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Penn State School of Law
Thompson, Samuel C.




This outline covers basic federal income tax with reference to key provisions of the IRC and case law. References to applicable code provisions are provided in the outline where necessary.

What is Income

I) Introduction

A) Constitutional Authority

1) Article I

2) 16th Amendment

B) Haigs-Simon Equation

1) Market value of rights exercised in consumption; plus

2) Change in value of the share of property rights during the period

C) Things to Consider

1) What we want to tax is more important than internal consistency derived from a logical nexus of the term “income”

2) “How well-off is an individual who did thing x, or to whom thing y happened, compared to individuals whose circumstances are similar except they did not share experiences of this kind”

II) Noncash Benefits

A) Introduction

1) Hoping to instill a sense of economic substance over form

2) Gross income includes income realized in any form, whether in money, property, or services. Regs § 1.61-1(a)

3) What matters is only the idea of economic benefit

4) Old Colony – employer’s payment of federal income tax on behalf of the employee constituted income to the employee

i) The principle derived from this is quite broad – discharge by a third person of an obligation to him is equivalent of receipt by that person (constructive receipt)

ii) It can suggest that absent a statutory provision to the contrary, a worker’s income includes not only the paycheck but the value of any and all benefits that the employer provides by any means

B) Meals and Lodging Provided to an Employee Section 119

1) Could potentially avoid a significant amount of income if we did not tax this because competent parties would find ways to engage in avoiding income tax liability

2) This exception however is limited to minor things

3) Section 119 put an end to the use of case law to determine convenience to the employer as seen in Bengalia

i) Language of the rule rules out self-employed and independent contractors

C) Other Fringe Benefits

1) Other important fringe benefits

i) Insurance / Medical insurance payments

ii) Discounts of merchandise

iii) Parking / Travel

2) Problems raised by fringe benefits

i) Valuation

ii) Enforcement

iii) Political Acceptance

3) Section 132 Fringe Benefits

i) Purpose – Statutory exclusion for established practices in order to forestall growth of the practice.

ii) Requirements of specific Section 132 Fringe Benefits – “No Additional Cost Services” and “Qualified Employee Discounts”

(a) Must not be discriminatory

(b) Must be working in that “line of business”

D) Cafeteria Plans – Section 125

1) Plan under which an employee may choose among a variety of noncash benefits or may choose cash

2) Effectively, they may choose to reduce salary and take benefit or increase salary

3) Without the provision in the code the choice of benefits would lead to tax liability due to constructive receipt

4) Benefits available for cafeteria plans

i) Group-term life insurance (up to 50k) – Section 79

ii) Dependent care assistance – Section 129

iii) Adoption assistance – Section 137

iv) Excludable accident and health benefits – Section 105 and 106(a)

v) Elective contributions under a qualified cash or deferred arrangement under Section 401(k)

5) NOTE – “Use it or Lose it Rule”

i) Section 125(d)(2)(A)

ii) Proposed Regs Section 1.125-1

iii) If employees opt to take the benefit, they have to use it all, or won’t get redeemed

E) Health Insurance

1) Section 106(a) – An employee’s gross income does not include amounts paid by the employer under an accident or health plan

2) A similar benefit is given to self employed individuals under Section 162(L)

3) Presumably it’s deductible as a business expense under Section 162

4) Life insurance though is not to be excluded See Section 79

III) Imputed Income

A) Overview

1) People may use their property or services to provide benefits to themselves or people who live in their own household

2) Section 262 denies deductions for personal expenses

3) Arguments to not tax imputed income

i) Practicality

ii) Privacy

iii) Enforcement

iv) Public Comprehension

B) Drawing the Line – The difference

or the acquirer is the lesser of

(a) The adjusted basis of the decedent

(b) The FMV of the property at the date of the decedent’s death

ii) Basis may be increased according to Section 1022(b)(2) – however, limited by Section 1022(d)(2)

2) Normal Rules

i) Basis of the property is the FMV at the date of death Section 1014 or basis is the FMV 6 months after death Section 2032

3) Income in Respect of Decedent

i) Section 1014(a) – excludes from taxation income or gain that had not been realized at the time of death

ii) Section 691 – includes in income gain that had been earned. See Section 1014(c) (not limited to wages, think contract)

V) Recovery of Capital

A) Overview

1) Income includes interest, rents, dividends, and other returns on one’s capital or cost, or investment

2) Income does not include returns or recovery’s of one’s capital

3) Allocation of basis among complicated property (land) will require judgment based on experience. Regs Section 1.61-6

B) Life Insurance

1) Section 101(a) – excludes amounts received under a life insurance contract if such amounts are paid by reason of death of the insured

2) Amounts paid by the insured are nondeductible presumably as personal expenses under Section 163

3) There are two elements to life insurance

i) Mortality protection; and

ii) Savings

4) Mortality protection is to be tax free, but it’s too difficult to divide this out

5) Employer purchase of life insurance

i) If the corporation is not the beneficiary Section 79 will allow them to take a deduction for payments (50k cap) as an ordinary business expense under Section 162; however

ii) If the corporation is the beneficiary then Section 264(a)(1) will block such an occurrence