BASIC INCOME TAX Spring 2009
I. Introduction [1/12/09] A. Overview
i. Gross Income- (§61(a))
c. Any form of $ or property (wealth)
f. Gains from selling property
g. **any form of gained wealth, unless there is an exclusion in the regulations (i.e. gift/inheritance)
ii. Adjusted Gross Income= Gross Income – “Above-the-line” Deductions
iii. Taxable Income = Adjusted Gross Income – “Below-the-line” Deductions
B. Basic Questions Addressed by an Income Tax System
i. What items of economic income or gain will be includable in gross income?
ii. What items of expense will be allowable as deductions?
iii. When is an amount included in income? When is the taxpayer entitled to claim a deduction for an amount that is clearly deductible?
iv. Who is the taxpayer/Who is going to be taxed on items of income?
v. What is the Character of the items of income or the deductions?
II. Gross Income: Concepts and Limitations [1/13/09] A. The Definition of Income
i. Items to look at- need to look at congressional purpose, administrative goals, accounting concepts and public policy (defined by Congress, courts and Treasury)
a. WHAT to Include
b. HOW MUCH to include
c. WHO has to include it
d. WHEN must it be included
B. The Search for a definition of income p.24
i. Gains, profits and income derived from any source. §61
ii. §61(a)(1) GI includes compensation for services, including fees, commission, fringe benefits, and similar items.
iii. §61(a)(3): gains derived from dealings in property. §1001 definitions help compute these gains.
iv. Gross income is merely the first step in the calculation for AGI and taxable income.
v. Eisner v. Macomber- Income is the gain derived from capital, from labor or from both combined.
C. Income Realized in any Form
i. Whether money, property, services etc.
ii. Fair market value is the price a willing buyer would pay a willing seller with neither under a compulsion to buy or sell.
iii. Amount realized
a. Adjusted Basis to see if you have gain or loss.
b. Adjusted basis and cost basis is the cost of the property §§1011, 1012
D. Realization, Imputed Income and bargain purchases p.27
i. Realization requirement:
a. Not income until realized.
b. For example if buy stock at $100 and value goes up to $200, don’t count as income until sell stock.
c. Need a realization event such as sale or other disposition to be appreciated.
E. Imputed Income p.30
i. Not taxed even though the code has no specific exclusion
ii. Two categories
a. imputed income from services
b. imputed income from property
iii. Self-help not income
iv. Barter transactions: services for services are compensation and included in GI. Use FMV of services.
v. Bargain Purchases- generally not included in gross income.
F. Case Law
i. Punitive damages are GI (Glenshaw Glass)
a. This is accession to Wealth
b. Clearly Realized
c. And Taxpayers have complete dominion.
ii. Treasure Trove is taxable as GI (Cesarini- П found money in piano)
a. Taxable in year discovered.
b. Treasure trove is in regulations, not expressly listed in §61.
iii. Whenever corporation pays debts of employee, the employee is taxed for GI (Old Colony- corporation paid employee’s taxes)
a. That is compensation and therefore taxable as income
b. Form of income makes no difference.
iv. Pleasure conference/rewards are taxable as GI (McCann- employee was sent to Vegas w/spouse for conference as a reward for good work; fully paid by company)
a. Taxable as gross income b/c was reward and not required.
b. Use FMV.
v. Doing work for reduced rate for purpose of obtaining future work is not GI for receiver of reduced work (Peller- construction contractor built house for Pellers at a reduced price to try to make her dad happy so he’d throw more work his way)
a. No different than contractor buying lavish gifts or entertaining.
b. Not taxable as gross income.
vi. Qui tam rewards are taxable as GI (Roco- taxpayer received reward from government for being a whistleblower in a qui tam case)
a. Rewards are taxable
b. Also had to pay late penalties b/c he had not made a good-faith effort to determine if it needed to be paid and therefore it should not have been late.
III. The Effect of An Obligation to Repay [1/15/09] A. Loans- does not represent an “accession to wealth” or increase the taxpayer’s net worth because the loan proceeds are accompanied by an equal and offsetting liability to repay
i. Taking out a loan doesn’t constitute GI (“gross income”)
a. Payment of one’s liabilities by another may give rise to GI
b. Failure to repay may generate tax consequences
ii. Providing a loan doesn’t constitute GI when it is repaid either
B. Claim of Right- coming upon assets (i.e. finding a wallet)
i. $ received under a claim of right, w/o restriction as to disposition, is income
a. even if it may still be claimed that he is not entitled to retain the $, ultimately
b. if claimed that he is not entitled, will get a deduction in taxes
c. must include the $/assets at the time of finding it
ii. Boundaries of doctrine
a. When no restriction as to disposition (you can use however you want)- must claim
b. When you do not have power to dispose of assets as you wish (i.e. in hands of police or court clerk)- need not claim
C. Illegal Income- embezzlement and bribery (James v. US- US 1961- petitioner embezzled >$738,000 over several years, did not include in GI on tax return)
i. When a taxpayer acquires earnings, lawfully or unlawfully, w/o the consensual recognition, express or implied of an obligation to repay and w/o restriction as to their disposition, he has received income which he is required to include in GI, even if he is ultimately found to not be entitled to retain the assets
a. Embezzlement is not like a loan
ii. Gains from an illegal business may be taxed
iii. Repayment of illegal income entitles the taxpayer to a deduction
a. Take current deduction, rather than amending previous returns
i. Security deposits- Rent paid in advance generally is GI in the year it is received (§1.61-8(b))
ii. Advance payments vs. Loans- based upon the rights and obligations of the parties at the time the money is received (Commissioner v. Indianapolis Power & Light Company- US 1990- utility co receiving deposits from customers w/questionable credit; if customer met all payments, could determine whether the deposits would be applied to future payments or received a refund)
a. Advance payments is income
i. Must have “complete dominion” over the funds in order to be an advanced payment
1. Recipient must have some guarantee that he will be allowed to keep the money
ii. Individual making the payment retains no right to insist upon return of funds
iii. So long as recipient fulfills terms of the bargain, money is its to keep
b. Loans/Deposits are not income
i. Individual making payment retains right to insist upon repayment
ii. Recipient acquires no unfettered “dominion” over the $ at the time of receipt
c. Always need to decide whether the particular payment is more like an advance payment or more like a loan
iii. Discounts (Westpac Pacific Food v. Commissioner- 9th Cir 2006- under K, П promis
5) for Mario Kart game ($50 FMV)
a. Gain = $50 (FMV property received) – $45 (AB for property transferred)
b. AB in Mario Kart = $50 (paid taxes on GI of total AR)
iv. Debt: Betsy buys property worth $100,000; pays $20K cash and an $80K loan/mortgage
a. AB is $100,000 (because this is the cost)
b. No change in AB of $100,000 once she starts paying off loan
v. Betsy sells property for $110,000; $80,000 goes to bank and $30,000 goes to Bestsy
a. AR= $110,000 (irrelevant that she is not getting all the $ herself and rather paying off the lender w/it)
b. AB= all money including borrowed money
D. Problems (p. 79)
i. If sold for $1,000,000 after buying 100-acres for $250,000
a. AR = 1,000,000; AB $250,000; GR = $750,000
b. When dividing by five 20-acre parcels and sell each for $400,000-
i. are each worth same FMV?
ii. What costs are associated with the division of the land?
iii. Include in the AB all of the fees + cost; as the AB goes up, the Gain goes down and the GI is lower
ii. Purchasing summer home for $500,000; put $100,000 cash down and $400,000 borrowed from local bank
a. AB= $500,000; no difference if seller gave the $400,000 loan
b. Paying down the loan changes nothing in the AB
c. Maggie refinanced and borrowed additional $200,000 (does not change AB in the house, just means she owes more to bank); uses $50,000 to make improvements on home, $100,000 to purchase a tract of land for investment, and $50,000 for trip
i. AB of tract of land- $100,000
ii. AB in summer home= $500,000 (original) + $50,000 (improvements- see §1016)
iii. C owes L $10,000 in legal fees; L accepts painting from C as partial payment; C would normally sell painting for $5500; L sells painting for $10,000 [1/22/09] a. L: $10,000 (AR) – $5500 (FMV/Basis) = $4500 (GR)
b. C: $5500 (AR- eliminated this much of debt) – $100 (basis) = $5400 (GR)
E. Additional Examples from Angel
i. H buys car for $9000 (AB); sells car for $10,000 and stock worth $1,000 ($11,000 = AR); GR = $2000
a. Count stock as part of the AR because it is stuff that he gets in this transaction
b. AB in stock = $1000 (FMV at the time he bought it)
ii. M receives a car as a sales bonus from employer; list price of car $12,000
a. GI = $12,000 (See Reg 1.61-2(a)(1))
i. If employer paid $11,000, then would use $11,000 as GI
b. M sells the car for $14,000
i. AB in car = $12,000 (bc she was already taxed on it as GI when she received the car) (See Reg 1.61-2(d)(2))