FEDERAL INCOME TAXATION
Spring 2012 – Professor Gutting
II. GROSS INCOME
A. GROSS INCOME
§61. Gross income Defined
(a) General definition: Gross income means all income from whatever source derived (16th Amendment), including (but not limited to) the following items:
(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;
(3) Gains derived from dealings in property;
(8) Alimony and separate maintenance payments;
(12) Income from discharge of indebtedness;
(b) More Details: 71 to 90 provide additional inclusions. 101 to 139 specify exclusions.
TR §1.61-1(a). Gross Income: GI means all income from whatever source derived, unless excluded by law. GI includes income realized in any form, whether in money, property, or services.
§ 1.61–14 mentions several miscellaneous items of GI not listed specifically in §61(a). Gross income, however, is not limited to the items so enumerated (look at case law).
Glenshaw Glass Co. (US 1955): Glenshaw was awarded $324,529 of punitive damages, but did not report this portion as income. Court held the damages were taxable as income.
Rule: Congress can tax all gains except those specifically exempted. Income is undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.
REALIZATION
We do not tax mere appreciation in value of property because the appreciation has not been realized. Gain or loss is realized from the conversion of property into cash or from the exchange of property for other property differing materially either in kind or in extent.
Cottage Savings Association v. Commissioner (US 1991): Realization is not a constitutionally required pre-req to taxation – but is an administrative convenience.
Taxpayers would have to sell their assets just to pay the taxes
B. COMPENSATION
§61(a)(1): GI includes compensation from services, including fees, commissions, fringe benefits, and similar items
TR §1.61-2. Compensation
(a)(1) Types: Wages, salaries, commissions, percentage of profits, tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury fees, pay of persons in the military, retired pay of employees, pensions.
(d)(1) Other Than Cash: GI = FMV of property/services received
Property or Exchange of Services: if services are paid for in property or in exchange for other services, GI = FMV of the property or such other services taken in payment
FMV Presumed: If the services are rendered at a stipulated price, such price will be presumed to be the FMV of the compensation received in the absence of evidence to the contrary.
Revenue Rule 79-24. Barter: If services are paid for other than in money, the FMV of the property or services taken in payment must be included in income. Barter is a taxable event.
Favors are taxable: If you let someone stay rent free at your apt in exchange for a painting, each has income of FMV of service/painting
TR §1.61-2(d)(2)(i): ERßà EE Property Transfers (see also EE gifts)
If property is transferred by an ER to an EE as compensation for services, for an amount less than FMV, there is GI.
EE Compensation Income = FMV at time of transfer – Amount Paid to ER
EE AB = FMV at time of transfer
ER PAYS TAXES
If an ER pays EE taxes, it constitutes income to EE: Old Colony Trust Co. (§1.61-14(a))
BUSINESS TRIPS
NOT INCOME: If required to go and most EEs go
INCOME: Bonus, reward, tied closely to performance
McCann: McCann received this benefit as a reward for good work in increasing her net sales – which was clearly compensation for services. Income = FMV of the trip
C. OTHER CONSIDERATIONS
IMPUTED INCOME
Imputed income (doing something yourself) is not taxed – even though there is no specific exclusion in the Code.
Morris v. Commissioner (1928): The value of farm products consumed by the owner was not income. These items are comparable to the rental value of a private residence – which has never been regarded as income.
BARGAIN PURCHASE
If you purchase an asset at a bargain price – FMV > Price – it is NOT included in GI. However, if it is later sold, that makes a taxable event.
Bargain purchase must be at arms length. (Pellar- must be transaction between willing seller and willing buyer)
(However, EE & ER transfers above).
TREASURE TROVE
Included in GI: Cesarini v. United States (OH 1969): P purchased a piano for $15, and later found $4,467 when cleaning it in 1964. TR §1.61-14(a): In addition to the items enumerated in 61(a), there are many other kinds of gross income including treasure trove, to the extent of its value in US currency, for the taxable year it is reduced to undisputed possession.
However, there has to be realization of wealth, so only discoveing the true value of something does not constitute income until it is sold.
REWARDS
Roco: P received share of settlement proceeds from a case because he assisted the United States as a relater for the qui tam action. This was the equivalent of a reward for P’s efforts to obtain judgment; therefore, it should have been included in gross income.
LOANS – Not income because repayment is presumed.
IV. GAINS DERIVED FROM DEALINGS IN PROPERTY
o §61(a)(3) à Gross income includes “GAINS derived from DEALINGS in PROPERTY”
o TR §1.61-6(a). Gain
§ 1) Dealing – sale or exchange
§ 2) Property – tangible/intangible
§ 3) Gain – cross references to §1001 calculate gain
o §1001. **Gain Realized = Amount Realized – Adjusted Basis** (Loss is vice versa)
o (a) Adjusted Basis: Directs reader to §1011(a) for a definition of adjusted basis
§ §1011(a): AB = §1012 Basis +/- §1016 adjustments (depreciation or investment).
· §1012: Basis = cost ($ paid + FMV of property/services given + Liabilities Assumed)
o Loans: Repayment of the loan does NOT affect basis. – Tufts: Because of the obligation to repay, the taxpayer is entitled to include the amount of the loan in computing his basis in the property (even if seller finances).
o Exchange Exception (Philadelphia Park): For a pure exchange where FMV of property unequal, 1012 cost basis = FMV of property received
§ If FMV of one item unknown, assumption it is the FMV of known item because people do fair/equal exchanges.
§ If FMV of both unknown, carryover basis of property given up (basis in new = basis of old) (§1.1001-1(a))
· §1016: adjust basis in property to reflect any recovery of investment or any additional investment made in the property.
o + improvements, capital expenditures
o – tax depreciation, recovery of investment such as insurance proceeds if damaged
o (b) Amount Realized: Money Received + FMV of any Property Received (+ Assumption of Liabilities by Purchaser).
§ §1.1001-2(a)(1). AoL- Liabilities of a seller, assumed by a purchaser, are included in the seller’s AR
o (c) Recognition of Gain or Loss: Must only report gain/loss if it is recognized – it is always recognized unless there is a reason not to.
§ Not Recognizing Gain à
§121 Sale of Principle residence
§267(d) Previous Loss Deduction Disallowed, So subsequent Sale don’t recognize Gain
§1041- Spouses and Former
Loss- Tee’s basis for determining loss from a future sale is the FMV at time of gift
Gain- Tee’s basis for determining gain from future sale is the carryover basis
Notch Transaction- No Gain/No Loss §1.1015-1(a)(2)
SUMMARY
APPRECIATED (Sale Gain) à Carryover Basis
APPRECIATED (Sale Loss) à Carryover Basis
DEPRECIATED (Sale Gain) à Carryover Basis
DEPRECIATED (Sale Loss) à FMV at the time of gift
D. BASIS OF BEQUEST or INHERITANCE (STEP UP/DOWN BASIS)
§1014. Basis of property acquired from a decedent
(a) In general.—The basis of property in the hands of a Devisee/Heir = FMV at date of death
Appreciated – Stepped Up Basis (appreciation pre-death is not taxed)
Depreciated – Stepped Down Basis (prevents passing of losses)
(e) Appreciated property acquired by decedent by gift within 1 year of death.
(1)(A) If appreciated property was acquired by the decedent by gift during the 1-year period ending on the date of the decedent’s death, and (B) such property is acquired from the decedent by the donor of such property (or the spouse of such donor), the basis of such property in the hands of such donor (or spouse) shall be the AB of the decedent immediately before his death
This prevents donor’s from getting a tax windfall if they gift highly appreciated property to a terminally ill relative expecting to get the property back at death – intent is irrelevant.
(2) Definitions. – (A) Appreciated property.–The term “appreciated property” means any property if the FMV of such property on the day it was transferred to the decedent by gift exceeds its adjusted basis.
E. PART GIFT – PART SALE
First determine why the sale price is less than FMV. Is it a gift, compensation, or bargain purchase? If it is a gift, make sure it is detached and disinterested under Duberstein.
Transferor’s Gain/Loss: TR §1.1001-1(e)(1).
Gain= AR – AB [Do 61((a)(3) analysis)
Loss- No loss if AR < AB [REASON NOT TO RECOGNIZE under 1001(c)]
Amount of Gift: TR §1.1001-1(e)(2)
FMV – AR
Example 1. A transfers property to his son for $60,000. Such property in the hands of A has an adjusted basis of $30,000 (and a FMV of $90,000). A’s gain is $30,000, the excess of $60,000, the amount realized, over the adjusted basis, $30,000. He has made a gift of $30,000, the excess of $90,000, the fair market value, over the amount realized, $60,000.
Transferee’s Basis
Do 61(a), GG, 102 analysis first.
TR §1.1015-4(a) AB is the greater of:
(i) The amount paid by the transferee for the property, or
(ii) The transferor’s AB for the property at the time of the transfer (+ gift tax paid per §1015(d))
But if depreciated property, and calculating loss, the AB is the FMV at time of gift
* Still PG/PS if transferee assumes liability and does not pay cash (Diedrich)
