Federal Income Tax, Stein
Fall 2013 Final Outline
I. What is income?
a. §61(a) defines gross income as follows: “Gross income means all income from whatever source derived. . . .” Section 61 also provides a nonexclusive list of specific items that are included in gross income.
i. Receipt of cash or property
ii. Windfalls — Reg. §1.61-14(a) requires taxpayers finding treasure to include it in gross income when reduced to undisputed possession.
iii. Receipt of intangible benefit: if it constitutes an economic benefit, it is income
1. Noncash compensation (i.e. annuity contract from employer)
a. If you receive an economic benefit (via contract/annuity) for services rendered, it is gross income equal to the value of the contract)
2. Satisfaction of obligation (i.e. employer pays income taxes of employee)
a. The satisfaction of a taxpayer’s obligation by another person constitutes an economic benefit to him (resulting in income)
3. Service-barter: would a painter and a lawyer have income if they traded services in turn for each other’s service?
a. Revenue Ruling 79-24, 1979-1 C.B. 60— both will have income in an amount equal to the fair market value of the services each received
II. Items that are NOT income:
a. Imputed income is the fair market value of the taxpayer’s performance of services for his or her personal benefit and the value of the taxpayer’s personal use of property that he or she owns.
i. The value of any service one performs for oneself, and the rental value of any property that one owns, constitutes imputed income. In terms of dollar value, there are two very significant types of imputed income that are omitted from most measures of gross domestic product.
1. Household services: The value of unpaid family caretaking performed by stay-at-home spouses or partners is an important type of imputed income in the U.S. economy.
2. Owner-occupied housing: The rental value of the home owned by the occupier is also an important type of imputed income.
b. Capital recovery – capital is the taxpayer’s unrecovered economic investment in property
i. Upon sale or disposition of property, taxpayer has a right to be taxed only on the income (profit) from the transaction, NOT the invested capital
ii. Capital recovery – timing: the timing of recovery is within the discretion of congress
1. i.e. – if Blackacre was a commercial office building (instead of a farm), then Ingrid would have been entitled to obtain her tax-free capital recovery during her ownership of the property through depreciation or MACRS deductions (as opposed to receiving tax-free recovery for Blackacre upon sale at the end of her investment)(CHAPTER 7(IV)(E))
iii. BASIS: a taxpayer’s economic investment in property
1. Basis is adjusted downward for capital recovery deductions, producing a taxpayer’s adjusted basis (CHAPTER 9(V)(C))
c. LOANS – the creation of a loan does not generate income for the debtor or the creditor
i. Discharge of indebtedness income: If the debtor’s obligation to repay is canceled in whole or in part, the debtor will have discharge of indebtedness income in the amount of the cancellation. (CHAPTER 3 (VII)
1. Possible exclusion – §108: exclusion from gross income for discharge of indebtedness income in certain circumstances
d. General Welfare exclusion – the IRS takes the position that payments to individuals by governmental units under legislatively provided social benefit programs for the promotion of the general welfare are excludable from gross income.
III. Specific Inclusions in Gross Income (note: if an item is EXCLUDED from gross income, it will NEVER be taxed)
a. Services income — Section 61(a)(1) includes in gross income compensation for services, including fees, commissions, fringe benefits, and similar items, whether performed as an employee or otherwise.
i. Identifying the transaction — look for two related events:
1. Provision of service: taxpayer provides services for another, or promises to do so
2. Compensation: person receiving benefit of services transfers money or other property (or the promise of such) to the service provider
ii. Forms of compensation –service provider must include gross income in the amount of money, or FAIR MARKET VALUE of whatever is received as compensation
2. Property – FMV received, as compensation is included in income of service provider.
a. The objective fair market value, i.e., the value at which goods will changes hands between unrelated buyers and sellers, must be used in determining the amount to be included.
i. The service provider will then have a “basis” in the property equal to the amount he or she included in gross income.
ii. Property can include items such as the employer’s inventory (a car or washing machine) or can include stock or stock options or other rights with respect to the employer.
3. Barter of services: if taxpayers exchan
include the interest in income? à depends on the creditor’s method of accounting
b. Character: interest is ordinary income
c. Deduction: payor of interest may be able to deduct the interest paid or accrued (CHAPTER 6(VI) and 7(III)(A)
iv. Rental Income: §61(a)(5)
1. amount paid by the lessee of property to the lessor for the use of tangible property. Reg. §1.61-8(a).
a. possible deduction: a lessee using premises for business purposes may be able to deduct the rental payment (CHAPTER 7(II)(A))
v. Royalty Income: §61(a)(6)
1. amount paid for the use of intangible property, such as a copyright, trademark, or patent. Reg. §1.61-8(a).
a. Royalty income also includes the payment (in money or in kind) made by an operator of oil and gas properties to the owner as a portion of the oil and gas mined from the property.
b. Possible deduction? à payor may be able to deduct the royalty payment
vi. Income Derived from Annuities: §61(a)(9)
1. In business and tax circles, an annuity is a kind of investment in which a company promises to pay an amount of money monthly to a person in exchange for the person paying premiums (in a lump sum or over time) to the issuer of the annuity.
a. An annuity can be an “immediate annuity,” in which the person purchasing the annuity begins to receive monthly payments right away, or it can be a “tax-deferred annuity,” in which the payments won’t begin until sometime in the future.
b. The annuity can last for the lifetime of the taxpayer, or the joint lifetimes of the taxpayer and another person, such as his or her spouse.
c. The issuer of the annuity invests the premiums in order to satisfy its future promise to pay the taxpayer.
d. The annuity contract can have any number of choices for the taxpayer to withdraw his or her money: withdrawing amounts from time to time; electing to receive periodic (usually monthly or annual) amounts; or withdrawing the entire amount in a lump sum.
i. It is common for taxpayers to use annuities in retirement planning.