Assignment 2 – Internal Revenue Code
Question 1
0
(10 points)
1
MC
1
4
The Internal Revenue
Code (IRC) is often criticized for its length and complexity. It is indeed lengthy and complex. However, it is
important to recognize that the IRC contains the statutory law governing all federal taxes, and the
administration of those taxes. Its scope is much broader than the federal income tax alone.
Log on to CHECKPOINT and go to the Research tab. Note the gray bar just below the tabs. At the right hand
side of this bar you have two choices: Search and Table of Contents. Click on Table of Contents. Ten
“libraries” pop up. Click the “+” beside “Federal Library.” Three options appear. Click the “+” beside “Federal
Source Materials.” Now eight options appear. Click the “+” beside “Code, Regulations, Committee Reports &
Tax Treaties” and then click on the heading “Internal Revenue Code.” This reveals the Table of Contents.
From the Table of Contents, what is the general topical content of Subtitle C of the Current Internal Revenue
Code?
a. Employment Taxes and Collection of Income Tax
b. Income Taxes
c. Miscellaneous Excise Taxes
d. Corporate Distributions and Adjustments
Question 2
1
(10 points)
2
MC
1
4
Continue drilling down
through the Internal Revenue Code. Note that Subtitle A (Income Taxes) consists of 6 chapters. Chapter 1
consists of IRC Sections 1-1400U-3, all of which fall into the category of "Normal Taxes and Surtaxes." This
chapter is divided into 25 "Subchapters," one for each letter of the alphabet, excluding Z. Professionals often
refer to these subchapters to describe a particular area of practice. For example, Subchapter C contains
most of the rules relating to advanced corporate transactions (distributions, redemptions, reorganizations,
etc.). Subchapter S contains special rules applicable to S Corporations. Subchapter K contains special rules
applicable to partnerships, etc. Although other chapters under Subtitle A are also broken into subchapters,
professionals are usually referring to Chapter 1 of Subtitle A of the IRC when they use subchapter references
as shorthand for a particular area of specialization (partnership tax, etc.)
Let's focus on Subchapter P -- Capital Gains and Losses for a moment. How many statutes (i.e., laws) are
contained in Subchapter P?
Question 3
2
(10 points)
3
MC
1
4
Now drill down through
Subchapter A. What is the maximum marginal income tax rate applicable to a corporation's taxable income?
a. 35%
b. 39%
c. 15%
d. 38%
Question 4
(10 points)
3
4
MC
1
4
MC
1
4
OK, now find historic
corporate tax rates. (There is a “Hist” tab above the code section you are currently reading). What was the
maximum income tax rate applicable to a corporation's U.S. taxable income for tax years beginning before
July 1, 1987?
a. 35%
b. 39%
c. 46%
d. 51%
Question 5
(10 points)
4
5
Now let's get personal.
Assume you are married, with a combined taxable income of $75,000. Note that this is taxable income so
that your actual gross income is clearly higher. Ignore that, however, and focus on taxable income. Read the
historical notes applicable to Section 1 (those applicable to the entire section).
If the tax rates applicable in 1981 were still in effect today, what would be your marginal tax rate?
(Remember, assume that you are married.)
Question 6
(10 points)
5
6
MC
1
4
Now let's do some basic
research in the Internal Revenue Code. Go back to the research tab and check the box beside Internal
Revenue Code. Do a keyword search to answer the following question.
Assume we have two clients, Ed and Martha Dubose. Ed is 65 years old, and Martha is 62. They married
three years ago, at which time Ed moved into Martha's home. The home, which is owned in Martha's name
only, has been their principal residence since their marriage. This year, after 34 months of marriage, Ed and
Martha sold the home, realizing a gain of $525,000. They sold the home to purchase a somewhat smaller
home on a nearby lake. Neither Ed nor Martha has sold a home in the previous two years. How much
taxable gain will they be required to report on their joint tax return?
a. $525,000
b. $175,000
c. $25,000
d. zero
Question 7
6
(10 points)
7
MC
1
4
Assume in the previous
example that Ed and Martha did not sell Martha's home. Rather, assume that the home was completely
destroyed by a tornado. The home was insured, and the couple received a settlement payment from the
insurance company of $900,000 in recovery of their loss. The tax basis of the home was $275,000, and the
couple's realized gain was $625,000 (rather than $525,000 as above).
Does the receipt of the insurance payment following destruction of their home by tornado qualify as a sale
for purposes of Code Sec. 121?
a. No. Destruction by a storm, fire, or unexpected event will be deductible as a casualty loss,
offsetting the gain realized from the deemed "sale" to the insurance company. If Sec. 121 was
allowed to apply to the same transaction, the taxpayers would essentially receive a double benefit
(deduction of the loss accompanied by exclusion of the gain). Thus, such destruction is not treated
as a sale for purposes of Sec. 121.
b. Yes, destruction of their home by a tornado is treated as a sale of the home for purposes of Sec.
121.
c. Destruction of the couple's home by a tornado would be treated as a sale only to the extent not
compensated for by insurance.
d. No. However, the couple may exclude their gain under Sec. 1033 if they reinvest the proceeds in a
replacement home within 2 years of the loss.
Question 8
7
(10 points)
8
MC
1
4
As illustrated in the
above question, there are times when more than one statute may be applicable to a particular transaction.
In such cases, one or more of the statutes will take precedence, and the remaining statute(s) will apply only
to the extent that elements of the transaction fall outside the primary statute.
There are two examples of this type resolution to conflicting rules inherent in Sec. 121. The first example is
relatively straightforward. Assume that the DuBoses sell Ed's house, rather than Martha's. To this point, we
have not discussed where Ed was living prior to the couple's marriage, or what he did with his own home.
Let us assume that Ed converted the home to rental property following his marriage to Martha. Further
assume that he has claimed depreciation deductions totaling $18,000. Assume that the couple decides to
sell Ed's house to purchase property on the lake, but will continue to live in Martha's house as their primary
residence. Finally, assume that Ed just meets the ownership and use requirements of Sec. 121 -- that is, he
has owned the house and used it as his primary residence for just over two years out of the last five.
Which of the following best describes the interaction between Sec. 121 and the depreciation recapture rules
of Sec. 1250?
a. Sec. 121 explicitly overrides the application of Sec. 1250. Ed will not be required to recapture any
depreciation deductions previously claimed on the house.
b. In this case, since Ed did not use an accelerated method to compute depreciation expense, he
would not be required to recognize any depreciation recapture under Sec. 1250. Consequently,
Sec. 121 would apply to his entire gain (to the extent it does not exceed $250,000).
c. Sec. 121 applies only to the extent that Ed's gain exceeds the aggregate depreciation deductions
claimed against the house since he converted it to rental property.
d. By converting his house to rental property, Ed is disqualified from using Sec. 121 when he later
sells the home.
Question 9
8
(10 points)
9
MC
1
4
The second potential
conflict between Sec. 121 and another statute is implicit in question 7 above. Assume that Martha's house,
which has served as her and Ed's principal residence since they were married, was destroyed by a tornado.
The home was insured and Martha collected $900,000 in insurance proceeds. Her tax basis in the home was
$275,000 so that she realized a $625,000 gain in connection with the destruction of the home. Further
assume that (unlike in question 7), Ed had lived in the house for less than one year when it was destroyed.
Which of the following best describes the interaction between the application of Secs. 121 and 1033 with
regard to this transaction?
a. Martha and Ed will be allowed to exclude $250,000 of the gain under Sec. 121. The remaining gain
will be taxable under Sec. 1033 only to the extent that they reinvest less than $650,000 of the
insurance proceeds in a new home within two years.
b. Sec. 121 is presumed to be the controlling statute unless the Duboses elect to apply the provisions
of Sec. 1033 instead.
c. Under Sec. 1033, Ed and Martha must recognize gain to the extent that they do not reinvest the
entire proceeds from the insurance policy in a replacement home within two years. If they choose
not to rebuild, they can exclude $250,000 of the gain under Sec. 121.
d. Ed and Martha must elect to apply either Sec. 121 or Sec. 1033 to their gain. They cannot apply
both provisions to the same transaction.
Question 10
9
(10 points)
10
MC
1
4
Finally, it is clear from
reading Sec. 121 that the statute cannot address all the kinds of questions that may arise when taxpayers
sell their primary residences. The best example is found in Section 121(c)(2)(B), which allows taxpayers to
claim a partial exclusion if they fail to meet the 2 year requirement "by reason of a change in place of
employment, health, or, to the extent provided in regulations, unforeseen circumstances." A literal reading
of the statute suggests that circumstances are unforeseen only if provided for in regulations. However, the
Service has taken a softer approach than that, identifying unforeseen circumstances not only in the regs,
but also in a series of letter rulings and Revenue Rulings.
Based on a reading of the statute, which of the following would be least likely to qualify as unforeseen
circumstances for purposes of this statute?
a. The taxpayer received a promotion and large raise and opted to use the additional income to
purchase a larger house.
b. Taxpayer was assaulted and robbed on the sidewalk in front of his house. He believed that the
rising crime rate in his neighborhood rendered his current home unfit to raise his family and
moved to a comparable home in a different, and safer, neighborhood.
c. Taxpayers adopted an additional child, and the state agency in charge of regulating adoptions
required them to have another bedroom before the adoption would be approved.
d. Approximately 15 months after taxpayers purchased their home their daughter lost her job and is
in the process of divorcing her husband. Their daughter and grandchild need to move in with
taxpayers. However, because of the age restrictions in taxpayers' community, the grandchild
would be unable to live with them. Accordingly, taxpayers must sell their home and buy one that
will allow them to accommodate their daughter's and granddaughter’s needs.