Fourth Edition William Kratzke
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Basic Income Tax 2016-2017 Fourth Edition William Kratzke Professor of Law The University of Memphis CALI eLangdell Press 2016 About the AuthorProfessor William Kratzke is a Cecil C. Humphreys Professor of Law at the University of Memphis. He received his B.A. in Political Science and the Far Eastern & Russian Institute from the University of Washington in 1971. This naturally caused him to be interested in attending law school. He received his J.D. from Valparaiso University in 1974 and was a member of the Valparaiso University Law Review’s editorial board. He received his LL.M. from Georgetown University in 1977. Professor William Kratzke teaches tax law courses at the University of Memphis. He has been a faculty member there since 1979. He has taught courses across the curriculum. In addition to tax courses, he has taught trademarks, torts, civil procedure, world trade law, economic analysis, and other courses. He visited Santa Clara University and the University of Mississippi. He received Fulbright Teaching Awards in 1997 (Moldova) and 2001-2002 (Russia). Professor Kratzke has written in the areas of tax law, trademark law, tort law, and antitrust law. Notices This is the fourth edition of this casebook, updated June 27, 2016. Visit http://elangdell.cali.org/ for the latest version and for revision history.
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Suggested attribution format for original work: William Kratzke, Basic Income Tax 2016-2017, Published by CALI eLangdell Press. Available under a Creative Commons BY-NC-SA 3.0 License. CALI® and eLangdell® are United States federally registered trademarks owned by the Center for Computer-Assisted Legal Instruction. The cover art design is a copyrighted work of CALI, all rights reserved. The CALI graphical logo is a trademark and may not be used without permission. Should you create derivative works based on the text of this book or other Creative Commons materials therein, you may not use this book’s cover art and the aforementioned logos, or any derivative thereof, to imply endorsement or otherwise without written permission from CALI. This material does not contain nor is intended to be legal advice. Users seeking legal advice should consult with a licensed attorney in their jurisdiction. The editors have endeavored to provide complete and accurate information in this book. However, CALI does not warrant that the information provided is complete and accurate. CALI disclaims all liability to any person for any loss caused by errors or omissions in this collection of information. The author wishes to express thanks to his research assistants, Magdalene Smith and Jay Clifton. About CALI eLangdell PressThe Center for Computer-Assisted Legal Instruction (CALI®) is: a nonprofit organization with over 200 member US law schools, an innovative force pushing legal education toward change for the better. There are benefits to CALI membership for your school, firm, or organization. ELangdell® is our electronic press with a mission to publish more open books for legal education. How do we define "open?"
Find available and upcoming eLangdell titles at elangdell.cali.org. Show support for CALI by following us on Facebook and Twitter, and by telling your friends and colleagues where you received your free book. PrefaceThis book is a basic income tax text. I intend this text to be suitable for a three-hour course for a class comprised of law students with widely different backgrounds. Certain principles permeate all of tax law. I have found that certain axioms or principles will carry us a long way. For example, income is taxed once – or treated as if it has been taxed. Once it has been taxed, its investment gives the taxpayer basis – which I define not as cost but as money that will not be subject to tax again. Etc. The text returns to these principles throughout. I usually put these matters in text boxes. At a minimum, I want students who have completed basic income tax to know these principles and to be able to apply them, i.e., to develop some “tax intuition.” This intuition will serve well the student who wishes to take more tax classes. I tried to identify what I want students to know before enrolling in corporate tax or partnership tax – and to make certain that I covered these principles in the basic course. Such intuition will also serve well the student for whom the basic course is a “one and done” experience. Like it or not, tax law affects most legal topics, and such intuition should at least give students working in other areas of the law an idea of when it is time to ask questions concerning lurking tax issues. At the end of every chapter, I have included a short section entitled “What have you learned?” This page may be examined before beginning the study of a chapter. I intend it to be a statement of learning objectives: a student should have a solid understanding of the items listed. In some areas, I have relied heavily on the CALI drills by Professor James Edward Maule (Villanova University). These drills both review and, in some instances, teach a little substance. Each zeroes in on a specific topic and should take a student about twenty minutes to complete if she has adequately prepared to do the drill. Of course, students can work through such drills at their own speed. I have tried to make this text very readable – so that students can easily understand. I have aimed at law students who “know” they have no interest in income tax – but who may find that they in fact have a considerable interest in tax law. With my political science background, I was such a student. I am proof that one does not have to have an accounting background to find income tax law both important and interesting. Additionally, Magdalene Smith and Jay Clifton III were two such students; they assisted me greatly in making this text as accessible as possible to all law students. I thank them now for their work. I have alternated from one chapter to the next my usage of singular indefinite pronouns. I have used the feminine forms for chapters 1, 3, 5, 7, and 9. I have used the masculine forms for chapters 2, 4, 6, 8, and 10. WPK
Memphis, Tennessee, July 2013 and May 2016 My use of pronouns referring to non-specific persons alternates between the feminine and masculine chapter by chapter. Table of Contents About the Author 2 About CALI eLangdell Press 4 Preface 5 Chapter 1: The Government Raises Money: Introduction to Some Basic Concepts of Taxes and Taxing Income 8 I. Introduction to Some Basic Concepts 8 II. Taxing Income 12 IV. Layout of the Code 21 V. Not All Income Is Taxed Alike 22 VI. Illustration of the Tax Formula: 23 VII. Sources of Tax Law and the Role of Courts 26 VIII. Some Income Tax Policy and Some Income Tax Principles 28 IX. What Is Income? 29 Wrap-up Questions for Chapter 1 39 What have you learned? 39
I. The Constitutional and Statutory Definitions of “Gross Income” 40 II. The Constitutional and Statutory Definitions of “Gross Income:” Accessions to Wealth 70 III. The Constitutional and Statutory Definitions of “Gross Income:” Realization 108 Wrap-up Questions for Chapter 2: 128 What have you learned? 128 Chapter 3: Exclusions from Gross Income 129 I. The Society and Government that We Want 130 II. Social Benefits 154 III. Employment-Based Exclusions from Gross Income 168 Wrap-up Questions for Chapter 3: 188 What have you learned? 188 Chapter 4: Loans and Cancellation of Indebtedness 189 II. Cancellation of Indebtedness 190 III. Is It a Loan? Is There an Accession to Wealth? 195 IV. Section 108(a)'s Other Provisions 216 V. Transactions Involving Property Subject to a Loan 218 VI. Transactions Treated as Loans 237 Wrap-up Questions for Chapter 4 239 What have you learned? 240 Chapter 5: Progressivity and Assignment of Income 240 I. Compensation for Services 274 II. Income Splitting and the Joint Return 282 III. Income Derived from Property 290 IV. Interest Free Loans and Unstated Interest 300 Wrap-Up Questions for Chapter 5 302 What have you learned? 303
I. Expense or Capital 306 II. Deductibility Under §§ 162 or 212 368 III. Depreciation, Amortization, and Cost Recovery 443 Wrap-Up Questions for Chapter 6 456 What have you learned? 456 Chapter 7: Personal Deductions 457 I. “Tax Expenditures” 494 II. Denial of Discretion in Choosing How or What to Consume 507 III. Creating a More Efficient and Productive Economy 517 Wrap-Up Questions for Chapter 7 521 What have you learned? 521 Chapter 8: Tax Consequences of Divorce and Intra-Family Transactions 522 I. Introduction 522 II. Before Marriage 523 III. During Marriage 527 IV. After Marriage: Tax Consequences of Divorce 533 Wrap-Up Questions for Chapter 8 548 What have you learned? 550
II. Deferral Mechanisms 561 III. Basic Accounting Rules 566 Wrap-Up Questions for Chapter 9: 587 What have you learned? 588
I. Capital Gain 590 II. Sections 1245 and 1250: Depreciation Recapture 598 III. Section 1231: Some Limited Mismatching 602 IV. Some Basis Transfer Transactions: §§ 1031, 1033 604 V. More Matching 606 Wrap-Up Questions for Chapter 10 610 What have you learned? 610 8 8 8 8 9 9 9 9 10 10 11 11 11 12 12 16 16 17 18 18 18 18 19 19 20 20 21 21 22 26 28 29 29 29 31 32 33 36 38 38 39 39 40 40 42 55 57 70 70 71 73 75 81 85 85 89 94 94 96 96 106 108
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