Taxation of Income for Individuals
1) Gross Income: The Scope of Section 61
a) § 61 Gross Income Defined
i) All income from whatever source derived.
(1) § 102 Excludes gifts and bequests.
ii) Fair market value The price that would change hands between a willing buyer and a willing seller if neither was under pressure and both knew the relevant facts
(1) Compensation paid other than in cash (Reg. § 1.61-2(d)(1))
(a) If services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation
(b) If services are paid for in exchange for other services, the fair market value of such other services must be included in income as compensation
(2) Gross income derived from business
(3) Gains derived from dealings in property
(4) Interest
(5) Rents
(6) Royalties
(7) Dividends
(8) Alimony and separate maintenance payments
(9) Annuities
(10) Income from life insurance and endowment contracts
(11) Pensions
(12) Income from discharge of indebtedness
(13) Distributive share of partnership gross income
(14) Income in respect of a decedent
(15) Income from an interest in an estate or trust
iii) Cesarini v. United States: Taxpayers found $4.5K in a piano they purchased. Included it in income but later changed their minds and asked for refund. Court held that, since found money is not expressly excluded from gross income, the finder of treasure-trove is in receipt of taxable income for the taxable year in which it is reduced to undisputed possession.
iv) Gross income includes the receipt of any financial benefit which is:
(1) Not a mere return of capital
(2) Not accompanied by a contemporaneously (during the same period of time) acknowledged obligation to repay
(3) Not excluded by a specific statutory provision
v) The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed
vi) Frequent flyer miles: attributable to the taxpayers business of official travel, do not need to be reported as gross income, even if used for personal travel (IRS Announcement 2002-18).
b) Old Colony Trust Co. v. Commissioner: Taxpayer’s company paid all of his income taxes. SCOTUS held that this constituted additional income to the taxpayer because they were paid as valuable consideration for services rendered by the taxpayer.
c) Glenshaw Glass definition of gross income
i) Instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion
(1) The mere appreciation of property is not realization
(a) Only when you sell it do you realize the profit
d) Commissioner v. Glenshaw Glass Co.: Company received a settlement for fraud and antitrust violations. The Service wanted to tax the portion representing punitive damages. SCOTUS held that Congress intended to tax all gains except those specifically exempted – exerting the full constitutional measure of its taxing power.]
(1) Loans are not gross income because they are based on concurrently acknowledged obligations to repay which, offsetting the receipt, negate any accession to wealth
(a) Same with a security deposit
(2) Illegal gain is income despite a legal obligation to make restitution
e) Imputed Income
i) The flow of satisfaction from durable goods owned and used by the taxpayer and goods and services produced by the taxpayer’s own efforts for the taxpayer’s own use and enjoyment
(1) Services – Services performed for yourself (housework, painting house, etc) are imputed income, not taxed.
(2) Property (rent-non taxable)
f) Bargain Purchases- FMV of the asset is greater than the price just paid for it.
i) General assumption: bulk of arm’s length transactions contain no bargain element.
g) If services are paid for other than in money, the fair market value of the property or services taken in payment must be included in income.
i) Ex. Lawyer and housepainter exchange legal services for housepainting
h) Revenue Ruling 79-24: Section 1.61-2(d)(1) of the regulations provides that if services are paid for other than in money, the fair market value of the property or services taken in payment must be included in income. Price paid will be assumed to be FMV in the absence of evidence to the contrary.
i) McCann v. U.S.: Whether the McCanns should have included in their income tax return, as part of their gross income, an amount based upon the cost to the company of defraying their travel and other expenses on the trip to Las Vegas… Holding: Gross income is defined as all income from whatever source derived [§ 61(a)]. Gross income may be realized, therefore in the form of services, meals, accommodations, stock, or other property, as well as in cash [§ 1.61-1(a)]. Also the court holds that this is income b/c it is closely tied to her performance at work, mainly increased sales. Generally, just about anything related to the employer/employee relationship is regarded as income.Note: When services are paid for in a form other than money, it is necessary to determine the fair market value of the thing received [See § 1.61-2(d)(1)]
j) Pellar v. Commissioner: Whether the petitioners received income by virtue of the construction of a residence for them where the cost of construction and the fmv ($70,000) of the residence materially exceeded the agreed upon price paid to the contractor ($55,000) for such construction. Is this $15,000 difference income to the Pellars?The purchase of property for less than the FMV does not, of itself, give rise to the realization of taxable income.
i) Caveat: This could be considered income if it is not an arm’s length transaction, or the relationship of the parties introduces into the transaction other elements indicating that the transaction is not simply a purchase, but rather is an exchange of other considerations. (e.g., employer/ employee, gift, etc.). In this case we do not have a special relationship b/c there is no future obligation b/t the parties. The contractor did the job for less to stay in good graces with the father, but the father does not have an obligation to send business the contractor’s way in the future.
ii) Remember that the Pellars will be taxed when they sell the property and realize the gain. Since they took the property at a lower basis, they will have more gain when they sell it.
2) Obligation to repay
a) Loans
i) Loans are not included in Gross Income
ii) There is no accession to wealth because you must repay the loan
(1) If the Taxpayer fails to pay any of the loan back it may be includable in the taxpayer’s income. Debt Discharge
(2) §61(a)(2) and §108 Payment of one’s liabilities by another may give rise to gross income.
(3) If someone repays YOUR debt on a loan in order to be free of a debt which they owe YOU, then YOU have to report income as such (unless of course the repayment was a gift by them to you).
b) Claim of Right
i) Finding a wallet
(1) Included in Gross Income.
(2) If you repay the amoun
, devise, or inheritance (§ 102(a)))
i) §102 Gifts are excluded from Gross Income.
ii) §102(a) the value of property acquired by bequest, devise or inheritance is excludable from Gross Income. The exclusion from Gross Income does not apply if the legacy is not of a donative nature and instead is compensation for services, payment for property, or some other payment which would be included in income if received directly rather than by means of a will.
iii) Income from such property is not excluded (§ 102(b))
(1) Duberstein definition of gift
iv) A gift in the statutory sense proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses.
b) [Commissioner v. Duberstein: Taxpayer often provided helpful business leads to old friend, Berman. Berman gave taxpayer a Cadillac and deducted the value as a business expense. SCOTUS held that car was compensation for business tips and includible in gross income.]
i) Whether that which is received can be characterized as a gift, bequest, devise or inheritance? (facts and circumstances)
ii) Donative Intent is key.
c) Employee gifts
i) Any amount transferred by or for an employer to, or for the benefit of, an employee is included in gross income (§ 102(c))
(1) Exceptions
(a) Employee achievement awards (§ 74(c))
(b) De minimis fringe (§ 132(e))
(i) Any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable
(c) Extraordinary transfers to the natural objects of an employer’s bounty if the employee can show that the transfer was not made in recognition of the employee’s employment (Prop. Reg. 1.102-1(f)(2))
d) Limitations on §102 exclusions
i) §102(b)
(1) The income from property excluded as a gift is not excluded from Gross Income.
(a) If X gets IBM stock, the value of the stock is excluded from gross income, but not the dividends that IBM distributes to X.
(b) Where the gift, bequest, devise, or inheritance is of income from property, the amount of the income from the property is included in gross income.
(c) Mom dies, leaving bonds in trust for her son. The son has a life estate, the income received by the trustees and paid over to A would be income.
(i) Example,
1. Mom sets up a trust when she dies. 1 million – says all the income will be paid to her daughter. Then when she dies, all the income goes to the mom’s grandchildren. Daughter gets 100,000. Is it excludable? No, under §102(b)(2) the 100,000 is not excludable because it is income generated from the trust.
e) General Rule:
i) Donee takes the Donor’s basis where the FMV is greater than the adjusted basis of the property transferred. This is substituted basis or transferred basis.
f) Carry over basis rule:
