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Federal Income Tax
Rutgers University, Newark School of Law
Blum, Cynthia A.

Introduction, Filing Status, Progressivity
§§1(a)-(d) – Filing Status
(a)     – Married
(b)     – “head of household”
(c)     – unmarried and not “head of household”
(d)     – Married filing separately
§6013(d)(3)
– Imposes joint and several liability for any deficiency on the return – if the spouses do not include income on the return or mistakenly claim improper deductions on the return (intentionally or unintentionally) either one can be liable to pay the entire tax deficiency resulting from the error
§6015(b)(1)
– provides “innocent spouse” relief if the taxpayer satisfies five requirements; (A) joint return has been made for a taxable year; (b) on such return there is an understatement of tax attributable to erroneous items of one individual filing the joint return; (c) the other individual establishes that in signing the return he/she did not know, and had no reason to know, that there was such understatement; (d) it is inequitable to hold the other indiv. liable for the deficiency; AND (e) the other indiv elects the benefits of this subsection no later than … 2 years after ….
– Cheshire v Commisioner – innocent spouse case
§6015( c)(1)
– allows any divorced (or separated) individual to elect to assume responsibility for only that portion of a joint tax deficiency that is properly allocable to that individual
§6015(c)(3)(C)(i)
-the benefit of the §6015(c) election is not available to an individual with actual knowledge of “any item giving rise to a deficiency”
-definition of “item” – from Cheshire – an item of income, deduction or credit – which would bar relief for all spouses with actual knowledge of the income-producing transaction – even if they lacked knowledge of the incorrect tax reporting of that transaction
§6015(f)
-confers power upon the Secretary and the Commissioner to grant equitable relief where a taxpayer is not entitled to relief under §6015(b) or (c), but “taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency.
§7703(a)

Taxable Income
§61(a)
-gross income = “all income from whatever source derived.”
-lists 15 examples of gross income items, but the list is not exhaustive
§62(a)
– adjusted gross income – gross income minus 18 specifically identified deductions
– deductions are called above-the-line deductions because they are used in computing adjusted gross income (AGI = “the line.”)
§63(a),(b),(c )(1)-(3),(d)
-§63 contains two methods for computing “taxable income.” Every taxpayer can choose between the two methods
-§63(a) – “gross income minus the deductions allowed by this chapter (other than the standard deduction.”
-§63(b) – an alternate definition for taxable income – “adjusted gross income, minus the standard deduction and the deduction for personal exemptions.”
-§63(c) – standardized deduction – comprised of a “basic standard deduction” and where appropriate, an “additional standard deduction.” Adjusted annually for inflation §63(c)(4).
-§63(d) – itemized deductions – all deductions other than above-the-line deductions and the personal exemptions
§67(a),(b)
-§67(a) – “the two-percent hair cut” – a taxpayer can deduct “miscellaneous itemized deductions” only to the extend that such deductions (in the aggregate) exceed two percent of the taxpayer’s adjusted gross income
-§67(b) – miscellaneous itemized deductions are all itemized deductions OTHER than the 12 deductions listed in this section
§68
-§68(a) – “phase out of itemized deductions” – affluent taxpayers with taxable incomes in excess of an “applicable amount” will lose up to 80% of their total itemized deductions. Taxpayer with an AGI in excess of the “applicable amount” must reduce the amount of itemized deductions by three percent of such excess, but the reduction will never exceed 80% of the total itemized deductions
-§68(b)(1) – applicable amount is $100,000 for individuals ($50,000 for individuals filing separately)
-§68(c) – itemized deductions spared from the “phase-out”
-§68(f) – the §68(a) phase-out will be phased out in upcoming years.
-§68(g) – in 2010 the §68(a) phase out will no longer apply until 2011 (for one year)
§151(a),(b),(c ),(d)(1)-(2)
-personal exemptions NOT taken “above-the-line” – must be taken into account after a taxpayer has determined adjusted gross income.
-represent a Congressional policy that a certain amount of income must be used to meet basic subsistence needs like food, shelter and clothing
§161
-deductions generally – only deductions specifically authorized by the Code may be used to compute taxable income
THE TAX LADDER
Gross Income (§61(a))
LESS              Deductions listed in §62(a)
EQUALS         Adjusted Gross Income
LESS                Personal Exemptions
& LESS EITHER the Standard Deduction (§63(c) OR
Itemized deductions (§63(d)
EQUALS          TAXABLE INCOME
§32(a),(b)

Personal Exemptions
§151
-§151(a) – allows a deduction for all of the personal exemptions provide elsewhere in §151
-§151(b) – exemptions for taxpayer (and for the taxpayer’s spouse with non gross income and is not the dependent of another)
-§151(c) – exemptions for taxpayers dependents
§152
-Working Families Tax Relief Act of 2004 – divides exemption-eligible dependents into two groups:
1) qualifying relatives – must meet 5 part test
2) qualifying children – must meet different 5 part test
Credits
Household & Dependent Care Credit
-§21 – limited credit for certain expenses related to the care of a dependent
-generally taxpayer can credit 20-35% of such costs against the taxpayer’s federal income tax liability
-max. credit amount is $3,000 (6,000 if household contains more than one dependent)
-qualifying individual – dependent under age 13, dependent of any age who share the same principal place of abode and are physically/mentally incapable of caring for themselves; spouses…who are physically or mentally incapable of caring for themselves
-taxpayer must also “maintain the household”
Hope Scholarship and Lifetime Learning Credit
-§25A(b) – Hope Scholarship – tuition and related expenses incurred during the first 2 years of post-secondary education, must go on at least half-time basis and credit is lost if student is convicted of a felony drug offense. First 1,000 is fully creditable, and half of expenses in excess of $1,000
-§25A(c) – Lifetime Learning Credit – not limited to the first 2 years – creditable as long as the tuition/related expenses relate to any course of instruction designed to develop or improve the student’s job skills. Limited to 20% of the first $10,000 in qualified tuition and related expenses
-both are subject to an income limitation
Credit for Income Taxes withheld on Wages
-§31(a) – amounts withheld from wages are credited against the taxpayer’s pre-credit tax liability to determine if enough tax was collected through the withholding process
Earned Income Credit
-§32 – eligible taxpayers can credit from 7.65% to 40% of their “earned income” against their pre-credit federal income tax liabilities. Credit is targeted to low-income taxpayers, so the credit amount is phased-out as the taxpayer’s adjusted gross income (or earned income, if larger) exceeds $5,280 (adjusted for inflation)
-provides a work incentive for low-income taxpayers
Gross Income Generally
§61(a)
-Gross income defined – all income from whatever source derived
-§61(a) offers 15 examples of items that are included in gross income, but the list is representative and not exclusive
-Haig-Simons definition if income – “income is the sum of a taxpayer’s consumption plus his or her change in wealth for a particular period.”
Eisner v Macomber – a pro rata stock dividend where a shareholder received no actual cash or other property and retained the same proportionate share of ownership of the corporation as was held prior to the dividend was not taxable income and that an income tax imposed by the Revenue Act of 1916 was unconstitutional, even where the dividend indirectly represented accrued earnings of the corporation. Distinguished accretion and appreciation on one hand and income on the other. In order to have income – the taxpayer must receive some right or asset that is sufficiently distinct from the property – a “realization” of the profits. Holmes (Day) and Brandeis (Clarke) dissented
Commissioner v Glenshaw Glass Company – all gain except that which is specifically exempted is taxable, so the award of treble damages is taxable income. Comprehensitve test for income which required the taxpayer to have 1) undeniable accessions to wealth, 2) clearly realized, and 3) over which the taxpayer has complete dominion. The Glenshaw Glass definition of income is the preferred test for identifying whether a taxpayer has income.
Cesarini v United States – the court ruled that treasure trove property is included in gross income when it was discovered (when the property was reduced to undisputed possession)
Regs. §1.61-14(a) – codified holding of Cesarini
-Requires taxpayers finding treasure to include it in their gross income when reduced to undisputed possession
Barter Exchanges
Regs. §1.61-2(d)(1)
– 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. If the services were rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary
– NOTE – it doesn’t matter if the barter is uneven – you must include the fair market value of the service received
-Imputed income – benefits resulting from a taxpayer’s personal efforts is NOT included in taxable income
Illegal Income
Illegal Income
James v United States– union official embezzles over half a million in union funds. Rule – if a taxpayer received income – legally or illegally – without consensual recognition to repay that money (i.e. loan note), that income is included into income and is taxable. Rationale – the 16th Amendment suggests that unlawful as well as lawful, gains are included in “gross income”
Compensation for Services: Payments to Third Parties
§61(a)(1)
-all forms of compensation for services must be included in gross income. This includes fees, commissions, fringe benefits, etc. Taxable income does NOT need to be received directly by the taxpayer
Old Colony Trust Co. v Commissioner – taxpayers employer would pay taxpayer’s taxes as part of his employment contract. Issue – was the employer’s payment of the taxpayer’s taxes considered income? Rule – payment of someone’s taxes was for services – not a gift – and constitutes additional income. Rationale – satisfying a taxpayer’s obligation constitutes an economic benefit which should be taxed as income
§74(a)
-gross income includes amounts received as  
McCann v United States – employer sent

§274(b)(1),(j)(1)-(4)

§274(j)(4)( c)(i)


Loans and Cancellation of Debt
Fundamental Rules
Axiom 1: A loan is NOT gross income to the borrower
o    Rationale – because the borrower has an obligation to repay the loan and thus has no “accession to wealth” from the loan
Axiom 2: Lender may NOT deduct the amount of the loan
Axiom 3: Amount paid to satisfy the loan is NOT deductible to borrower
Axiom 4: Repayment of loan is not gross income to the lender
o    The repayment merely represents the return of capital to the lender
Axiom 5: Interest paid to the lender is included in lender’s gross income
o    §61(a)(4)
Axiom 6: Interest paid to the lender MIGHT be deducible by the borrower
o    §163 – interest paid in connection with borrower’s business activities will be deductible. Note – interest paid on loans for personal use are NOT deductible
Cancellation of Debt – if a lender forgives or cancels an outstanding debt, there may be income tax consequences for the borrower
United State v Kirby Lumber Co. – the company issued bonds and then later that year repurchased some of those bonds on the open market for less than the original value. Holding – if a corporation purchases and retires bonds at a price less than the issuing price or face value, the excess of issuing price or face value over the purchase price is gain or income for the taxable year.
Zarin v Commissioner – taxpayer-gambler has $3 million dispute with casino resort. He settles the dispute with $500K. Holding – taxpayer did not have discharge of debt income, because he had no debt.
§61(a)(4),(12)
-§61(a)(4)The interest paid is compensation for the use of the lender’s money or property and thus is taxable because it represents an accession to wealth
-§61(a)(12) – cancellation of debt is accession to wealth. If there is no obligation of repayment – the amount must be included in gross income.
§108(a),(b)(1)-(2),
(c ),(d)(1)-(3),(e)(5)
-§108(e)(1) – gross income includes income from discharged debt
-§103(d)(1) – indebtedness defined as for which the taxpayer is liable and subject to which the taxpayer holds property
-“Contested Liability Doctrine” – states that if the amount is in dispute, the settlement amount is treated as the amount of the original loan
Gains from Dealings in Property
§61(a)(3)
-gross income includes gains from dealings in property
§102

§109
-expressly enacted to overrule the Supreme Court’s holding that a landlord had gross income upon reclaiming possession of real property from a tenant where the tenant had made permanent improvements to the property.
-§109 provides that the value of the improvements is excluded from gross income – but also provides the taxpayer’s basis in the property cannot be adjusted to reflect the value of such improvements.
-Helvering v. Bruun – see below
§1001(a)-( c)
-§1001(a) – gain = the excess of the amount realized over the actual basis in the property exchanged; loss = the excess of the adjusted basis over the amount realized
-§1001(b) – amount realized is the sum of any money received plus fair market value of the property (other than money) received
-§1001 only applies when there is an exchange and where the taxpayer receives money or other property in the transaction (the “amount realized”)
-§1001(c) – all realized gains shall be “recognized” except as provided elsewhere in the Code. To “recognize” a gain simply means to include it in computing gross income.
Helvering v Bruun – a taxpayer realized a gain after repossessing property improved by a tenant. Under the facts of the case, a taxpayer leased real property for a 99-year term. During the course of the lease, the tenant was permitted to tear down existing improvements and to construct a new building on the property. Pursuant to the lease agreement, the tenant returned the property and all improvements to the taxpayer after default occurred in the eighteenth year. The court lists four events that would trigger a realization of a gain or loss: (1) a property exchange; (2) relief of a legal obligation owed to a third party; (3) relief of a legal obligation owed to the party receiving property; and (4) other profit transactions (a taxpayer realizes profit by receiving an asset with a quantifiably enhanced value in a transaction with another party.)
§1011(a)
-adjusted basis is a taxpayer’s basis as adjusted.