Federal Income Tax—Blum—Spring 2013
I) Gross Income
A) The Definition of Gross Income
(a) The starting point for computing a taxpayer’s tax liability is determining what is included in gross income.
(b) Section 61 of the Code defines gross income broadly as “all income from whatever source derived,” and then lists receipts that are included in gross income.
(c) The list is not exhaustive, and it is necessarily preceded and supplemented by a catch-all clause that includes non-listed items that may be properly defined as income.
(i) A widely-accepted definition, which defines income as gains or increases in wealth over a particular period regardless of whether spent on consumption or saved.
(ii) Without modification, this definition would be difficult to apply for tax purposes.
(iii) Because of practical limitations, courts have searched for a more workable concept of income for tax purposes.
(iv) In Commissioner v. Glenshaw Glass, the Supreme Court defined income as “undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion.”
2) The Realization Requirement
(a) Glenshaw Glass defines income as “undeniable accessions to wealth, clearly realized.”
(b) The realization requirement is a principle of accounting that has important tax application. It essentially determines the proper timing of taxation by telling us when income or gain should be recorded.
(c) Generally, realization does not occur, and income or gain is not recorded, until a provider of services or a seller of property has fulfilled all the material steps on her side of a bargain.
3) Statutory Exclusions from Gross Income
(i) The Code contains numerous provisions excluding particular kinds of receipts from gross income, even though such receipts are clearly accessions to wealth.
(b) Gifts (§102)
(i) The “except as otherwise provided” language of section 61 tells us to look for statutory exclusions. Section 102 specifically excludes “gifts” from gross income.
(c) Discharge of Indebtedness
(i) Section 61(a)(12) specifically includes the amount of a taxpayer’s discharge of indebtedness in gross income.
(ii) However, section 108, a more specific statutory provision, excludes discharge of indebtedness income from gross income if the discharge occurs in a bankruptcy case or when the debtor is insolvent.
(d) Employee Benefits
(i) Section 74(a) specifically includes “prizes and awards” in gross income.
(ii) Section 132 specifically excludes certain enumerated fringe benefits.
(iii) Section 74(c) specifically excludes “employee achievement awards” as defined in section 274(j).
4) Long-Standing Administrative Practices
(i) The government has a long-standing practice of not including certain items in a taxpayer’s tax base even though such items represent clear accessions to wealth and no statutory exclusion applies to them.
(b) Imputed Income
(i) Whenever a taxpayer performs services for his own benefit or produces goods for his own consumption, the taxpayer has economic gain equal to the amount he saves by not having to pay someone else to provide the services or goods.
(1) This type of gain is called imputed income since the income is attributed to the value of labor or property the taxpayer performs or produces for himself.
(c) Bargain Purchases
(i) The government generally does not require a buyer to report the benefit of a bargain (the true value of the item purchased minus the amount paid for it) at the time of purchase, regardless of whether the buyer knew the purchased item was more valuable than the seller knew.
(ii) An important exception to this government practice exists when a bargain purchase occurs in an employment setting (Treasury Regulations §1.61-2(d)(2)(i)).
(d) Frequent Flyer Trips
(i) In announcement 2002-18, 2002-1 C.B. 621, the IRS said that it will not attempt to tax personal benefits received through the use of frequent flyer miles or other in-kind promotion benefits attributable to a taxpayer’s business travel, unless the benefits are converted to cash.
B) Gross Income May Be Realized in Any Form
1) Glenshaw Glass emphasizes that gross income is a very broad concept, as broad as the Constitution allows
2) Section 61 does not make a distinction between cash and noncash benefits. Indeed, the regulations under section 61 provide that gross income may be realized in any form, whether in money, property, or services (Treasury Regulation §1.61-1(a)).
3) If property is included in gross income, the fair market value of the property received is the amount of income reported.
4) If services are included in gross income, the fair market value of the services received is the amount to be included.
C) A Note on “Basis”
1) If property is included in gross income, it is important to keep track of the “basis” (cost basis) of the property to prevent double taxation upon a later sale of the property.
D) Impact of Obligations to Repay
1) If a taxpayer receives money or property, but has a contractual obligation to return it or repay it, the money or property is not considered to be an accession to wealth and thus not income within the meaning of section 61.
2) The offsetting obligation to return or repay the funds negates any accession to wealth.
1) Commissioner v. Glenshaw Glass Co.
(a) Money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble-damage antitrust recovery must be reported by a taxpayer as gross income.
(b) The Court has frequently stated that the language used by Congress to exert in this field “the full measure of its taxing power.”
(c) Here we have undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion. The mere fact that the payments were extracted from the wrongdoers as punishment for unlawful conduct cannot detract from their character as taxable income to the recipients.
(d) Recoveries are taxable to the extent that they compensate for damages actually incurred. It would have an anomaly that could not be justified in the absence of clear congressional intent to say that a recovery for actual damages is taxable but not the additional amount extracted as punishment for the same conduct that caused the injury.
2) Cesarini v. United States
(a) The starting point in determining whether an item is to be included in gross income is section 61(a).
(i) “Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including but not limited to . . . “
(1) Subsections (1) through (15) lists items specifically included in the computation of the taxpayer’s gross income.
(2) Part III of subchapter B deals with items specifically excluded from gross income.
(3) Absence of express mention in any of the Code sections necessitates a return to the “all income from whatever source” language of section 61(a) of the Code, and the express statement there that gross income is “not limited to” the following examples.
(b) There is an IRS Revenue Ruling on Point:
(i) “The finder of treasure–trove is in receipt of taxable income, for federal income tax purposes, to the extent of its value in United States currency, for the taxable year in which it is reduced to undisputed possession (Treasury Regulation §1.61-14(a) (1964))
(c) Under the statutory scheme, income from all sources is taxed unless the taxpayer can point to an express exemption.
(d) It is generally true that revenue rulings may be disregarded by the courts if in conflict with the Code and the regulations, or with other judicial decisions.
3) Old Colony Trust v. Commissioner
(a) Payment by an employer of the income taxes assessable against the employee constitutes additional taxable income.
(b) A taxpayer, having induced a third-person to pay his income tax or having acquiesced in such payment as made in discharge of an obligation to him, may not avoid the making of a return thereof and the payment of a corresponding tax.
(c) The payment of the tax by an employer is in consideration of the services rendered by the employee, and is a gain derived by the employee from his labor. The form of the payment is expressly declared to make no difference.
(d) The discharge by a third-person of an obligation to him is equivalent to receipt by the person taxed.
II) Gains and Losses from Dealings in Property
(a) Section 1001(a) provides that gain from a sale or other disposition of property is the excess of amount realized over adjusted basis.
(b) Conversely, loss from the sale or other disposition of property is the excess of adjusted basis over amount realized.
e same basis in the property received as he or she had in the property given up in the transaction (see e.g., IRC §§358, 1031(d))
(a) Philadelphia Park Amusement Co. v. United States
(i) The cost basis of property received in a taxable exchange is the fair market value of the property received in the transaction.
(ii) The value of the two properties exchanged in an arms-length transaction are either equal in fact, or are presumed to be equal (when the FMV of one of the properties exchanged is difficult to discern).
III) Gifts and Inheritances
(a) Although gross income is a very broad concept, there are limitations on its meaning.
(b) Congress decided to exclude (or partially exclude) certain types of receipts or benefits from the income tax base (IRC §§101-140).
(i) Section 102 is the long-standing exclusion rule for gifs and inheritances.
2) General Exclusionary Rule for Gifts and Inheritances—Section 102(a)
(a) Exclusion for Inter Vivos Gifts
(i) Section 102(a) specifically excludes the value of property “acquired by gift” from gross income.
(ii) Although the Code does not define “gift” for income tax purposes, the Supreme Court has established criteria for determining whether a particular transfer is a gift (Commissioner v. Duberstein).
(b) Exclusions for Bequests, Devises, and Inheritances
(i) Section 102(a) also provides that the value of property acquired by “bequest, devise, or inheritance” is excusable.
(ii) The phrase “bequest, devise, or inheritance” refers to property “received under a will or under statutes of descent and distribution.” Treasury Regulation §1.102-1(a).
(iii) The Supreme Court has held that the exclusion also applies to a settlement obtained in a will contest action.
(iv) However, not everything received under a will is excludable (Duberstein must be taken into account).
(c) Policy Reasons Behind Section 102(a)
(i) It should be noted that the Duberstein test for determining whether a transfer is excludable from gross income does not apply to transfers between spouses.
(1) When property is transferred to a spouse (or to a former spouse if the transfer is incident to a divorce), the property is treated by the Code as received by the transferee spouse as a gift and is excludable from gross income (IRC §1041(b)(1)).
(ii) It should be noted that the exclusion for gifts does not apply to prizes, awards, or scholarships, which have their own special statutory rules for inclusion or exclusion (IRC §§74, 117).
3) Statutory Limitations on the Exclusion—Sections 102(b) and 102(c)
(a) The broad exclusionary rule of section 102(a) is subject to important limitations.
(i) The exclusion does not apply to income from property received by gift, bequest, devise, or inheritance (IRC §102(b)(1)).
(1) These limitations clearly prevent donees and heirs from living on income from property without paying any tax.
(ii) Another limitation on the broad exclusion for gifts applies to gifts given in the employment setting.
(1) The Code clearly denies gift classification to “any amount transferred by or for an employer, to or for the benefit of the employee.” (IRC §102(c)).
(2) Section 74 (c) provides certain “employee achievement awards” are not included in an employee’s gross income.
(3) Section 132(e) excludes from an employee’s income certain “de minimis” fringe benefits.
(4) These specific statutory rules of exclusion override section 102(c)’s broader statutory rule of inclusion.