Federal tax and business law share one shape: a broad default, then narrow rules that carve out exceptions. Gross income starts with everything, a realized gain is taxed unless a rule defers it, and a contract binds unless a defense undoes it. Most problems come down to finding the default, finding the exception that applies, and running the rules in their required order. The chapters move from individual income, deductions and property through canceled debt, corporations, pass-throughs, giving and procedure, then to contracts, secured credit, bankruptcy and business entities. Orientation for study, not tax or legal advice, and not affiliated with the IRS, any exam body or any state board of accountancy. Where a rule changed in a stated year, the chapter names the year; check the current rule before acting on it.
Each chapter opens with the short version. Tap one to read the detail.
What counts as income, and what character it has
~2 min
Gross income includes everything unless a specific rule excludes it, and an exclusion covers the property, not what it later earns. Gains and losses are sorted by holding period and netted within each group before the groups combine.
Gross income reaches income from any source, and the Code's list of examples is not complete. So you start by assuming an item is taxable and then look for a rule that excludes it. Exclusions cover the property itself, not what it earns: inherited stock arrives tax-free, but its dividends are income. Timing follows availability, so if you use the cash method, a check you receive on December 31 is income that year even if you deposit it in January.
Next comes character. An asset held more than one year gives long-term gain or loss; one year or less gives short-term. You net short-term items together and long-term items together, then combine the two results. Say you have a $6,000 long-term gain and a $4,000 short-term loss. Only the $2,000 left over is net capital gain eligible for the lower rates, because the short-term loss absorbed part of it. A net capital loss offsets ordinary income only up to a yearly cap set in the Code, and the rest carries forward with its character intact.
When you sell part of a holding bought in several lots, the shares you adequately identify are the ones sold. Without identification, the shares acquired first count as sold first.
The trap is assuming every refund is income. Under the tax benefit rule, a state income tax refund is income only if you itemized and the deduction cut your tax. A federal income tax refund is never income, because federal income tax was never deductible.
Rule: start from inclusion, look for a specific exclusion, then sort what remains by character before you net anything.
From gross income to the tax you owe
~2 min
Adjustments reach adjusted gross income, the standard or itemized deduction reaches taxable income, and credits come off the tax itself. Self-employment tax, the net investment income tax and the alternative minimum tax run beside the regular computation.
Your return is a ladder, and where an item sits decides what it is worth. Adjustments such as student loan interest and half of self-employment tax come off gross income to reach adjusted gross income (AGI). Many limits key off AGI, so a deduction taken above it can also loosen other limits that depend on it. Below AGI you take the larger of the standard deduction and your itemized deductions. If you are married filing separately and your spouse itemizes, though, your standard deduction is zero.
Credits work on the tax itself. Say the next dollar of your income is taxed at 20 percent. A $1,000 deduction saves $200, while a $1,000 credit saves $1,000. A nonrefundable credit can bring your tax only to zero; a refundable one can produce a refund.
Some taxes run beside the regular computation. Self-employment tax generally applies to 92.35 percent of net earnings, and you deduct half of it in figuring AGI. The net investment income tax charges 3.8 percent on the lesser of net investment income or modified AGI above a threshold. The alternative minimum tax (AMT) recomputes income with some benefits removed, and you owe it only when that tentative tax exceeds regular tax.
The trap is believing that a refund at year end means you paid enough during the year. Estimated tax is judged installment by installment, each against its own due date, so the underpayment penalty can apply even when you end the year owed money back.
Rule: place each item on the ladder first, above AGI, below AGI or against the tax, before you ask what it saves.
Basis, realized gain and the rules that postpone it
~2 min
Gain is the amount realized minus adjusted basis, and it is taxed unless a rule postpones it. Most deferrals keep the old basis in the new property, so the untaxed gain waits in basis.
Every sale starts with one subtraction. The amount realized is money plus the fair market value of property received, plus any of your debts the buyer takes over. Subtract your adjusted basis and you have the realized gain or loss. A realized gain is recognized unless a rule defers it, and deferral usually works by carrying your old basis into the new property.
Basis has its own starting points: cost when you buy, the donor's basis when you receive a gift, and generally fair market value at death when you inherit.
Since 2018, a like-kind exchange covers only real property held for business or investment. Suppose your building has a $300,000 basis and is worth $500,000, and you trade it for a $450,000 building plus $50,000 cash. You realize $200,000 of gain but recognize only the $50,000 of cash, called boot. The new building's basis stays $300,000: old basis, plus gain recognized, minus cash received. The $150,000 you did not pay tax on now waits in that lower basis.
The other deferral rules share the idea. A wash sale adds the disallowed loss to the new shares' basis, and an installment sale reports gain as each payment arrives. Depreciation, though, can come back as ordinary income through recapture, and an installment sale still taxes that recapture in full in the year of sale.
The trap is the gifted asset that has lost value. If the donor's basis was $10,000 and the value at the gift was $7,000, your basis is $10,000 for gain and $7,000 for loss. A sale at $8,000 produces neither gain nor loss.
Rule: compute the realized gain first, then find the rule that defers it and the basis where the deferred gain waits.
Canceled debt, foreclosure and abandonment
~2 min
Canceled debt is generally income unless an exception or exclusion applies, and most exclusions are paid for by reducing tax attributes. In a foreclosure, recourse debt splits into a sale and canceled debt, while nonrecourse debt is all amount realized.
A canceled debt is generally income, because you kept money you no longer have to repay. Two kinds of rule can keep it off your return, and they work differently. An exception means no income arises at all: debt canceled as a gift, debt whose payment would have been deductible, and certain student loans. An exclusion removes income that did arise, and most exclusions have a price: you reduce tax attributes such as net operating losses, credits and basis. Exclusions run in a fixed order, so debt canceled in a title 11 bankruptcy case uses the bankruptcy exclusion, and insolvency does not apply there.
Insolvency is measured immediately before the cancellation and caps the exclusion. If your liabilities are $300,000 and your assets, retirement accounts included, are worth $260,000, you are insolvent by $40,000. Cancel $50,000 and you exclude $40,000; the other $10,000 is income.
Foreclosure turns on the kind of debt. Say property with a $180,000 basis secures $250,000 of debt and is worth $200,000. With recourse debt the amount realized is the $200,000 value, so you have a $20,000 gain, and the $50,000 the lender cancels is separate ordinary income that may be excludable. With nonrecourse debt the full $250,000 is the amount realized, giving a $70,000 gain and no canceled-debt income.
The trap is treating Form 1099-C as the verdict. It reports an event, such as an agreement or a decision to stop collecting, and an exception or exclusion can still keep the amount out of income.
Rule: separate the disposition from the debt, then test exceptions before exclusions and count what each exclusion costs.
C corporations and the two layers of tax
~2 min
A C corporation is taxed on its profit, and its shareholders are taxed again on dividends. Property goes in tax-free under the 80 percent control rule, and distributions come out as dividends to the extent of earnings and profits.
A C corporation pays tax on its profit when it earns it, and shareholders pay again when that profit is distributed as dividends. Most corporate rules either protect that second layer or stop owners from avoiding it.
Getting property in is usually tax-free. Under section 351, transferors who together hold at least 80 percent control right afterward generally recognize no gain or loss. Cash or other property received triggers gain up to its amount, and stock received for services falls outside the rule because services are not property.
Getting value out is where the layers bite. A distribution is a dividend to the extent of earnings and profits (E&P), then a tax-free return of stock basis, then capital gain. Suppose a corporation has a $40,000 accumulated E&P deficit but $15,000 of current E&P, and it distributes $25,000 to a shareholder whose stock basis is $6,000. The first $15,000 is a dividend, $6,000 returns basis, and the last $4,000 is capital gain.
Other rules close the escape routes. A redemption counts as a sale only if it passes one of a short list of tests, most of which ask whether your ownership really shrank, and shares held by your spouse, children, grandchildren and parents can count as yours. A complete liquidation taxes appreciation at both levels. Penalty taxes can reach a corporation that keeps profits beyond its reasonable needs, or a closely held one that lives mostly on passive income.
The trap is reading a negative accumulated E&P balance as a promise of tax-free distributions. Current E&P is measured at year end and can make a distribution a dividend on its own.
Rule: follow value in and out of the corporation, and ask at each step which layer of tax the step touches.
S corporations, partnerships and trusts: income that passes through
~2 min
Pass-through owners report a share of the entity's income, and basis is the running account that limits their losses and tax-free distributions. A loss must clear basis, then the at-risk rules, then the passive activity rules.
S corporations and partnerships pay no income tax on their profits. Each owner reports a share, and basis is the running account that decides what the owner can deduct and receive tax-free: income raises it and distributions lower it.
An S corporation needs one class of stock and a limited number of eligible shareholders. A shareholder deducts losses only up to stock basis plus basis in loans the shareholder made to the corporation. Suppose your stock basis is $10,000, you have lent the company $4,000, and your share of the loss is $20,000. You can deduct $14,000, and the other $6,000 carries forward to you indefinitely. Because distributions escape employment taxes, an owner who works in the business must take reasonable wages before taking distributions.
A partnership adds debt to the picture. Your share of partnership liabilities counts as money you contributed, so it raises your outside basis. A loss that clears basis then faces the at-risk rules and, after those, the passive activity rules.
Trusts and estates pay tax on income they keep and deduct what they distribute, up to distributable net income, and the beneficiaries report their shares. A grantor trust's income is reported by the grantor instead.
The trap is assuming that no cash means no gain. When your share of partnership debt falls, the drop is treated as a distribution of money, and it is taxable to the extent it exceeds your basis.
Rule: update basis every year, because every pass-through loss and distribution must clear basis before any other limit applies.
Giving property away: charity, gifts and estates
~2 min
The donee's category and the type of property decide how much of a charitable gift you can deduct. Gifts to people fall under the gift and estate tax, which share one lifetime credit, and basis carries over on a gift but generally resets at death.
A charitable deduction starts with the donee. The gift must go to a qualified organization, so gifts to individuals, even needy ones, and to political groups do not count. The donee's category also sets the ceiling, a percentage of AGI. Gifts above it carry forward up to five years and are applied after the current year's gifts.
What a gift is worth depends on what you give. Property that would produce ordinary income or short-term gain if sold is deducted at value minus that gain, which usually means basis. Long-term capital gain property is generally deducted at full value. The deduction drops to basis, though, for most gifts to private nonoperating foundations and for tangible personal property the charity puts to an unrelated use.
A bargain sale is part sale and part gift, and your basis is split between the parts by value. Sell land worth $100,000 with a $40,000 basis to a charity for $30,000. The gift part is $70,000, the sale part uses only $12,000 of basis, and you report an $18,000 gain even though you sold below cost.
Gifts to people follow a separate system. The gift tax exempts a set amount per recipient each year, and taxable gifts use up a lifetime credit shared with the estate tax. Gifted property keeps the donor's basis, while inherited property generally takes its value at death.
The trap is giving a painting that the charity then sells. A sale counts as unrelated use even when it funds the mission, so the deduction falls to basis.
Rule: identify the donee, the property type and the use before you put a value on any gift.
Deadlines, penalties and disputes with the IRS
~2 min
Filing deadlines, the assessment period and the refund window are the clocks that govern every return. Failing to file costs ten times as much per month as failing to pay, and a dispute moves from Appeals to one of three courts.
Tax procedure runs on clocks. A calendar-year individual or C corporation return is due on the 15th day of the fourth month after year end, and partnership and S corporation returns a month earlier. An extension gives more time to file, never more time to pay.
The penalties are lopsided. Failing to file costs 5 percent of the unpaid tax per month and failing to pay costs one-half percent, each capped at 25 percent, and in a month when both apply the filing penalty is reduced by the payment penalty. Owe $10,000 and file and pay three months late, and the two total $1,500. File on time but pay three months late, and the payment penalty alone is $150.
The IRS generally has three years from filing to assess, and an early return counts as filed on its due date. Omitting more than 25 percent of the gross income you reported stretches that to six years, and fraud or no return leaves it open. A refund claim is due within three years of filing or two years of payment, whichever is later.
A disputed examination can go to an Appeals Office independent of the examiner. A notice of deficiency then gives you 90 days to petition the Tax Court, while a refund claim that is denied can go to a federal district court or the Court of Federal Claims.
The trap is weighing the odds of an audit. Every confidence standard for a position, from reasonable basis through substantial authority to more likely than not, ignores the chance that the return is never examined.
Rule: file on time even when you cannot pay, and judge a position by its authorities, never by the odds of review.
Contracts, sales of goods and negotiable instruments
~2 min
A contract needs assent and consideration, and in Utah a sale of goods falls under the state's enacted Article 2, which relaxes several common-law rules. Shipping terms decide when the risk of loss passes from seller to buyer.
A contract needs mutual assent, judged by outward words and acts rather than private intent, and consideration, a bargained-for exchange. At common law a counteroffer rejects the original offer. Promissory estoppel can enforce a promise that someone relied on to their detriment when justice requires it.
The first question is which lane you are in. Utah, for example, governs sales of goods by its enacted Article 2 of the Uniform Commercial Code (UCC), and contracts outside it stay with the common law. In a mixed deal of goods and services, Utah's text applies all of Article 2 when the sale-of-goods aspects predominate, and only its goods-related provisions when they do not. The lane matters because Article 2 relaxes the common law: under Utah's text, a merchant's signed offer that promises to stay open is irrevocable without consideration for the stated time, never more than three months, and a modification needs no new consideration.
Article 2 also allocates risk. Suppose a Utah seller ships goods F.O.B. its own warehouse, and the truck crashes on the highway. That is a shipment contract, so the risk passed to the buyer when the goods were delivered to the carrier. Had the term been F.O.B. the buyer's city, the seller would have carried the loss until the goods were tendered there.
The statute of frauds requires a signed writing for some contracts, including an interest in land and a deal that cannot possibly be performed within a year. Under Washington's enacted UCC, a holder in due course of a negotiable instrument takes free of ordinary defenses but still faces real defenses such as infancy.
The trap is applying common-law rules to a sale of goods, such as treating a merchant's signed firm offer as revocable because nothing was paid to keep it open.
Rule: decide the lane first, then apply that lane's formation, writing and risk rules.
Secured credit, sureties and bankruptcy
~2 min
A security interest attaches to become enforceable and is perfected to protect its rank against other claimants, and a purchase-money lender can jump ahead if it perfects in time. Bankruptcy stops most collection and lets a trustee undo some payments made just before filing.
A security interest works in two steps. Attachment makes it enforceable against the debtor; under Utah's enacted Article 9 that takes value, the debtor's rights in the collateral and usually a signed security agreement describing it. Perfection, typically by filing a financing statement or taking possession, protects it against others. Perfected interests generally rank by the earlier of filing or perfection.
A purchase-money security interest, which secures credit used to buy the collateral itself, can jump the line. A bank takes a security interest in all of a bakery's equipment, including equipment acquired later, and files on March 1. On April 10 a supplier sells the bakery an oven on credit and delivers it, then files on April 25. Utah's Article 9 lets such an interest in goods other than inventory beat the earlier one if perfected within 20 days after the debtor receives the goods, so the supplier wins on the oven.
A surety who pays another's debt can seek reimbursement from the debtor and contribution from co-sureties. A binding change to the debt made without the surety's consent can release it, but mere delay in collecting does not.
Bankruptcy reorders all of this. Chapter 7 liquidates, Chapter 11 reorganizes, and Chapter 13 gives an individual with regular income a three-to-five-year plan. Filing triggers an automatic stay that halts most collection without any court order. A trustee can recover preferences paid on old debts in the 90 days before filing, or a year for an insider, and some debts, such as domestic support, survive the discharge.
The trap is treating a signed security agreement as protection against other creditors. Until it is perfected, the interest loses to a perfected one and generally to a creditor who gets a lien on the collateral first.
Rule: attach, perfect, then rank, and check what a bankruptcy trustee could undo.
Business entities, agents and securities law
~2 min
Entity form sets owners' personal liability, while federal tax classification is a separate choice. Agents bind principals through authority the principal created, and securities law ties an accountant's liability to the part of a filing it certified.
Entity choice sets liability. You become a sole proprietor just by doing business, with unlimited personal liability, as general partners have. A limited partnership, a limited liability company (LLC) or a corporation is created by registering with the state, and owners of an LLC or a corporation are generally not personally liable for its debts.
Tax classification is a separate decision. For federal income tax, a single-member LLC is disregarded and a multi-member LLC is a partnership by default, and either can elect corporate treatment on Form 8832.
Directors owe the corporation duties of care and loyalty, but a director who used reasonable care is not liable for a decision that turned out badly. An agent binds the principal through actual authority, through apparent authority that the principal's own conduct created, or through a later ratification of the whole transaction.
Selling securities requires registration under the Securities Act of 1933 or an exemption from it. An accountant named as having certified part of a registration statement can be liable under section 11 for misstatements in that part only. Say an audit firm certifies the financial statements in a registration statement, and an error turns up in another section of the filing. The firm's exposure covers the part it certified, and even there it has a defense if, after reasonable investigation, it had reasonable ground to believe, and did believe, the statements true.
The trap is treating an agent's own claims as apparent authority. Apparent authority has to come from what the principal did or said, so the agent's word alone binds no one.
Rule: separate legal form from tax status, and tie every liability to the act or document it attaches to.
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