax Court considered a number of factors, including (1) the employee’s
qualifications and training, (2) the nature, extent, and scope of her duties, (3) responsibilities and
hours involved, (4) the size and complexity of the business, (5) the results of the employee’s efforts,
(6) the prevailing rates for comparable employees in comparable businesses, (7) the scarcity of other
qualified employees, (8) the ratio of compensation to the gross and net income of the business,
(9) the salary policy of the employer to other employees, and (10) the amount of compensation paid
to the employee in prior years.
c. The facts of these cases are similar in the following respect: in both cases, the
taxpayers were corporations that claimed a deduction for payments made to the spouse or ex-spouse
of a sole shareholder. The facts are different in these respects: (1) In Summit the IRS contended
that only a portion of the salary payments were nondeductible; in J.B.S., it argued that none of the
salary payments were deductible. (2) In Summit, the spouse performed extensive services for the
firm; in J.B.S., the ex-spouse appears to have performed no services. (3) In Summit, the court took
into consideration the corporation’s rising profits; in J.B.S., the court did not. (In fact, the latter
opinion does not mention the firm’s profits or loss position). (4) In Summit, the payments did not
appear to be motivated by tax avoidance. (Because the corporation paid substantial dividends to its
sole shareholder, the payments to the spouse did not appear to be “disguised dividends”). In J.B.S.,
the payments did appear to be motivated by tax avoidance. (Testimony indicated that some tax
positions had been taken to minimize the corporation’s tax liability).
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C:1-67 The memorandum should supply the following answers:
a. Revenue Proc. 2012-6, I.R.B. 2012-1, 197 and Rev. Proc. 2012-4, I.R.B. 2012-1,
125, govern requests for determination letters.
b. Form 5300, “Application for Determination for Employee Benefit Plan,” must be
filed with the request.
c. The following information must be provided in the request:
1. Complete statement of facts and other information
2. Copies of all contracts, wills, deeds, agreements, instruments, plans, and
other documents
3. Analysis of material facts
4. Statement regarding whether the same issue was addressed in an earlier
return
5. Statement regarding whether the same or similar issue was previously ruled
on or requested, or is currently pending
6. Statement of supporting authorities
7. Statement of contrary authorities
8. Statement identifying pending litigation
9. Statement identifying information to be deleted from the copy of
determination letter for public inspection
10. Signature by the taxpayer or authorized representative
11. Names of authorized representatives
12. Power of attorney and declaration of representative
13. Penalties of perjury statement
d. Actions that must accompany the filing include payment of appropriate user fee and
notification of interested parties.
e. The request must be filed at the following address:
EP Determinations
Internal Revenue Service
P.O. Box 192
Covington, KY 41012-0192
C:1-67 The memorandum should supply the following answers:
a. Revenue Proc. 2012-6, I.R.B. 2012-1, 197 and Rev. Proc. 2012-4, I.R.B. 2012-1,
125, govern requests for determination letters.
b. Form 5300, “Application for Determination for Employee Benefit Plan,” must be
filed with the request.
c. The following information must be provided in the request:
1. Complete statement of facts and other information
2. Copies of all contracts, wills, deeds, agreements, instruments, plans, and
other documents
3. Analysis of material facts
4. Statement regarding whether the same issue was addressed in an earlier
return
5. Statement regarding whether the same or similar issue was previously ruled
on or requested, or is currently pending
6. Statement of supporting authorities
7. Statement of contrary authorities
8. Statement identifying pending litigation
9. Statement identifying information to be deleted from the copy of
determination letter for public inspection
10. Signature by the taxpayer or authorized representative
11. Names of authorized representatives
12. Power of attorney and declaration of representative
13. Penalties of perjury statement
d. Actions that must accompany the filing include payment of appropriate user fee and
notification of interested parties.
e. The request must be filed at the following address:
EP Determinations
Internal Revenue Service
P.O. Box 192
Covington, KY 41012-0192
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C:1-15
“What Would You Do In This Situation?” Solution
Ch. C:1, p. C:1-35. Inconsistent Figures.
In this context, you have two professional duties: first, a duty of confidentiality to each
client, and second, a duty to verify information that appears to be incorrect on its face. According to
Statement No. 3 of the Statements on Standards for Tax Services, a CPA who is required to sign a
tax return should consider information actually known to the CPA from the tax return of another
client if (1) that information is relevant to the former return, (2) its consideration is necessary to
properly prepare that return, and (3) the use of such information does not violate any rule of
confidentiality. Here, (1) the information relating to each return is relevant to the other;
(2) its consideration is necessary to properly prepare the other return; and (3) the use of such
information does not violate any rule of confidentiality, so long as the information is not disclosed to
the other client. Your considering the tax return information should lead you to believe that it is
incorrect on its face; therefore, you have a duty to verify it.
Accordingly, without revealing the basis for your belief, you should request from each client
documentary evidence of its respective claim. Such evidence should consist of a paid invoice, a
canceled check, a signed or certified receipt, a bill of lading, or any other document that indicates the
essential terms of the contract of sale.
“What Would You Do In This Situation?” Solution
Ch. C:1, p. C:1-35. Inconsistent Figures.
In this context, you have two professional duties: first, a duty of confidentiality to each
client, and second, a duty to verify information that appears to be incorrect on its face. According to
Statement No. 3 of the Statements on Standards for Tax Services, a CPA who is required to sign a
tax return should consider information actually known to the CPA from the tax return of another
client if (1) that information is relevant to the former return, (2) its consideration is necessary to
properly prepare that return, and (3) the use of such information does not violate any rule of
confidentiality. Here, (1) the information relating to each return is relevant to the other;
(2) its consideration is necessary to properly prepare the other return; and (3) the use of such
information does not violate any rule of confidentiality, so long as the information is not disclosed to
the other client. Your considering the tax return information should lead you to believe that it is
incorrect on its face; therefore, you have a duty to verify it.
Accordingly, without revealing the basis for your belief, you should request from each client
documentary evidence of its respective claim. Such evidence should consist of a paid invoice, a
canceled check, a signed or certified receipt, a bill of lading, or any other document that indicates the
essential terms of the contract of sale.
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C:2-1
Chapter C:2
Corporate Formations and Capital Structure
Discussion Questions
C:2-1 Various. A new business can be conducted as a sole proprietorship, partnership, C corporation,
S corporation, LLC, or LLP. Each form has tax and nontax advantages and disadvantages. See pages
C:2-2 through C:2-7 for a listing of the tax advantages and disadvantages of each form. A comparison
of the C corporation, S corporation, and partnership alternative business forms appears in Appendix F.
pp. C:2-2 through C:2-8.
C:2-2 Alice and Bill should consider forming a corporation and making an S corporation election.
An S corporation election will permit the losses incurred during the first few years to be passed
through to Alice and Bill and be used to offset income from other sources. The corporate form
affords them limited liability. As an alternative to incorporating, Alice and Bill might consider
setting up a limited liability company that is taxed as a partnership. pp. C:2-6 through C:2-8.
C:2-3 Yes, several alternative classifications. The only default tax classification for the LLC is a
partnership. Because the LLC has two owners, it cannot be taxed as a sole proprietorship. The
entity can elect to be taxed as a C corporation or an S corporation. If the entity makes such an
election, Sec. 351 applies to the deemed corporate formation. The entity would have to make a
separate election to be treated as an S corporation. pp. C:2-8 and C:2-9.
C:2-4 The default tax classification for White Corporation is a C corporation. However, White can
be treated as an S corporation if it makes the necessary election. Following an S corporation
election, the entity’s income will be taxed to its owners. The S corporation election is made by filing
Form 2553 within the first 2½ months of the corporation’s existence (see Chapter C:11).
pp. C:2-6 and C:2-7.
C:2-5 The only default tax classification for the LLC is a sole proprietorship. Because the LLC has
only a single owner, it cannot be treated as a partnership. Thus, the default classification is a
“disregarded entity” taxed as a sole proprietorship. The entity can elect to be taxed as a C corporation
or an S corporation. If the entity makes such an election, Sec. 351 applies to the deemed corporate
formation. pp. C:2-8 and C:2-9.
C:2-6 Possible arguments include:
PRO (Corporate formations should be taxable events):
1. A corporate formation is an exchange transaction; therefore, parties to the exchange should
recognize gains and losses.
2. Making a corporate formation a taxable event increases tax revenues.
3. Simplification is achieved by eliminating one of the two options - whether a transaction is
taxable or not. This change will make administration of the tax laws easier.
Chapter C:2
Corporate Formations and Capital Structure
Discussion Questions
C:2-1 Various. A new business can be conducted as a sole proprietorship, partnership, C corporation,
S corporation, LLC, or LLP. Each form has tax and nontax advantages and disadvantages. See pages
C:2-2 through C:2-7 for a listing of the tax advantages and disadvantages of each form. A comparison
of the C corporation, S corporation, and partnership alternative business forms appears in Appendix F.
pp. C:2-2 through C:2-8.
C:2-2 Alice and Bill should consider forming a corporation and making an S corporation election.
An S corporation election will permit the losses incurred during the first few years to be passed
through to Alice and Bill and be used to offset income from other sources. The corporate form
affords them limited liability. As an alternative to incorporating, Alice and Bill might consider
setting up a limited liability company that is taxed as a partnership. pp. C:2-6 through C:2-8.
C:2-3 Yes, several alternative classifications. The only default tax classification for the LLC is a
partnership. Because the LLC has two owners, it cannot be taxed as a sole proprietorship. The
entity can elect to be taxed as a C corporation or an S corporation. If the entity makes such an
election, Sec. 351 applies to the deemed corporate formation. The entity would have to make a
separate election to be treated as an S corporation. pp. C:2-8 and C:2-9.
C:2-4 The default tax classification for White Corporation is a C corporation. However, White can
be treated as an S corporation if it makes the necessary election. Following an S corporation
election, the entity’s income will be taxed to its owners. The S corporation election is made by filing
Form 2553 within the first 2½ months of the corporation’s existence (see Chapter C:11).
pp. C:2-6 and C:2-7.
C:2-5 The only default tax classification for the LLC is a sole proprietorship. Because the LLC has
only a single owner, it cannot be treated as a partnership. Thus, the default classification is a
“disregarded entity” taxed as a sole proprietorship. The entity can elect to be taxed as a C corporation
or an S corporation. If the entity makes such an election, Sec. 351 applies to the deemed corporate
formation. pp. C:2-8 and C:2-9.
C:2-6 Possible arguments include:
PRO (Corporate formations should be taxable events):
1. A corporate formation is an exchange transaction; therefore, parties to the exchange should
recognize gains and losses.
2. Making a corporate formation a taxable event increases tax revenues.
3. Simplification is achieved by eliminating one of the two options - whether a transaction is
taxable or not. This change will make administration of the tax laws easier.
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C:2-2
4. This change eliminates the need for taxpayers to artificially structure transactions to avoid
Sec. 351 to recognize gains and/or losses.
CON (No change should occur to current law):
1. A change in current law would hurt start-up corporations by reducing their capital through
the income tax paid by transferors on an asset transfer.
2. No economic gains or losses are realized. Just a change in the form of ownership (direct vs.
indirect) has occurred. Therefore, it is not appropriate to recognize gains and losses at this
time.
3. With taxation, corporations will have to raise more capital because transferors of noncash
property will have less capital to invest and because money must be diverted to pay taxes.
4. Taxpayers are prevented from recognizing losses under the current system, thereby
increasing revenues to the government.
5. With taxation, businesses would be deterred from incorporating because of the tax
consequences, and therefore economic growth in the U.S. would be adversely affected.
pp. C:2-9 and C:2-10.
C:2-7 The following tax consequences, if Sec. 351 applies: Neither the transferor nor the transferee
corporation recognizes gain or loss when property is exchanged for stock. Unless boot property is
received, the transferor’s realized gain or loss is deferred until he or she sells or exchanges the stock
received. If boot property is received, the recognized gain is the lesser of (1) the amount of money
plus the FMV of the nonmoney boot property received or (2) the realized gain. The transferor
recognizes no losses even if boot property is received. The transferor’s basis in the stock received
references his or her basis in the property transferred and is increased by any gain recognized and is
reduced by the amount of money plus the FMV of the nonmoney boot property received and the
amount of any liabilities assumed by the transferee corporation. The basis of the boot property is its
FMV. The transferee corporation recognizes no gain on the transfer. The transferee corporation’s
basis in the property received is the same basis that the transferor had in the property transferred
increased by any gain recognized by the transferor. pp. C:2-12, C:2-16, and C:2-17.
C:2-8 The following items are considered to be property: Money and almost any other kind of
tangible or intangible property, including installment obligations, accounts receivable, inventory,
equipment, patents, trademarks, trade names, and computer software. Property does not include
services, an indebtedness of the transferee corporation that is not evidenced by a security, or interest
on an indebtedness that accrued on or after the beginning of the transferor’s holding period for the
debt. pp. C:2-12 and C:2-13.
C:2-9 “Control” is defined as follows: Transferrers as a group must own at least 80% of the total
combined voting power of all classes of stock entitled to vote and at least 80% of the total number of
shares of all other classes of stock. The nonvoting stock ownership is tested on a class-by-class
basis. pp. C:2-13 through C:2-16.
C:2-10 The IRS has interpreted the phrase as follows: Sec. 351 requires the transferors to control the
transferee corporation immediately after the exchange but does not specify how long this control
must be maintained. The transferors, however, must not have a prearranged plan to dispose of their
4. This change eliminates the need for taxpayers to artificially structure transactions to avoid
Sec. 351 to recognize gains and/or losses.
CON (No change should occur to current law):
1. A change in current law would hurt start-up corporations by reducing their capital through
the income tax paid by transferors on an asset transfer.
2. No economic gains or losses are realized. Just a change in the form of ownership (direct vs.
indirect) has occurred. Therefore, it is not appropriate to recognize gains and losses at this
time.
3. With taxation, corporations will have to raise more capital because transferors of noncash
property will have less capital to invest and because money must be diverted to pay taxes.
4. Taxpayers are prevented from recognizing losses under the current system, thereby
increasing revenues to the government.
5. With taxation, businesses would be deterred from incorporating because of the tax
consequences, and therefore economic growth in the U.S. would be adversely affected.
pp. C:2-9 and C:2-10.
C:2-7 The following tax consequences, if Sec. 351 applies: Neither the transferor nor the transferee
corporation recognizes gain or loss when property is exchanged for stock. Unless boot property is
received, the transferor’s realized gain or loss is deferred until he or she sells or exchanges the stock
received. If boot property is received, the recognized gain is the lesser of (1) the amount of money
plus the FMV of the nonmoney boot property received or (2) the realized gain. The transferor
recognizes no losses even if boot property is received. The transferor’s basis in the stock received
references his or her basis in the property transferred and is increased by any gain recognized and is
reduced by the amount of money plus the FMV of the nonmoney boot property received and the
amount of any liabilities assumed by the transferee corporation. The basis of the boot property is its
FMV. The transferee corporation recognizes no gain on the transfer. The transferee corporation’s
basis in the property received is the same basis that the transferor had in the property transferred
increased by any gain recognized by the transferor. pp. C:2-12, C:2-16, and C:2-17.
C:2-8 The following items are considered to be property: Money and almost any other kind of
tangible or intangible property, including installment obligations, accounts receivable, inventory,
equipment, patents, trademarks, trade names, and computer software. Property does not include
services, an indebtedness of the transferee corporation that is not evidenced by a security, or interest
on an indebtedness that accrued on or after the beginning of the transferor’s holding period for the
debt. pp. C:2-12 and C:2-13.
C:2-9 “Control” is defined as follows: Transferrers as a group must own at least 80% of the total
combined voting power of all classes of stock entitled to vote and at least 80% of the total number of
shares of all other classes of stock. The nonvoting stock ownership is tested on a class-by-class
basis. pp. C:2-13 through C:2-16.
C:2-10 The IRS has interpreted the phrase as follows: Sec. 351 requires the transferors to control the
transferee corporation immediately after the exchange but does not specify how long this control
must be maintained. The transferors, however, must not have a prearranged plan to dispose of their
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C:2-3
stock outside the control group. If they have such a plan, the IRS may not treat the transferors as in
control immediately after the exchange. p. C:2-16.
C:2-11 No. The Sec. 351 requirements are not met because Peter is not considered a transferor of
property. Even though he transferred $1,000 of money, this property is of nominal value--less than
10% of the value of the stock he received for services ($49,000). Therefore, only John and Mary are
deemed to have transferred property and, since they own only 66-2/3% of the stock of New
Corporation, they are not in control. The 10% minimum is specified in Rev. Proc. 77-37 and applies
only for advance ruling purposes. The shareholders may choose to engage in the transaction without
an advance ruling, report it as nontaxable, and run the risk of being audited, with the result that the
IRS treats the transaction as taxable. Alternatively, they might restructure the transaction by having
Peter provide a larger amount of cash to the corporation and take more shares of stock. Another
option would be for Peter to provide fewer services with the increased amount of cash and still
receive 100 shares of stock. pp. C:2-14 and C:2-15.
C:2-12 No. Section 351 does not require that the shareholders receive stock equal in value to the
property transferred. Section 351 would apply to the transfer by Susan and Fred if all other
requirements are met. However, Fred probably will be deemed to have made a gift of 25 shares of
stock, paid compensation of $25,000, or repaid a $25,000 debt to Susan by transferring the Spade
stock. pp. C:2-15 and C:2-16.
C:2-13 Yes. Section 351 applies to property transfers to an existing corporation. For the exchange to
be tax-free, the transferors must be in control of the corporation after the exchange. In this example,
Carl is not in control since he owns only 75 out of 125 shares, or 60% of the North stock. Therefore,
the Sec. 351 requirements are not met. To qualify under Sec. 351, Carl can transfer enough property
to acquire a total of 200 shares out of 250 (200 shares held by Carl and 50 shares held by Lynn)
outstanding shares. In this situation, Carl would own exactly 80% of North stock (250 shares x 0.80
= 200 shares). A less expensive alternative would be for Lynn to transfer property equal to or
exceeding $10,000 (50 shares owned x $2,000 per share x 10% minimum) to be considered a
transferor. pp. C:2-14 and C:2-15.
C:2-14 The transferor’s basis in stock received in a Sec. 351 exchange is determined as follows
(Sec. 358(a)):
Adjusted basis of property transferred to the corporation
Plus: Any gain recognized by the transferor
Minus: FMV of boot received from the corporation
Money received from the corporation
The amount of any liabilities assumed by the
transferee corporation
Adjusted basis of stock received
For purposes of calculating stock basis, liabilities assumed by the transferee corporation are
considered money and reduce the shareholder’s basis in any stock received (Sec. 358(d)).
stock outside the control group. If they have such a plan, the IRS may not treat the transferors as in
control immediately after the exchange. p. C:2-16.
C:2-11 No. The Sec. 351 requirements are not met because Peter is not considered a transferor of
property. Even though he transferred $1,000 of money, this property is of nominal value--less than
10% of the value of the stock he received for services ($49,000). Therefore, only John and Mary are
deemed to have transferred property and, since they own only 66-2/3% of the stock of New
Corporation, they are not in control. The 10% minimum is specified in Rev. Proc. 77-37 and applies
only for advance ruling purposes. The shareholders may choose to engage in the transaction without
an advance ruling, report it as nontaxable, and run the risk of being audited, with the result that the
IRS treats the transaction as taxable. Alternatively, they might restructure the transaction by having
Peter provide a larger amount of cash to the corporation and take more shares of stock. Another
option would be for Peter to provide fewer services with the increased amount of cash and still
receive 100 shares of stock. pp. C:2-14 and C:2-15.
C:2-12 No. Section 351 does not require that the shareholders receive stock equal in value to the
property transferred. Section 351 would apply to the transfer by Susan and Fred if all other
requirements are met. However, Fred probably will be deemed to have made a gift of 25 shares of
stock, paid compensation of $25,000, or repaid a $25,000 debt to Susan by transferring the Spade
stock. pp. C:2-15 and C:2-16.
C:2-13 Yes. Section 351 applies to property transfers to an existing corporation. For the exchange to
be tax-free, the transferors must be in control of the corporation after the exchange. In this example,
Carl is not in control since he owns only 75 out of 125 shares, or 60% of the North stock. Therefore,
the Sec. 351 requirements are not met. To qualify under Sec. 351, Carl can transfer enough property
to acquire a total of 200 shares out of 250 (200 shares held by Carl and 50 shares held by Lynn)
outstanding shares. In this situation, Carl would own exactly 80% of North stock (250 shares x 0.80
= 200 shares). A less expensive alternative would be for Lynn to transfer property equal to or
exceeding $10,000 (50 shares owned x $2,000 per share x 10% minimum) to be considered a
transferor. pp. C:2-14 and C:2-15.
C:2-14 The transferor’s basis in stock received in a Sec. 351 exchange is determined as follows
(Sec. 358(a)):
Adjusted basis of property transferred to the corporation
Plus: Any gain recognized by the transferor
Minus: FMV of boot received from the corporation
Money received from the corporation
The amount of any liabilities assumed by the
transferee corporation
Adjusted basis of stock received
For purposes of calculating stock basis, liabilities assumed by the transferee corporation are
considered money and reduce the shareholder’s basis in any stock received (Sec. 358(d)).
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C:2-4
The shareholder’s holding period for the stock includes the holding period of any capital
assets or Sec. 1231 assets transferred. If the shareholder transfers any other property (e.g.,
inventory), the holding period for any stock received begins on the day after the exchange date. This
rule can cause some shares of transferee corporation stock to have two different holding periods.
The shareholder’s basis for any boot property is its FMV and the holding period begins on the day
after the exchange date (Sec. 358(a)(2)). pp. C:2-18 and C:2-19.
C:2-15 Two sets of circumstances may require recognition of gain when liabilities are transferred.
• First, all liabilities assumed by a controlled corporation are considered boot if the
principal purpose of the transfer of any portion of such liabilities is tax avoidance or
if no bona fide business purpose exists for the transfer (Sec. 357(b)).
• Second, if the total amount of liabilities transferred to a controlled corporation
exceeds the total adjusted basis of all property transferred by the transferor, the
excess liability amount is treated as a gain taxable to the transferor without regard to
whether the transferor had actually realized gain or loss (Sec. 357(c)).
Under the second set of circumstances, the transferor recognizes gain, but the excess
liabilities are not considered to be boot. Section 357(c)(3) provides special rules for cash and hybrid
method of accounting transferors who transfer excess liabilities to a corporation. pp. C:2-22 through
C:2-25.
C:2-16 The IRS likely would consider the following two factors: (1) The transferor’s reason for
incurring the liability (e.g., did the liability relate to the transferor’s trade or business). (2) The length
of time from when the liability was incurred to the transfer date. If the transferor incurred the
liability in connection with his or her trade or business, a Sec. 357(b) “problem” probably would not
exist even if the transferor incurred the liability shortly before the transfer date. pp. C:2-12 through
C:2-27.
C:2-17 If Mark receives no boot, depreciation is not recaptured (Secs. 1245(b)(3) and 1250(d)(3)).
The recapture potential is transferred to Utah Corporation along with the property. If Mark does
receive boot and must recognize gain, the recognized gain is treated as ordinary income but not in an
amount exceeding the recapture potential. Any remaining recapture potential is transferred to Utah.
If Utah sells the property at a gain, it must recapture depreciation deducted by Mark and not
recaptured at the time of the transfer, as well as depreciation that it has claimed. Depreciation in the
year of transfer must be allocated between the transferor and transferee according to the number of
months each party has held the property. The transferee is considered to have held the property for
the entire month in which the property was transferred. pp. C:2-25 through C:2-27.
C:2-18 The assignment of income doctrine could apply to a transfer of unearned income. However,
the assignment of income doctrine does not apply to a transfer of accounts receivable by a cash
method transferor in a Sec. 351 exchange if (1) the transferor transfers substantially all the assets and
liabilities of a business and (2) a business purpose exists for the transfer. (See Rev. Rul. 80-198,
1980-2 C.B. 113.) p. C:2-27.
The shareholder’s holding period for the stock includes the holding period of any capital
assets or Sec. 1231 assets transferred. If the shareholder transfers any other property (e.g.,
inventory), the holding period for any stock received begins on the day after the exchange date. This
rule can cause some shares of transferee corporation stock to have two different holding periods.
The shareholder’s basis for any boot property is its FMV and the holding period begins on the day
after the exchange date (Sec. 358(a)(2)). pp. C:2-18 and C:2-19.
C:2-15 Two sets of circumstances may require recognition of gain when liabilities are transferred.
• First, all liabilities assumed by a controlled corporation are considered boot if the
principal purpose of the transfer of any portion of such liabilities is tax avoidance or
if no bona fide business purpose exists for the transfer (Sec. 357(b)).
• Second, if the total amount of liabilities transferred to a controlled corporation
exceeds the total adjusted basis of all property transferred by the transferor, the
excess liability amount is treated as a gain taxable to the transferor without regard to
whether the transferor had actually realized gain or loss (Sec. 357(c)).
Under the second set of circumstances, the transferor recognizes gain, but the excess
liabilities are not considered to be boot. Section 357(c)(3) provides special rules for cash and hybrid
method of accounting transferors who transfer excess liabilities to a corporation. pp. C:2-22 through
C:2-25.
C:2-16 The IRS likely would consider the following two factors: (1) The transferor’s reason for
incurring the liability (e.g., did the liability relate to the transferor’s trade or business). (2) The length
of time from when the liability was incurred to the transfer date. If the transferor incurred the
liability in connection with his or her trade or business, a Sec. 357(b) “problem” probably would not
exist even if the transferor incurred the liability shortly before the transfer date. pp. C:2-12 through
C:2-27.
C:2-17 If Mark receives no boot, depreciation is not recaptured (Secs. 1245(b)(3) and 1250(d)(3)).
The recapture potential is transferred to Utah Corporation along with the property. If Mark does
receive boot and must recognize gain, the recognized gain is treated as ordinary income but not in an
amount exceeding the recapture potential. Any remaining recapture potential is transferred to Utah.
If Utah sells the property at a gain, it must recapture depreciation deducted by Mark and not
recaptured at the time of the transfer, as well as depreciation that it has claimed. Depreciation in the
year of transfer must be allocated between the transferor and transferee according to the number of
months each party has held the property. The transferee is considered to have held the property for
the entire month in which the property was transferred. pp. C:2-25 through C:2-27.
C:2-18 The assignment of income doctrine could apply to a transfer of unearned income. However,
the assignment of income doctrine does not apply to a transfer of accounts receivable by a cash
method transferor in a Sec. 351 exchange if (1) the transferor transfers substantially all the assets and
liabilities of a business and (2) a business purpose exists for the transfer. (See Rev. Rul. 80-198,
1980-2 C.B. 113.) p. C:2-27.
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C:2-5
C:2-19 In enacting Sec. 385, Congress mandated that the following factors be taken into account in
determining whether an amount advanced to a corporation should be characterized as debt or equity
capital:
• Whether there is a written unconditional promise to pay on demand or on a specified
date a sum certain in money in return for an adequate consideration in money or
money’s worth, and to pay a fixed rate of interest,
• Whether the debt is subordinate to or preferred over other indebtedness of the
corporation,
• The ratio of debt to equity of the corporation,
• Whether the debt is convertible into the stock of the corporation, and
• The relationship between holdings of stock in the corporation and holdings of the
interest in question.
Although Congress enacted Sec. 385 in an attempt to provide statutory guidelines for the debt/equity
question, the lack of a subsequent set of interpretative regulations has required taxpayers, the IRS,
and the courts to continue to use these statutory factors and other factors identified by the courts in
ascertaining whether an instrument is debt or equity. Amendment of Sec. 385 in 1989 to permit
part-debt and part-equity corporate instruments has lead to the issuance of administrative
pronouncements (e.g., Notice 94-97, 1947-1 C.B. 357) that interpret the Sec. 385 statutory
guidelines. See also O.H. Kruse Grain & Milling v. CIR, 5 AFTR 2d 1544, 60-2 USTC ¶9490 (9th
Cir., 1960) cited in footnote 47 of the text, which lists additional factors the courts might consider.
pp. C:2-27 and C:2-28.
C:2-20 Advantages of using debt include: Interest is deductible by the payor while a dividend
payment is not deductible, and the repayment of an indebtedness generally is treated as a return of
capital while a stock redemption often is treated as a dividend. Disadvantages of using debt include
that dividend payments are eligible for a dividends-received deduction when received by a corporate
shareholder; stock can be received tax-free as part of a corporate formation and/or reorganization
while the receipt of debt usually is treated as boot; a distribution of stock to shareholders can be a
nontaxable stock dividend while a distribution of a debt usually results in dividend income; and
worthless stock results in an ordinary loss under Sec. 1244 while a worthless debt instrument
generally results in a capital loss. pp. C:2-29 and C:2-30.
C:2-21 Ordinary loss treatment. The principal advantage of satisfying the Sec. 1244 small business
stock requirements is the ordinary loss treatment available for individual shareholders and certain
partnerships reporting up to $50,000 (or $100,000 if married and filing jointly) of losses incurred on
a sale or exchange of the stock. Ordinary loss treatment is available only if the loss is incurred by a
qualifying shareholder who acquired the stock from the small business corporation; the corporation
was a small business corporation at the time it issued the stock (i.e., a corporation whose aggregate
money and other property received for stock is less than $1 million); the corporation issued the stock
for money or property (other than stock or securities); and the issuing corporation derived more than
50% of its aggregate gross receipts from active sources during the most recent five tax years ending
on the date when the stock was sold or exchanged. pp. C:2-32 and C:2-33.
C:2-19 In enacting Sec. 385, Congress mandated that the following factors be taken into account in
determining whether an amount advanced to a corporation should be characterized as debt or equity
capital:
• Whether there is a written unconditional promise to pay on demand or on a specified
date a sum certain in money in return for an adequate consideration in money or
money’s worth, and to pay a fixed rate of interest,
• Whether the debt is subordinate to or preferred over other indebtedness of the
corporation,
• The ratio of debt to equity of the corporation,
• Whether the debt is convertible into the stock of the corporation, and
• The relationship between holdings of stock in the corporation and holdings of the
interest in question.
Although Congress enacted Sec. 385 in an attempt to provide statutory guidelines for the debt/equity
question, the lack of a subsequent set of interpretative regulations has required taxpayers, the IRS,
and the courts to continue to use these statutory factors and other factors identified by the courts in
ascertaining whether an instrument is debt or equity. Amendment of Sec. 385 in 1989 to permit
part-debt and part-equity corporate instruments has lead to the issuance of administrative
pronouncements (e.g., Notice 94-97, 1947-1 C.B. 357) that interpret the Sec. 385 statutory
guidelines. See also O.H. Kruse Grain & Milling v. CIR, 5 AFTR 2d 1544, 60-2 USTC ¶9490 (9th
Cir., 1960) cited in footnote 47 of the text, which lists additional factors the courts might consider.
pp. C:2-27 and C:2-28.
C:2-20 Advantages of using debt include: Interest is deductible by the payor while a dividend
payment is not deductible, and the repayment of an indebtedness generally is treated as a return of
capital while a stock redemption often is treated as a dividend. Disadvantages of using debt include
that dividend payments are eligible for a dividends-received deduction when received by a corporate
shareholder; stock can be received tax-free as part of a corporate formation and/or reorganization
while the receipt of debt usually is treated as boot; a distribution of stock to shareholders can be a
nontaxable stock dividend while a distribution of a debt usually results in dividend income; and
worthless stock results in an ordinary loss under Sec. 1244 while a worthless debt instrument
generally results in a capital loss. pp. C:2-29 and C:2-30.
C:2-21 Ordinary loss treatment. The principal advantage of satisfying the Sec. 1244 small business
stock requirements is the ordinary loss treatment available for individual shareholders and certain
partnerships reporting up to $50,000 (or $100,000 if married and filing jointly) of losses incurred on
a sale or exchange of the stock. Ordinary loss treatment is available only if the loss is incurred by a
qualifying shareholder who acquired the stock from the small business corporation; the corporation
was a small business corporation at the time it issued the stock (i.e., a corporation whose aggregate
money and other property received for stock is less than $1 million); the corporation issued the stock
for money or property (other than stock or securities); and the issuing corporation derived more than
50% of its aggregate gross receipts from active sources during the most recent five tax years ending
on the date when the stock was sold or exchanged. pp. C:2-32 and C:2-33.
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C:2-6
C:2-22 The two advantages of business bad debt treatment are (1) a business bad debt deduction can
be claimed for partial worthlessness and (2) a business bad debt can be deducted as an ordinary loss. A
nonbusiness bad debt can be deducted only in the year in which total worthlessness occurs. No partial
write-offs of nonbusiness bad debts are permitted. A nonbusiness bad debt can be deducted only as a
short-term capital loss. These losses can offset capital gains or be deducted by individuals up to
$3,000 in a tax year. No limit exists on business bad debt deductions and, if such losses exceed
income, they can be carried back as part of a net operating loss. To claim a business bad debt
deduction, the holder must show that the dominant motivation for the loan was related to the
taxpayer’s business and was not related to the taxpayer’s investment activities. pp. C:2-33 and C:2-34.
C:2-23 To recognize gain or loss. Shareholders might avoid Sec. 351 treatment if, in transferring
property, they realize a gain or loss that they want to recognize. They may be able to avoid Sec. 351
treatment by violating one or more of its requirements, for example, by selling the property to the
corporation for cash, by selling the property to a third party who contributes it to the corporation, or
by receiving sufficient boot to recognize the gain. pp. C:2-34 through C:2-36.
C:2-24 The reporting requirements areas follows: Every person who receives stock, securities, or
other property in a Sec. 351 exchange must attach a statement to his or her tax return for the period that
includes the date of the exchange. The statement must include all the facts pertinent to the exchange
(see Reg. Sec. 1.351-3(a)). Similarly, the transferee corporation must attach a statement to its tax
return for the year in which the exchange took place (see Reg. Sec. 1.351-3(b)). The transferee’s
statement requires a description of the property and liabilities received from the transferors and the
stock and property transferred to the transferors in exchange for the property. p. C:2-36.
Issue Identification Questions
C:2-25 Mary and Peter should consider the following tax issues:
• Does the property transfer meet the Sec. 351 requirements?
• Have Peter and Mary transferred property? Does Peter’s controlling Trenton
Corporation prior to the transfer change the tax result?
• Are the transferors in control of the corporation following the transfer?
• Do the transferors receive transferee corporation stock?
• What is each shareholder’s recognized gain?
• What is each shareholder’s basis in his or her stock?
• What is each shareholder’s holding period for his or her stock?
• Does Trenton recognize gain when it issues its stock?
• What is Trenton’s basis in the property received from Mary?
• What is Trenton’s holding period for the property received from Mary?
The property transfer meets all the Sec. 351 requirements. Peter and Mary are considered to
own all 195 of the Trenton shares immediately after the exchange. Peter’s contribution of cash for
stock is not considered to be a nominal amount according to IRS rules relating to the issuance of
private letter rulings (i.e., it equals or exceeds 10% of the value of Peter’s prior stock holdings).
Thus, his stock is counted towards the 80% minimum stock ownership for control. Mary recognizes
no gain on the asset transfer and takes a $50,000 basis in the Trenton shares she receives. The
C:2-22 The two advantages of business bad debt treatment are (1) a business bad debt deduction can
be claimed for partial worthlessness and (2) a business bad debt can be deducted as an ordinary loss. A
nonbusiness bad debt can be deducted only in the year in which total worthlessness occurs. No partial
write-offs of nonbusiness bad debts are permitted. A nonbusiness bad debt can be deducted only as a
short-term capital loss. These losses can offset capital gains or be deducted by individuals up to
$3,000 in a tax year. No limit exists on business bad debt deductions and, if such losses exceed
income, they can be carried back as part of a net operating loss. To claim a business bad debt
deduction, the holder must show that the dominant motivation for the loan was related to the
taxpayer’s business and was not related to the taxpayer’s investment activities. pp. C:2-33 and C:2-34.
C:2-23 To recognize gain or loss. Shareholders might avoid Sec. 351 treatment if, in transferring
property, they realize a gain or loss that they want to recognize. They may be able to avoid Sec. 351
treatment by violating one or more of its requirements, for example, by selling the property to the
corporation for cash, by selling the property to a third party who contributes it to the corporation, or
by receiving sufficient boot to recognize the gain. pp. C:2-34 through C:2-36.
C:2-24 The reporting requirements areas follows: Every person who receives stock, securities, or
other property in a Sec. 351 exchange must attach a statement to his or her tax return for the period that
includes the date of the exchange. The statement must include all the facts pertinent to the exchange
(see Reg. Sec. 1.351-3(a)). Similarly, the transferee corporation must attach a statement to its tax
return for the year in which the exchange took place (see Reg. Sec. 1.351-3(b)). The transferee’s
statement requires a description of the property and liabilities received from the transferors and the
stock and property transferred to the transferors in exchange for the property. p. C:2-36.
Issue Identification Questions
C:2-25 Mary and Peter should consider the following tax issues:
• Does the property transfer meet the Sec. 351 requirements?
• Have Peter and Mary transferred property? Does Peter’s controlling Trenton
Corporation prior to the transfer change the tax result?
• Are the transferors in control of the corporation following the transfer?
• Do the transferors receive transferee corporation stock?
• What is each shareholder’s recognized gain?
• What is each shareholder’s basis in his or her stock?
• What is each shareholder’s holding period for his or her stock?
• Does Trenton recognize gain when it issues its stock?
• What is Trenton’s basis in the property received from Mary?
• What is Trenton’s holding period for the property received from Mary?
The property transfer meets all the Sec. 351 requirements. Peter and Mary are considered to
own all 195 of the Trenton shares immediately after the exchange. Peter’s contribution of cash for
stock is not considered to be a nominal amount according to IRS rules relating to the issuance of
private letter rulings (i.e., it equals or exceeds 10% of the value of Peter’s prior stock holdings).
Thus, his stock is counted towards the 80% minimum stock ownership for control. Mary recognizes
no gain on the asset transfer and takes a $50,000 basis in the Trenton shares she receives. The
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C:2-7
holding period for the Trenton shares includes her holding period for the property transferred.
Trenton recognizes no gain when it issues its stock and takes a $50,000 basis in the property.
pp. C:2-12 through C:2-30.
C:2-26 Carl and his son should consider the following tax issues:
• Does the property transfer meet the Sec. 351 requirements?
• Have Carl and his son transferred property?
• Are the transferors in control of the corporation immediately after the
transfer?
• Do the transferors receive transferee corporation stock?
• Does the property contribution/receipt of stock as described in the facts reflect the
true nature of the transaction? Or, has a deemed gift or other event occurred?
• What is each shareholder’s recognized gain?
• What is each shareholder’s basis in his stock?
• What is each shareholder’s holding period in his stock?
• If a deemed gift has been made, is it a taxable gift from Carl to his son? (This
question could be rewritten for events other than a gift (e.g., repayment of a loan.))
• What is Cook Corporation’s basis in the property received from Carl?
• What is Cook’s holding period for the property received from Carl?
The contribution is nontaxable because it meets all the Sec. 351 requirements, and Carl and
Carl, Jr. own all the Cook stock. Carl, Jr. receives a disproportionate amount of stock relative to his
$20,000 capital contribution. It appears that the transaction should be recast so that Carl is deemed
to receive 80 shares of stock, each valued at $1,000. He then gifts 30 shares to Carl, Jr. The deemed
gift leaves each shareholder with 50 shares of stock. Neither shareholder recognizes any gain, and
Carl takes a $50,000 adjusted basis in the 80 shares he receives. He recognizes no gain on the
transfer of 30 shares to Carl, Jr., and $18,750 [(30/80) x $50,000] of his basis accompanies the
deemed gifted shares. Carl’s basis in his remaining 50 shares is $31,250 ($50,000 - $18,750). Carl,
Jr’s basis in his 50 shares is $38,750 ($20,000 + $18,750). pp. C:2-9 through C:2-27.
C:2-27 Bill should consider the following tax issues:
• Was the stock sold to a related party (Sam), as defined by Sec. 267(b)? If so, Bill cannot
recognize the loss, and the remaining issues need not be examined. If not, then...
• Is the stock a capital asset?
• Is Bold a qualifying small business corporation?
• If so, does the stock qualify for Sec. 1244 stock treatment?
• If Sec. 1244 stock, what is Bill’s marital and filing status?
• Has Bill’s basis in the stock changed relative to its initial acquisition cost?
• What is the amount and character of Bill’s recognized loss?
Bill’s stock sale results in the realization of a $65,000 ($100,000 - $35,000) long-term capital
loss. If the purchaser is a related party, Sec. 267(a) precludes Bill from recognizing the loss.
Because Bill is the original holder of the stock, the loss may be characterized as ordinary under Sec.
1244, assuming the various requirements of that provision are satisfied. pp. C:2-32 and C:2-33.
holding period for the Trenton shares includes her holding period for the property transferred.
Trenton recognizes no gain when it issues its stock and takes a $50,000 basis in the property.
pp. C:2-12 through C:2-30.
C:2-26 Carl and his son should consider the following tax issues:
• Does the property transfer meet the Sec. 351 requirements?
• Have Carl and his son transferred property?
• Are the transferors in control of the corporation immediately after the
transfer?
• Do the transferors receive transferee corporation stock?
• Does the property contribution/receipt of stock as described in the facts reflect the
true nature of the transaction? Or, has a deemed gift or other event occurred?
• What is each shareholder’s recognized gain?
• What is each shareholder’s basis in his stock?
• What is each shareholder’s holding period in his stock?
• If a deemed gift has been made, is it a taxable gift from Carl to his son? (This
question could be rewritten for events other than a gift (e.g., repayment of a loan.))
• What is Cook Corporation’s basis in the property received from Carl?
• What is Cook’s holding period for the property received from Carl?
The contribution is nontaxable because it meets all the Sec. 351 requirements, and Carl and
Carl, Jr. own all the Cook stock. Carl, Jr. receives a disproportionate amount of stock relative to his
$20,000 capital contribution. It appears that the transaction should be recast so that Carl is deemed
to receive 80 shares of stock, each valued at $1,000. He then gifts 30 shares to Carl, Jr. The deemed
gift leaves each shareholder with 50 shares of stock. Neither shareholder recognizes any gain, and
Carl takes a $50,000 adjusted basis in the 80 shares he receives. He recognizes no gain on the
transfer of 30 shares to Carl, Jr., and $18,750 [(30/80) x $50,000] of his basis accompanies the
deemed gifted shares. Carl’s basis in his remaining 50 shares is $31,250 ($50,000 - $18,750). Carl,
Jr’s basis in his 50 shares is $38,750 ($20,000 + $18,750). pp. C:2-9 through C:2-27.
C:2-27 Bill should consider the following tax issues:
• Was the stock sold to a related party (Sam), as defined by Sec. 267(b)? If so, Bill cannot
recognize the loss, and the remaining issues need not be examined. If not, then...
• Is the stock a capital asset?
• Is Bold a qualifying small business corporation?
• If so, does the stock qualify for Sec. 1244 stock treatment?
• If Sec. 1244 stock, what is Bill’s marital and filing status?
• Has Bill’s basis in the stock changed relative to its initial acquisition cost?
• What is the amount and character of Bill’s recognized loss?
Bill’s stock sale results in the realization of a $65,000 ($100,000 - $35,000) long-term capital
loss. If the purchaser is a related party, Sec. 267(a) precludes Bill from recognizing the loss.
Because Bill is the original holder of the stock, the loss may be characterized as ordinary under Sec.
1244, assuming the various requirements of that provision are satisfied. pp. C:2-32 and C:2-33.
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C:2-8
Problems
C:2-28 With the given facts, the C corporation option with the salary payment results in the lowest
total tax, as determined in the following analysis:
Sole
Proprietorship
C Corporation
With Salary
C Corporation
With Dividend
S Corporation
With Salary
S Corporation
With Distribution
Entity Level:
Income before salary $50,000 $50,000 $50,000 $50,000 $50,000
Salary deduction -0- (20,000) -0- (20,000) -0-
Taxable income $50,000 $30,000 $50,000 $30,000 $50,000
Entity level tax $ -0- $ 4,500 $ 7,500 $ -0- $ -0-
Lucia:
Pass-through income $50,000 $ -0- $ -0- $30,000 $50,000
Salary income -0- 20,000 -0- 20,000 -0-
Dividend income -0- -0- 20,000 -0- -0-
Total income to Lucia $50,000 $20,000 $20,000 $50,000 $50,000
Lucia’s tax $12,500a $ 5,000b $ 3,000c $12,500d $12,500e
Total Tax $12.500 $ 9,500 $10,500 $12.500 $12.500
a$50,000 x 0.25 = $12,500
b$20,000 x 0.25 = $5,000
c$20,000 x 0.15 = $3,000
d$50,000 x 0.25 = $12,500
e$50,000 x 0.25 = $12,500
Because corporate taxable income is low enough to be taxed at 15% and dividends are taxed at 15%,
the C corporation options are better than the sole proprietor and S corporation options because, under
the latter options, all income is taxed at Lucia’s 25% ordinary tax rate. Within the C corporation
options, the salary situation is better than the dividend situation because less income is subject to
double taxation as a result of the salary deduction. These results apply only to the given factual
circumstances. For example, if the corporation’s income were taxed at higher marginal tax rates,
such as 35% or 39%, the C corporation options would be less attractive than the sole proprietor and
S corporation options. pp. C:2-2 through C:2-8.
Problems
C:2-28 With the given facts, the C corporation option with the salary payment results in the lowest
total tax, as determined in the following analysis:
Sole
Proprietorship
C Corporation
With Salary
C Corporation
With Dividend
S Corporation
With Salary
S Corporation
With Distribution
Entity Level:
Income before salary $50,000 $50,000 $50,000 $50,000 $50,000
Salary deduction -0- (20,000) -0- (20,000) -0-
Taxable income $50,000 $30,000 $50,000 $30,000 $50,000
Entity level tax $ -0- $ 4,500 $ 7,500 $ -0- $ -0-
Lucia:
Pass-through income $50,000 $ -0- $ -0- $30,000 $50,000
Salary income -0- 20,000 -0- 20,000 -0-
Dividend income -0- -0- 20,000 -0- -0-
Total income to Lucia $50,000 $20,000 $20,000 $50,000 $50,000
Lucia’s tax $12,500a $ 5,000b $ 3,000c $12,500d $12,500e
Total Tax $12.500 $ 9,500 $10,500 $12.500 $12.500
a$50,000 x 0.25 = $12,500
b$20,000 x 0.25 = $5,000
c$20,000 x 0.15 = $3,000
d$50,000 x 0.25 = $12,500
e$50,000 x 0.25 = $12,500
Because corporate taxable income is low enough to be taxed at 15% and dividends are taxed at 15%,
the C corporation options are better than the sole proprietor and S corporation options because, under
the latter options, all income is taxed at Lucia’s 25% ordinary tax rate. Within the C corporation
options, the salary situation is better than the dividend situation because less income is subject to
double taxation as a result of the salary deduction. These results apply only to the given factual
circumstances. For example, if the corporation’s income were taxed at higher marginal tax rates,
such as 35% or 39%, the C corporation options would be less attractive than the sole proprietor and
S corporation options. pp. C:2-2 through C:2-8.
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C:2-9
C:2-29 a. None. Dick does not recognize his $10,000 realized loss.
b. $60,000 basis in Triton shares received. Dick’s holding period begins in 2011.
c. None. Evan does not recognize his $15,000 realized loss.
d. $45,000 basis in Triton shares received. Evan’s holding period begins in 2010.
e. Fran recognizes $20,000 of ordinary income.
f. $20,000 basis in Triton shares received. Fran’s holding period begins the day after the
exchange date in 2013.
g. Triton takes a $50,000 basis in the land and a $30,000 basis in the machinery.
Because of the loss property limitation rule, the bases of these assets are reduced to their respective
FMVs, assuming the parties do not elect to reduce stock basis. Thus, both assets have a holding
period that begins the day after the transfer in 2013. The services, if capitalized, would have a
$20,000 basis and a holding period starting in 2013. pp. C:2-9 through C:2-22.
C:2-30 a. $20,000 gain. The Sec. 351 requirements have not been met because 30% of the stock
is issued for services. Therefore, Ed recognizes $20,000 ($35,000 - $15,000) of capital gain.
b. $35,000 basis in Jet shares received. Ed’s holding period begins on the day after the
exchange date.
c. Fran recognizes a $10,000 ($35,000 - $45,000) Sec. 1231 loss.
d. $35,000 basis in Jet shares received. Fran’s holding period begins on the day after the
exchange date.
e. George recognizes $30,000 of ordinary income.
f. $30,000 basis in Jet shares received. George’s holding period begins the day after the
exchange date.
g. Jet Corporation takes a $35,000 basis in the land and a $35,000 basis in the
machinery. Its holding period for each asset begins the day after the exchange date. The services, if
capitalized, would have a $30,000 basis.
h. Because the Sec. 351 requirements would now have been met, the answers change as
follows:
a. Ed recognizes no gain or loss.
b. $15,000 basis in the Jet shares received. Ed’s holding period begins in 2009.
c. Fran recognizes no loss.
d. $45,000 basis in the Jet shares received. Fran’s holding period begins in 2009.
e. George recognizes $25,000 of ordinary income.
f. $30,000 ($5,000 cash + $25,000 FMV of services) basis in the Jet shares
received. George’s holding period begins the day after the exchange date.
g. Jet’s basis in the land and machinery are $15,000 and $35,000, respectively.
The loss property limitation rule limits the corporation’s basis in the
machinery to its FMV. Jet’s holding period for the land begins in 2009. The
holding period for the machinery begins the day after the exchange date
because, by having its basis reduced to FMV, it no longer has a basis that
references the transferor’s basis before the exchange. The services, if
capitalized, would have a $25,000 basis. pp. C:2-12 through C:2-22.
C:2-31 a. The control requirement is not met. Transferors of property receive only 75% and
thus do not have 80% control.
C:2-29 a. None. Dick does not recognize his $10,000 realized loss.
b. $60,000 basis in Triton shares received. Dick’s holding period begins in 2011.
c. None. Evan does not recognize his $15,000 realized loss.
d. $45,000 basis in Triton shares received. Evan’s holding period begins in 2010.
e. Fran recognizes $20,000 of ordinary income.
f. $20,000 basis in Triton shares received. Fran’s holding period begins the day after the
exchange date in 2013.
g. Triton takes a $50,000 basis in the land and a $30,000 basis in the machinery.
Because of the loss property limitation rule, the bases of these assets are reduced to their respective
FMVs, assuming the parties do not elect to reduce stock basis. Thus, both assets have a holding
period that begins the day after the transfer in 2013. The services, if capitalized, would have a
$20,000 basis and a holding period starting in 2013. pp. C:2-9 through C:2-22.
C:2-30 a. $20,000 gain. The Sec. 351 requirements have not been met because 30% of the stock
is issued for services. Therefore, Ed recognizes $20,000 ($35,000 - $15,000) of capital gain.
b. $35,000 basis in Jet shares received. Ed’s holding period begins on the day after the
exchange date.
c. Fran recognizes a $10,000 ($35,000 - $45,000) Sec. 1231 loss.
d. $35,000 basis in Jet shares received. Fran’s holding period begins on the day after the
exchange date.
e. George recognizes $30,000 of ordinary income.
f. $30,000 basis in Jet shares received. George’s holding period begins the day after the
exchange date.
g. Jet Corporation takes a $35,000 basis in the land and a $35,000 basis in the
machinery. Its holding period for each asset begins the day after the exchange date. The services, if
capitalized, would have a $30,000 basis.
h. Because the Sec. 351 requirements would now have been met, the answers change as
follows:
a. Ed recognizes no gain or loss.
b. $15,000 basis in the Jet shares received. Ed’s holding period begins in 2009.
c. Fran recognizes no loss.
d. $45,000 basis in the Jet shares received. Fran’s holding period begins in 2009.
e. George recognizes $25,000 of ordinary income.
f. $30,000 ($5,000 cash + $25,000 FMV of services) basis in the Jet shares
received. George’s holding period begins the day after the exchange date.
g. Jet’s basis in the land and machinery are $15,000 and $35,000, respectively.
The loss property limitation rule limits the corporation’s basis in the
machinery to its FMV. Jet’s holding period for the land begins in 2009. The
holding period for the machinery begins the day after the exchange date
because, by having its basis reduced to FMV, it no longer has a basis that
references the transferor’s basis before the exchange. The services, if
capitalized, would have a $25,000 basis. pp. C:2-12 through C:2-22.
C:2-31 a. The control requirement is not met. Transferors of property receive only 75% and
thus do not have 80% control.
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C:2-10
b. The control requirement is met. Robert transferred more than a nominal amount of
property. The 80% control requirement has been met since all of Robert’s stock is counted for this
purpose.
c. The control requirement is not met. Sam owns only 33-1/3% of the Vast stock
immediately after the exchange. No stock ownership is attributed from Sam’s parents to Sam.
d. The control requirement is met. Charles and Ruth own 100% of the Tiny stock. The
transfers do not have to be simultaneous.
e. The control requirement is not met. Charles had a prearranged plan to sell a
sufficient amount of shares to fail the control test. Only if Sam were considered to be a transferor
(i.e., the sale took place as part of a public offering) would the transaction meet the requirements of
Sec. 351. pp. C:2-13 through C:2-16.
C:2-32 a. The control requirement is met. The property transferred by Fred is not considered to
be nominal relative to the value of stock received for services. Therefore, Fred and Greta are
considered to own 100% of the New stock.
b. The control requirement is not met. For advance ruling purposes, Maureen’s shares
are not counted towards determining whether the control requirement has been met because the
property she contributed was nominal (i.e., does not meet the 10% property minimum of Rev. Proc.
77-37) compared to the value of the stock received for services. The taxpayer may choose to enter
into the transaction without an advance ruling, report it as nontaxable, and run the risk of being
audited, with the result that the IRS treats the transaction as taxable. Alternatively, Maureen can
contribute additional property so that the amount of property equals or exceeds the 10% minimum.
The minimum property contribution is $4,545 [$4,545 = 0.1 x ($50,000 - $4,545)]. pp. C:2-13
through C:2-16.
C:2-33 Veronica needs to receive 1,000 additional shares in exchange for $25,000 worth of silver
bullion. The 200 shares currently held by Veronica equal 40% of the 500 shares outstanding. To
avoid recognizing a gain, Veronica must be “in control” of Poly-Electron immediately after the
exchange. Control implies ownership of at least 80% of the total number of Poly-Electron shares
outstanding.
The number of additional shares that Veronica must acquire to achieve control can be
calculated as follows, where A = additional shares needed:
(200 + A) / (500 + A) = 0.80
200 + A = 0.80 x (500 + A)
200 + A = 400 + 0 .80 A
0.20 A = 200
A = 1,000 additional shares
Thus, with the additional 1,000 shares, Veronica will have 80% control after the exchange
(i.e., 1,200 / 1,500 = 80%.) If each share is worth $25, the value of silver bullion that Veronica must
contribute is $25,000 (1,000 shares x $25). Having achieved control, Veronica’s exchange will
qualify for nontaxable treatment under Sec. 351. pp. C:2-13 through C:2-15.
C:2-34 a. No. The exchange does not qualify as nontaxable under Sec. 351 because Al and Bob
do not control West Corporation. (Al owns only 1,000/1,300 = 76.9% of the voting common stock
b. The control requirement is met. Robert transferred more than a nominal amount of
property. The 80% control requirement has been met since all of Robert’s stock is counted for this
purpose.
c. The control requirement is not met. Sam owns only 33-1/3% of the Vast stock
immediately after the exchange. No stock ownership is attributed from Sam’s parents to Sam.
d. The control requirement is met. Charles and Ruth own 100% of the Tiny stock. The
transfers do not have to be simultaneous.
e. The control requirement is not met. Charles had a prearranged plan to sell a
sufficient amount of shares to fail the control test. Only if Sam were considered to be a transferor
(i.e., the sale took place as part of a public offering) would the transaction meet the requirements of
Sec. 351. pp. C:2-13 through C:2-16.
C:2-32 a. The control requirement is met. The property transferred by Fred is not considered to
be nominal relative to the value of stock received for services. Therefore, Fred and Greta are
considered to own 100% of the New stock.
b. The control requirement is not met. For advance ruling purposes, Maureen’s shares
are not counted towards determining whether the control requirement has been met because the
property she contributed was nominal (i.e., does not meet the 10% property minimum of Rev. Proc.
77-37) compared to the value of the stock received for services. The taxpayer may choose to enter
into the transaction without an advance ruling, report it as nontaxable, and run the risk of being
audited, with the result that the IRS treats the transaction as taxable. Alternatively, Maureen can
contribute additional property so that the amount of property equals or exceeds the 10% minimum.
The minimum property contribution is $4,545 [$4,545 = 0.1 x ($50,000 - $4,545)]. pp. C:2-13
through C:2-16.
C:2-33 Veronica needs to receive 1,000 additional shares in exchange for $25,000 worth of silver
bullion. The 200 shares currently held by Veronica equal 40% of the 500 shares outstanding. To
avoid recognizing a gain, Veronica must be “in control” of Poly-Electron immediately after the
exchange. Control implies ownership of at least 80% of the total number of Poly-Electron shares
outstanding.
The number of additional shares that Veronica must acquire to achieve control can be
calculated as follows, where A = additional shares needed:
(200 + A) / (500 + A) = 0.80
200 + A = 0.80 x (500 + A)
200 + A = 400 + 0 .80 A
0.20 A = 200
A = 1,000 additional shares
Thus, with the additional 1,000 shares, Veronica will have 80% control after the exchange
(i.e., 1,200 / 1,500 = 80%.) If each share is worth $25, the value of silver bullion that Veronica must
contribute is $25,000 (1,000 shares x $25). Having achieved control, Veronica’s exchange will
qualify for nontaxable treatment under Sec. 351. pp. C:2-13 through C:2-15.
C:2-34 a. No. The exchange does not qualify as nontaxable under Sec. 351 because Al and Bob
do not control West Corporation. (Al owns only 1,000/1,300 = 76.9% of the voting common stock
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C:2-11
while Bob owns 100% of the nonvoting preferred stock). Al recognizes $25,000 of gain on the
transfer of the patent. His basis in his West stock is $25,000. Bob recognizes no gain or loss
because he contributed cash. His basis in the preferred stock is $25,000. Carl recognizes $7,500 of
ordinary income. His basis in his West stock is $7,500. West recognizes no gain or loss on the
exchange. Its basis for the assets is: cash, $25,000; patent, $25,000; and services, $7,500.
b. Nontaxable. The exchange now qualifies as nontaxable under Sec. 351 because Al
and Bob together own 1,200/1,500 = 80% of the voting common stock and 100% of the nonvoting
preferred stock. Al recognizes no gain or loss, and his basis in his West stock is zero. Bob
recognizes no gain or loss, and his basis in his West stock is $25,000. Carl recognizes $7,500 of
ordinary income, and his basis in his West stock is $7,500. The consequences to West are the same
as in Part a, except the basis for the patent is zero instead of $25,000.
c. Nontaxable. The exchange apparently would qualify under Sec. 351. Assuming the
$800 of cash contributed is acceptable under Rev. Proc. 77-37 because it meets the 10% property
minimum for advance ruling purposes, Al and Bob would recognize no gain or loss. Carl would
recognize $6,700 of ordinary income. The consequences to West are the same as in Part b except the
cash contributed by Carl takes an $800 basis and the services generate $6,700 of taxable income.
pp. C:2-13 through C:2-16.
C:2-35
Cash Equipment Building Land Total
FMV of assets $ 5,000 $90,000 $40,000 $30,000 $165,000
Fraction of total value 0.030303 0.545455 0.242424 0.181818 1.0000
FMV of stock received $ 3,788 $68,182 $30,303 $22,727 $125,000
Plus: Boot property 1,212 21,818 9,697 7,273 40,000
Total proceeds $ 5,000 $90,000 $40,000 $30,000 $165,000
Minus: Adj. basis of
assets ( 5,000) ( 60,000) ( 51,000) ( 24,000) (140,000)
Gain (loss) realized $ -0- $30,000 ($11,000) $ 6,000 $ 25,000
Allocation of boot $ 1,212 $21,818 $ 9,697 $ 7,273 $ 40,000
Gain recognized $ -0- $21,818 $ -0- $ 6,000 $ 27,818
a. $27,818 gain recognized:
Gain on equipment, ordinary income
(recapture on Sec. 1245 property) $21,818
Gain on land, Sec. 1231 gain 6,000
Total gain recognized $27,818
while Bob owns 100% of the nonvoting preferred stock). Al recognizes $25,000 of gain on the
transfer of the patent. His basis in his West stock is $25,000. Bob recognizes no gain or loss
because he contributed cash. His basis in the preferred stock is $25,000. Carl recognizes $7,500 of
ordinary income. His basis in his West stock is $7,500. West recognizes no gain or loss on the
exchange. Its basis for the assets is: cash, $25,000; patent, $25,000; and services, $7,500.
b. Nontaxable. The exchange now qualifies as nontaxable under Sec. 351 because Al
and Bob together own 1,200/1,500 = 80% of the voting common stock and 100% of the nonvoting
preferred stock. Al recognizes no gain or loss, and his basis in his West stock is zero. Bob
recognizes no gain or loss, and his basis in his West stock is $25,000. Carl recognizes $7,500 of
ordinary income, and his basis in his West stock is $7,500. The consequences to West are the same
as in Part a, except the basis for the patent is zero instead of $25,000.
c. Nontaxable. The exchange apparently would qualify under Sec. 351. Assuming the
$800 of cash contributed is acceptable under Rev. Proc. 77-37 because it meets the 10% property
minimum for advance ruling purposes, Al and Bob would recognize no gain or loss. Carl would
recognize $6,700 of ordinary income. The consequences to West are the same as in Part b except the
cash contributed by Carl takes an $800 basis and the services generate $6,700 of taxable income.
pp. C:2-13 through C:2-16.
C:2-35
Cash Equipment Building Land Total
FMV of assets $ 5,000 $90,000 $40,000 $30,000 $165,000
Fraction of total value 0.030303 0.545455 0.242424 0.181818 1.0000
FMV of stock received $ 3,788 $68,182 $30,303 $22,727 $125,000
Plus: Boot property 1,212 21,818 9,697 7,273 40,000
Total proceeds $ 5,000 $90,000 $40,000 $30,000 $165,000
Minus: Adj. basis of
assets ( 5,000) ( 60,000) ( 51,000) ( 24,000) (140,000)
Gain (loss) realized $ -0- $30,000 ($11,000) $ 6,000 $ 25,000
Allocation of boot $ 1,212 $21,818 $ 9,697 $ 7,273 $ 40,000
Gain recognized $ -0- $21,818 $ -0- $ 6,000 $ 27,818
a. $27,818 gain recognized:
Gain on equipment, ordinary income
(recapture on Sec. 1245 property) $21,818
Gain on land, Sec. 1231 gain 6,000
Total gain recognized $27,818
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C:2-12
b. $40,000 basis in stock:
Adj. basis of property transferred $140,000
Minus: FMV of boot received (40,000)
Plus: Gain recognized by transferor 27,818
Basis in stock $127,818
Basis in interest-bearing notes ($10,000 each): $ 40,000
c. $165,000 total basis in the property received:
Tom’s Basis Recog. Gain Reduction* Total
Cash $ 5,000 $ -0- $ -0- $ 5,000
Equipment 60,000 21,818 -0- 81,818
Building 51,000 -0- (2,818) 48,182
Land 24,000 6,000 -0- 30,000
Total $140,000 $27,818 $(2,818) $165,000
pp. C:2-16 through C:2-22.
*Total adjusted basis = $167,818 ($140,000 + $27,818); total FMV = $165,000. Thus, the
reduction under Sec. 362(e)(2) = $2,818 ($167,818 - $165,000). Per Prop. Reg. Sec. 1.362-
4(b)(4)(ii), adjusted basis includes the increase for gain recognized by the shareholder.
C:2-36 $15,000. Ann must recognize $15,000 ($25,000 - $10,000) of gain on the exchange. To
comply with the advance ruling requirements of Rev. Proc. 77-37, Fred must receive more than a
nominal amount of stock in exchange for his property. If Fred obtained additional stock worth at
least 10% of the value of the stock he already owned (i.e., at least five shares of stock in exchange
for $5,000), his stock likely would be counted for control purposes, and the Sec. 351 requirements
would be met. Ann may choose to enter into the transaction without increasing her property
contribution so as to acquire at least 80% of Zero’s stock or without having Fred increase his
contribution to at least $5,000, proceed without an advance ruling, and report the transaction as
being nontaxable. Ann and Fred then run the risk of being audited and the IRS’s arguing the
transaction is taxable. pp. C:2-14 and C:2-15.
C:2-37 $4,000. Lucy recognizes $4,000 ($12,000 - $8,000) gain on the exchange because she owns
less than 80% of the stock after the exchange [(50+10)/110=54.5%]. To qualify under Sec. 351:
(1) Lucy could contribute additional property for enough additional stock to obtain 80% control. To
meet the 80% control requirement, she would have to purchase an additional 150 shares to own 200
shares (of the 250 shares outstanding).
(2) Marvin could exchange enough property as part of the same transaction to qualify as a transferor
under Sec. 351. For advance ruling purposes under Rev. Proc. 77-37, Marvin would have to
contribute at least $6,000 for an additional five shares of stock to be considered a transferor of
property. The taxpayers may choose to engage in the transaction without Lucy’s and Marvin’s
increasing their property contributions, proceed without an advance ruling, and report it as being
nontaxable. However, they would run the risk of being audited and the IRS’s arguing the transaction
is taxable. pp. C:2-14 and C:2-15.
b. $40,000 basis in stock:
Adj. basis of property transferred $140,000
Minus: FMV of boot received (40,000)
Plus: Gain recognized by transferor 27,818
Basis in stock $127,818
Basis in interest-bearing notes ($10,000 each): $ 40,000
c. $165,000 total basis in the property received:
Tom’s Basis Recog. Gain Reduction* Total
Cash $ 5,000 $ -0- $ -0- $ 5,000
Equipment 60,000 21,818 -0- 81,818
Building 51,000 -0- (2,818) 48,182
Land 24,000 6,000 -0- 30,000
Total $140,000 $27,818 $(2,818) $165,000
pp. C:2-16 through C:2-22.
*Total adjusted basis = $167,818 ($140,000 + $27,818); total FMV = $165,000. Thus, the
reduction under Sec. 362(e)(2) = $2,818 ($167,818 - $165,000). Per Prop. Reg. Sec. 1.362-
4(b)(4)(ii), adjusted basis includes the increase for gain recognized by the shareholder.
C:2-36 $15,000. Ann must recognize $15,000 ($25,000 - $10,000) of gain on the exchange. To
comply with the advance ruling requirements of Rev. Proc. 77-37, Fred must receive more than a
nominal amount of stock in exchange for his property. If Fred obtained additional stock worth at
least 10% of the value of the stock he already owned (i.e., at least five shares of stock in exchange
for $5,000), his stock likely would be counted for control purposes, and the Sec. 351 requirements
would be met. Ann may choose to enter into the transaction without increasing her property
contribution so as to acquire at least 80% of Zero’s stock or without having Fred increase his
contribution to at least $5,000, proceed without an advance ruling, and report the transaction as
being nontaxable. Ann and Fred then run the risk of being audited and the IRS’s arguing the
transaction is taxable. pp. C:2-14 and C:2-15.
C:2-37 $4,000. Lucy recognizes $4,000 ($12,000 - $8,000) gain on the exchange because she owns
less than 80% of the stock after the exchange [(50+10)/110=54.5%]. To qualify under Sec. 351:
(1) Lucy could contribute additional property for enough additional stock to obtain 80% control. To
meet the 80% control requirement, she would have to purchase an additional 150 shares to own 200
shares (of the 250 shares outstanding).
(2) Marvin could exchange enough property as part of the same transaction to qualify as a transferor
under Sec. 351. For advance ruling purposes under Rev. Proc. 77-37, Marvin would have to
contribute at least $6,000 for an additional five shares of stock to be considered a transferor of
property. The taxpayers may choose to engage in the transaction without Lucy’s and Marvin’s
increasing their property contributions, proceed without an advance ruling, and report it as being
nontaxable. However, they would run the risk of being audited and the IRS’s arguing the transaction
is taxable. pp. C:2-14 and C:2-15.
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C:2-13
C:2-38 a. None. Neither Jerry nor Frank recognizes any gain or loss on the exchange because
the Sec. 351 requirements have been met.
b. $44,000. Because the exchange is disproportionate, Frank probably could be deemed
to have made a gift of 25 shares of Texas stock to Jerry. Jerry’s basis in his 75 shares is $44,000
($28,000 basis in property transferred by Jerry + $16,000 basis in the 25 shares received from
Frank). This calculation presumes that no gift taxes are paid on the transfer. If gift taxes are paid, a
second basis adjustment may be needed for the portion of the gift tax attributable to the appreciation.
c. $16,000. Frank’s basis in his 25 Texas shares is $16,000 [$32,000 basis in property
transferred x (25/50)]. pp. C:2-15 and C:2-16.
C:2-39 a. $20,000 capital gain:
Amount realized $170,000
Minus: Basis in land ( 30,000)
Realized gain $140,000
Boot received (note) $ 20,000
Gain recognized (capital in character) $ 20,000
b. $30,000. Basis of common stock and preferred stock: $30,000 + $20,000 - $20,000 =
$30,000. This basis must be allocated to the common and preferred stock based on their relative fair
market values.
Basis of common stock: $100,000
$150,000 x $30,000 = $20,000
Basis of preferred stock: $50,000
$150,000 x $30,000 = $10,000
Basis of short-term note: $20,000 (FMV).
c. Basis of land to Temple Corporation: $50,000 = $30,000 + $20,000
pp. C:2-16 through C:2-22.
C:2-40 a. None for Karen and Larry; $7,000 capital gain to Joe. Karen and Larry recognize no
gain or loss under Sec. 351 because they receive only stock. Joe recognizes a $7,000 ($15,000 -
$8,000) capital gain because he receives only notes and therefore does not qualify for Sec. 351
treatment.
b. Joe’s basis in the notes is $15,000. Karen’s basis in the stock is $18,000. Larry’s
basis in the stock is $25,000.
c. Gray Corporation’s basis in the land is $15,000. Gray’s basis in the equipment is
$18,000. The $10,000 of depreciation recapture potential is inherited by Gray because Karen does
not recognize a gain on the asset transfer. pp. C:2-16 through C:2-19.
C:2-41 a. $4,000 gain. Nora realizes a $7,000 gain [($18,000 + $4,000) - $15,000] and must
recognize a gain of $4,000, the amount of the boot (note) received. Of the $4,000 gain, $3,000 is
ordinary income recaptured under Sec. 1245. The remaining $1,000 is a Sec. 1231 gain.
b. $4,000 and $15,000. Nora’s basis in the note is $4,000, its FMV. Nora’s basis in the
stock is $15,000 ($15,000 + $4,000 gain - $4,000 FMV of note).
C:2-38 a. None. Neither Jerry nor Frank recognizes any gain or loss on the exchange because
the Sec. 351 requirements have been met.
b. $44,000. Because the exchange is disproportionate, Frank probably could be deemed
to have made a gift of 25 shares of Texas stock to Jerry. Jerry’s basis in his 75 shares is $44,000
($28,000 basis in property transferred by Jerry + $16,000 basis in the 25 shares received from
Frank). This calculation presumes that no gift taxes are paid on the transfer. If gift taxes are paid, a
second basis adjustment may be needed for the portion of the gift tax attributable to the appreciation.
c. $16,000. Frank’s basis in his 25 Texas shares is $16,000 [$32,000 basis in property
transferred x (25/50)]. pp. C:2-15 and C:2-16.
C:2-39 a. $20,000 capital gain:
Amount realized $170,000
Minus: Basis in land ( 30,000)
Realized gain $140,000
Boot received (note) $ 20,000
Gain recognized (capital in character) $ 20,000
b. $30,000. Basis of common stock and preferred stock: $30,000 + $20,000 - $20,000 =
$30,000. This basis must be allocated to the common and preferred stock based on their relative fair
market values.
Basis of common stock: $100,000
$150,000 x $30,000 = $20,000
Basis of preferred stock: $50,000
$150,000 x $30,000 = $10,000
Basis of short-term note: $20,000 (FMV).
c. Basis of land to Temple Corporation: $50,000 = $30,000 + $20,000
pp. C:2-16 through C:2-22.
C:2-40 a. None for Karen and Larry; $7,000 capital gain to Joe. Karen and Larry recognize no
gain or loss under Sec. 351 because they receive only stock. Joe recognizes a $7,000 ($15,000 -
$8,000) capital gain because he receives only notes and therefore does not qualify for Sec. 351
treatment.
b. Joe’s basis in the notes is $15,000. Karen’s basis in the stock is $18,000. Larry’s
basis in the stock is $25,000.
c. Gray Corporation’s basis in the land is $15,000. Gray’s basis in the equipment is
$18,000. The $10,000 of depreciation recapture potential is inherited by Gray because Karen does
not recognize a gain on the asset transfer. pp. C:2-16 through C:2-19.
C:2-41 a. $4,000 gain. Nora realizes a $7,000 gain [($18,000 + $4,000) - $15,000] and must
recognize a gain of $4,000, the amount of the boot (note) received. Of the $4,000 gain, $3,000 is
ordinary income recaptured under Sec. 1245. The remaining $1,000 is a Sec. 1231 gain.
b. $4,000 and $15,000. Nora’s basis in the note is $4,000, its FMV. Nora’s basis in the
stock is $15,000 ($15,000 + $4,000 gain - $4,000 FMV of note).
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C:2-14
c. $19,000. Needle Corporation’s basis in the machinery is $19,000 ($15,000 + $4,000
gain recognized). pp. C:2-16 through C:2-22 and C:2-25 through C:2-27.
C:2-42a. $3,000 of ordinary income: Jim realizes a $3,500 [($5,000 + $1,000 + $2,000) -
$4,500] gain and recognizes a $3,000 gain. Because the $2,000 education loan assumed by Gold
Corporation has no apparent business purpose, all liabilities transferred to Gold are treated as boot
under Sec. 357(b). All of Jim’s gain is ordinary income recaptured under Sec. 1245.
b. $4,500. Jim’s basis in his stock is $4,500 ($4,500 + $3,000 - $3,000).
c. Jim’s holding period for the additional shares includes his holding period for the
automobile.
d. $7,500. Gold’s basis in the automobile is $7,500 ($4,500 + $3,000). pp. C:2-22 and
C:2-23.
C:2-43 a. $3,000 of ordinary income, determined as follows:
Stock (FMV) received $17,000
Release from liability 28,000
Amount realized $45,000
Minus: Basis of property transferred
Machinery $15,000
Money 10,000 (25,000)
Realized gain $20,000
Liability assumed $28,000
Minus: Basis of all property transferred ( 25,000)
Recognized gain (Sec. 357(c)) $ 3,000
The gain is treated as ordinary income under Sec. 1245 recapture rules.
b. Zero basis:
Property transferred $25,000
Minus: Boot received (including liability) ( 28,000)
Plus: Gain recognized 3,000
Basis in Moore stock $ -0-
c. $18,000 basis:
Barbara’s basis in the machine $15,000
Plus: Barbara’s recognized gain 3,000
Moore corporation’s total basis in machinery $18,000
d. Sam recognizes no gain or loss.
e. $17,000 basis, the amount of money he contributed to Moore for the stock.
f. Barbara’s holding period for her stock includes her holding period for the machinery.
Sam’s holding period starts on the day after the exchange date.
g. Sec. 351 would not apply, so the answers would change as follows:
a. $20,000 ordinary income. Barbara would recognize $20,000 of ordinary
income recaptured under Sec. 1245.
b. $17,000 basis. Barbara’s basis in the stock would be $17,000, its FMV.
c. $35,000 basis. Moore’s basis in the machinery would be $35,000, its FMV.
d. $17,000 ordinary income. Sam would recognize $17,000 of ordinary income
from compensation.
c. $19,000. Needle Corporation’s basis in the machinery is $19,000 ($15,000 + $4,000
gain recognized). pp. C:2-16 through C:2-22 and C:2-25 through C:2-27.
C:2-42a. $3,000 of ordinary income: Jim realizes a $3,500 [($5,000 + $1,000 + $2,000) -
$4,500] gain and recognizes a $3,000 gain. Because the $2,000 education loan assumed by Gold
Corporation has no apparent business purpose, all liabilities transferred to Gold are treated as boot
under Sec. 357(b). All of Jim’s gain is ordinary income recaptured under Sec. 1245.
b. $4,500. Jim’s basis in his stock is $4,500 ($4,500 + $3,000 - $3,000).
c. Jim’s holding period for the additional shares includes his holding period for the
automobile.
d. $7,500. Gold’s basis in the automobile is $7,500 ($4,500 + $3,000). pp. C:2-22 and
C:2-23.
C:2-43 a. $3,000 of ordinary income, determined as follows:
Stock (FMV) received $17,000
Release from liability 28,000
Amount realized $45,000
Minus: Basis of property transferred
Machinery $15,000
Money 10,000 (25,000)
Realized gain $20,000
Liability assumed $28,000
Minus: Basis of all property transferred ( 25,000)
Recognized gain (Sec. 357(c)) $ 3,000
The gain is treated as ordinary income under Sec. 1245 recapture rules.
b. Zero basis:
Property transferred $25,000
Minus: Boot received (including liability) ( 28,000)
Plus: Gain recognized 3,000
Basis in Moore stock $ -0-
c. $18,000 basis:
Barbara’s basis in the machine $15,000
Plus: Barbara’s recognized gain 3,000
Moore corporation’s total basis in machinery $18,000
d. Sam recognizes no gain or loss.
e. $17,000 basis, the amount of money he contributed to Moore for the stock.
f. Barbara’s holding period for her stock includes her holding period for the machinery.
Sam’s holding period starts on the day after the exchange date.
g. Sec. 351 would not apply, so the answers would change as follows:
a. $20,000 ordinary income. Barbara would recognize $20,000 of ordinary
income recaptured under Sec. 1245.
b. $17,000 basis. Barbara’s basis in the stock would be $17,000, its FMV.
c. $35,000 basis. Moore’s basis in the machinery would be $35,000, its FMV.
d. $17,000 ordinary income. Sam would recognize $17,000 of ordinary income
from compensation.
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