FEDERAL INCOME TAXATION OUTLINE
PROF. JAMES MUSSELMAN
James J. Freeland et al., Fundamentals of Federal Income Taxation: Cases and Materials (14th ed. 2006)
Daniel J. Lathrope, Selected Federal Taxation Statutes and Regulations (2009 ed. 2008)
James L. Musselman, Federal Income Taxation Supplement (Fall 2008 ed. 2008)
I. Gross Income: The Scope of Section 61
a. Introduction to Income
i. Taxable Income = GI – deductions
ii. § 61. GI = “income from whatever source derived”
iii. What is “income”?
b. Equivocal Receipt of Financial Benefit
i. § 61. Gross income defined
1. (a) General definition.—Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
a. (1) Compensation for services, including fees, commissions, fringe benefits, and similar items;
b. (2) Gross income derived from business;
c. (3) Gains derived from dealings in property;
d. (4) Interest;
e. (5) Rent;
f. (6) Royalties;
g. (7) Dividends;
h. (8) Alimony and separate maintenance payments;
i. (9) Annuities;
j. (10) Income from life insurance and endowment Ks;
k. (11) Pensions;
l. (12) Income from discharge of indebtedness;
m. (13) Distributive share of partnership gross income;
n. (14) Income in respect of a decedent; and
o. (15) Income from an interest in an estate or trust.
ii. Reg. § 1.61-1. Gross income.
1. (a) General definition. . . . Gross income includes income realized in any form, whether in money, property, or services. . . .
iii. Reg. § 1.61-2. Compensation for services, including fees, commissions, and similar items.
1. (a) In general. (1) [C]ompensation for services . . ., commissions on ins. premiums, tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury fees, marriage fees . . ., retired pay of ees, pensions, and retirement allowances are income to the recipients . . .
2. (d) Compensation paid other than in cash—
a. (1) In general. [I]f services are paid for in property, the FMV of the prop taken in pmt must be included in income as compensation. If services are paid or in exchange for other services, the FMV of such other services taken in pmt must be included in income as compensation. . . .
iv. Reg. § 1.61-14. Miscellaneous items of gross income.
1. (a) In general. [P]unitive damages such as treble damages under the antitrust laws and exemplary damages for fraud are gross income. Another person’s pmt of the taxpayer’s income taxes constitutes GI to the taxpayer unless excluded by law. Illegal gains constitute GI. Treasure trove, to the extent of its value in US currency, constitutes GI of the taxable yr in which it was reduced to undisputed possession.
v. Income is “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” Glenshaw Glass.
1. Accession to Wealth: increase in financial net worth/value (get something you didn’t have before).
a. In an arm’s length transaction, the property’s value is presumed equal to what you paid for it. Thus, there is no accession to wealth.
b. Old Colony – payment by third person of a personal debt owed by a taxpayer is income in the amount of the debt
2. Clearly Realized
a. Realization Principle: there must be a notorious transaction or event that objectively shows an accession to wealth
i. Increases in the value of property already owned ≠ GI b/c they have not been clearly realized (no notorious event). Sale of such property would be a notorious event giving rise to GI.
3. Complete Dominion
a. Taxpayer has to own the accession to wealth
b. State law dictates when one receives title to property
vi. Alternative Analysis Framework
1. Received cash = GI
2. Received property
a. How did I acquire the property?
i. Bought it in an arm’s length transactionàpresume of no GI
ii. Acq’d it any other wayàGI = value of prop – value given up
vii. Problems (p. 63)
1. Would the result to the taxpayers in the Cesarini case be different it, instead of discovering $4,467 in old currency in the piano, they discovered that the piano, a Steinway, was the first Steinway piano ever built and it is worth $500k?
a. Accession to wealth? Yes
b. Clearly realized? No
i. The increase in value (albeit by discovery) has not been clearly realized b/c there was no notorious event
2. Winner attends the opening of a new department store. All persons attending are given free raffle tickets for a digital watch worth $200. Must Winner include anything w/in GI when she wins the watch in the raffle?
a. Accession to wealth? Yes
b. Clearly realized? Yes
i. Winning the watch is a notorious event
ii. The property was acq’d by a means other than buying it
3. Ee has worked for ER’s incorporated business for several years at a salary of $40k per yr. Another company is attempting to hire ee but ER persuades ee to agree to stay for at least two more yrs by giving ee 2% of the company’s stock, which is worth $20k, and by buying ee’s spouse a new car worth $15k. How much income does ee realize from these transactions?
a. Accession to wealth? Yes
b. Notorious event? Yes
i. Receipt of property not bought = GI
ii. Compensation = GI
4. Ins. Adjuster refers clients to an auto repair firm that gives Adjuster kickbacks of 10% of billings on all referrals.
a. Does Adjuster have GI?
i. Receipt of money = GI
b. Even if the arrangement violates local law?
i. Money acquired by illegal means is incl. in GI
5. Owner agrees to rent Tenant her lake house for the summer for $4k.
a. How much income does Owner realize if she agrees to charge only $1k if Tenant makes $3k worth of improvements to the house?
i. $1k rental income = GI. See § 61(a)(5).
ii. $3k improvements (property)
1. Accession to wealth? Yes
2. Realizable event? Yes; d/n buy the property
b. Is there a difference in result to Owner in (a) above, if Tenant effects exactly the same improvements but does all the labor himself and incurs a total cost of only $500?
i. No difference in result to Owner; all that matters is what Owner received.
c. Are there any tax consequences to Tenant in part (b) above?
i. Essentially getting $4k rent for labor (compensation = GI under § 61(a)(1))
ii. Offset by $1k paid cash
iii. Offset by $500 paid in supplies
iv. = $2500 GI
viii. Frequent Flier Miles
1. Email Response from Musselman
a. As of now, the only situation involving frequent flyer miles that requires the inclusion of gross income is one where the taxpayer ends up receiving cash in exchange for his miles, and he received the miles in the first place as a result of employer paid travel.
b. Conceptually, actually using those miles (received as a result
nerosity, out of affection, respect, admiration, charity or like impulses. The most critical consideration is the transferor’s intention. . . . The donor’s characterization of his action is not determinative—there must be an objective inquiry as to whether what is called a gift amounts to it in reality. . . . The proper criterion . . . is one that inquires what the basic reason for his conduct was in fact–the dominant reason that explains his action in making the transfer. Duberstein.
a. Factors to Consider
i. Pmts by ER to ee ≠ gift
ii. Quid pro quo ≠ gift
iii. Pmt for services ≠ gift
3. Problems (p. 78)
a. Our system of self-assessment req’s the taxpayer to make the initial determination of gift or income, and tax administration procedures give the Commissioner the power to challenge that decision. If a judicial controversy develops as to the determination of gift or income, why is the decision of the trial ct so important, and what role may an appellate ct play?
i. The trial ct’s decision is important b/c the determination is a question of fact. The appellate ct will only reverse if the evidence d/n support the trial ct’s determination.
b. At the Heads Eye Casino in Vegas, Lucky Louie gives the maitre d’ a $50 tip to assure a good table, and gives the croupier a $50 “toke” after a good night with the cubes. Does either the maitre d’ or the croupier have gross income?
i. Tips (“to insure prompt service”) are not gifts; see as quid pro quo
ii. Tokes are not gifts either
ii. Employee Gifts
1. § 102. Gifts and inheritances
a. (c) Employee gifts.—
i. (1) In general.—Subsection (a) shall not exclude from GI any amount transferred by or for an ER to, or for the benefit of, an ee.
2. § 274. Disallowance of certain entertainment, etc., expenses
a. (b) Gifts.—
i. (1) Limitation.—No deduction shall be allowed . . . for any expense for gifts made . . . to the extent that such expense, when added to prior expenses of the taxpayer for gifts made to such individual during the same taxable year, exceeds $25. For purposes of this section, the term “gift” means any item excludable from GI of the recipient under section 102 . . .
b. Note: § 274(b)(1) generally limits the deductible amount of business gifts to $25 per donee per yr, but it defines the term “gift” as items excludable from the recipient’s GI under § 102. As ee “gifts” now are includible in GI under § 102(c), they are not subject to the § 274(b)(1) ceiling. That ceiling is applicable only to non-ee bus. gifts.
3. Proposed Reg. § 1.102-1. Gifts and inheritances.
a. (f) Exclusions—
(2) Employer/Employee transfers. For the purposes of section 102(c), extraordinary transfers to the natural objects of an ER’s bounty will not be considered transfers to, or for the benefit of, an ee if the ee can show that the transfer was