Friday, October 26, 2012

Compensatory Damages Tax Exclusions Section 104

What types of damages from a personal injury lawsuit are excluded from income?

§ 104(a)(2) excludes from gross income “any damages (other than punitive damages) received (by suit or agreement/lump sums or as periodic payments) on account of personal physical injuries or physical sickness.”

Requirements of §104(a)(2)

Taxpayer must demonstrate that the underlying cause of action giving rise to a recovery is based upon tort or tort types of rights. And, the taxpayer must show that the damages were received “on accounting of personal injuries or sickness”

The determination of the nature of the claim is factual. Where there is a settlement agreement, that determination is usually made in reference to it. If the settlement agreement lacks express language stating what the amount paid pursuant to that agreement was to settle, the intent of the payor is critical to that determination. 

Nonpecuniary damages- Losing a body part is like selling it.  The IRC puts someone injured in the same tax position as if he had not been forced to realize the gain inherent to his arm.  The exclusion of nonpecuniary damages is based on special congressional solicitude for victims of forced sales.  Body part has zero basis. Permanent exclusion not conditioned on the taxpayer’s use of the damage award. § 1033 for forced sale is only deferral of taxes instead of exclusion. Maybe people should be giving deductions for losing an arm. This could create more overall equity to people with no tort recovery.

Medical Expenses: Exclusion of medical expense damages piggybacks on the §213 deduction for medical expenses. Normally, the medical expense deduction is allowed only for expenses in excess of 7.5% of the taxpayer’s gross income. No limitations to medical damages excluded under § 104(a)(2)

Lost Wages: Hardest part of §104(a)(2) to justify. Why should the tort equivalent of what someone would normally earn be excluded? Hard to allocate a lump sum. Maybe the money normally taxed would go to attorney? Most juries are not informed that the award is tax free. Only from when you physically cannot work. The exclusion for lost wages is sometimes explained as a tax subsidy for the tort plaintiff’s contingent attorney’s fees

Saturday, October 13, 2012

Determining IRS Tax Gifts

When determining whether something is a gift for taxation purposes, the critical consideration is the transferor's INTENTION. This is a question of fact that must be determined on a "case-by-case basis".

This is an OBJECTIVE inquiry that looks to "the mainsprings of human conduct to the totality of the fact of each case." Must consider totality of situation and determine if the transferor's intention was either disinterested or involved:

GIFT STANDARD: Gifts result from "detached and disinterested generosity." Gifts are often given out of "affection, respect, admiration, charity or like impulses." Contrast payments given as an "involved and intensely interested" There is a benefit, CONSIDERATION

IRS wanted a new rule that works for business situations. Lots of discretion given to the trier of fact to make a determination if something is really a gift.

Section 274(b) and Surrogate Taxation- §274(b) denies the transferor a business expense deduction for any business gift, to the extent the total value of gifts made by the taxpayer to the recipient exceeds $25.   

§ 102(c) declares that § 102(a) cannot apply to “any amount transferred by or for an employer to, or for the benefit of, an employee. No Gifts to Employees. Makes the tax advantage less desirable.

Educational Loan Interest Deduction §221

Section 221 Educational Loan Interest Deduction

In response to policy arguments that not allowing interest deductions was unfair to young adults, § 221 was added to the code. Limited Deduction up to $2500. Bizarrely it is ABOVE THE LINE, this helps people that don’t itemize deductions. Thus, taxpayers taking this deduction may also claim the benefits of the standard deduction.

POLICY: Helps lower income taxpayers who are less likely able to itemize their deductions and instead take the standard deduction. Only available if the loan in qualified under § 221(d). Qualified education expenses. Reasonable link to the time you took out the loan to the time you got the educationv.

The educational loan interest deduction starts to phase out at 50,000, 105,000 jointly filing.
Above 65,000 or $135,000 jointly, no deduction at all.

Information about Deducting Student Loan Interest and Form 1098-T

Wednesday, October 3, 2012

Unrealized Appreciation and Stock Dividends

There is no tax on the gain incurred by a taxpayer until the occurrence of a “realization event”, such as a cash dividend.  Although the cash dividend does not make the owner any richer, it serves as the trigger for taxing the enrichment that the tax system had previously ignored.

POLICY: What justifies that differing treatments of unrealized appreciation and cash dividends?   Valuation and Liquidity. In the absence of a realization event, it may be unclear how much an asset has increased in value, and in any event a mere increase in value gives the taxpayer no cash with which to pay a tax. Taxing a cash dividend, has no problems of VALUATION OR LIQUIDITY.

A pro rate stock dividend is between unrealized appreciation and a cash dividend. If appreciation in the value of stock is not taxed, then a pro rate stock dividend should also be excluded. Unrealized appreciation is not “income” within the meaning of the 16th amendment. Stock Dividends are a form of unrealized appreciation; and therefore, the attempt to tax stock dividends without apportionment was constitutionally invalid. Unless gain is clearly separated from the taxpayer’s original invested capital, as it is in the case of a cash dividend, but not in the case of a stock dividend, the gain is not income and it cannot be taxed by Congress without apportionment.

Popular Accounting Problems

The information on this site is for informational purposes only and should not be used as a substitute for the professional advice of an accountant, tax advisor, attorney, or other professional.