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Federal Income Tax
St. Johns University School of Law
Davidian, John E.

SCOPE OF GROSS INCOME
Gross Income – All income from whatever source derived
§61a)- Except as otherwise provided GI = all income from whatever source derived, including but not limited to
   -Item is GI unless code provides otherwise- specific exclusion provision, (gift or inheritance is excluded)
>Judicial description of GI- must be
 1) An Undeniable Accession to TP’s wealth
 2) Clearly Realized
 3) Over which TP has Complete Dominion & Control
 4) No Consensual Obligation to Repay financial benefit on TP.
 5) Not the Return of property/investments (basis is not GI, Accession to wealth = Value received – Basis)
 6) Financial benefit that is not excluded by gov action (i.e. gifts)
What is included in GI?
*“Clearly realized”-Receipt of a financial benefit indicates realization.  
   In most cases- receipt of cash/property considered wealth increase & realization event
   >For stocks- financial benefit not realized until they are sold, unrealized appreciation is not GI. 
        -A realization event must take place where the unrealized appreciation is converted into something else. 
        -Considering appreciation as GI would be difficult determine and enforce
        -Stock for painting of equal value=conversion which creates realization w/ respect to stock appreciation   
           >Form of exchange does not matter, only a change in existing ownership of the property.
Found Items are GI Cesarini v. US
TP purchased piano in ‘57, discovered 4K in ‘64. Reported, paid tax, filed amended tax return, then a refund suit
>Found cash is GI- By discovering it they had dominion over it- undeniable accession to wealth in 1964.    
   -Gov has 3 yrs from filing of tax return to assert TP owes additional taxes.
>The form GI takes is irrelevant to issue of whether it is GI- (§1.61-1(a) – states so generally)
   -Catching 70th home run in 2008 selling it for 100K in 2010.
      >GI became realized in 2008 before it was sold- most tax officials would say  
      >If security guard caught it- has no dominion & control b/c acts as agent- has to return it
Form of GI can be satisfaction of TP’s debt Old Colony Trust Co. v. Commissioner
 Corp pays salary & income tax=additional comp for services rendered, regardless if ER paid gov directly   
   >Accession to wealth b/c alleviates liability of EE, Realization & dominion bc as if ER paid $ to EE   
       >“discharge by 3rd person of TP’s obligation is equivalent to receipt by TP”  
Non-realization for bargain cash arms length deals– If buy property at arms length & pay less than FMV of
    property, do not have to pay taxes on benefit of bargain- have to wait until realization event
    -Does not apply in case of special relationships such as employer/EE situations
       >If EE gets property from ER at bargain, bargain amount is GI, but if later sells-basis includes GI+Amt paid
    -Does not apply when services for goods exchanged- When property is received for services rendered
    -Does not apply when TP sells & profits (X sells stock worth $300 for $310)- clear 1001 realization event
Punitive damages is GI to the recipient Commissioner v. Glenshaw Glass Co
  Antitrust violation P entitled to treble dams by statute. 125Gs compensatory lost profit & 225 Gs punitive
   -Damages received for substitution for what would have been GI is GI- BUT exclusion in §104 for pers inj
 *Illegal income- (kickbacks) is still GI despite fact that there may be a legal obligation for restitution, diff b/n
     the 2 is that there is no consensual indebtedness, it is forced by the court. 
§74 Prizes and Awards (applies to very few prizes & awards)
   a) General Rule- GI includes prizes & awards, except as otherwise provided in §74 & 117  
   b) Exception- GI DOES NOT include prizes & awards made primarily in recognition of religious, charitable,
        scientific, educational, artistic, literary, or civic achievement, BUT prize/award
        1) Must be selected without any action on TP’s part
        2) Must not be compensatory, can’t be required to render substantial future services as a condition
        3) Must be transferred by payor to gov/charitable org
   c) Exception for some employee achievement awards.
   d) §117- scholarships do not constitute GI
Income Without Receipt of cash/property
Imputed Income Self Benefit- The satisfaction derived from property owned & used by TP or by services of
   TP who exerts services in his own behalf are NOT GI (L who performs his own services)
    -Rental value of property used by owner is not GI- Helvering v. Independent Life  BUT
    -Once there is introduction of 3rd party in ownership of house- not imputed income- Dean v. Commissioner
     Creditors demanded house transferred to TP’s corp & TPs used it rent-free. Transferring house to separate &
      distinct entity, fair rental value constituted additional GI to TPs, owning 100% of corp shares is irrelevant
      >Should have structured this transaction to prevent GI by making house guaranty, not convey
      >If employer provides residence to EE- this is an additional benefit that constitutes GI
         -In certain limited circumstances value of lodging provided by ER to EE may be excluded- sec § 119
            >Only if EE required to accept lodging on ER’s business premises as a condition to employment
                -The forced nature of the transaction outweighs the benefit
 Compensation for services- No investment/basis in your own services, value received in return for them is GI.
    >Paint apartment for L’s services- FMV of both services included in GI. Basis =0/any $ spent on supplies.
    >Work of art in exchange for 6 month free rent- FMV of work and rental value included in GIs
 Barter Transactions: Rev Ruling 79-24- Gov has to tax bartered transactions
     >Exchange of Property/Service for Property/Services: 
    >GI is FMV of what you are receiving, but can simultaneously take a deduction for what you are giving
      -R. 1.61-if services are paid for by other than in $, FMV of prop/services must be included in GI, if services    
       rendered at stipulated price- assumed to be FMV absent evidence to the contrary.
§83- Property Transferred in Connection with Performance of Services from Employer
1. Does §83 apply? 
   >If in connection w performance of services, property is transferred to person other than for whom performed
    – Transfer requires a beneficial ownership, even if there are non-permanent (lapse) restrictions on property
    – Property includes real & personal but does not include $, or unsecured promise to pay $/prop in the future
    – In connection w/ performance of services- can apply to past, present/future services, or for a promise not to
        perform services, such as a covenant not to compete.
     >Employer wants to ensure employee remains with the company
     >Gov may be willing to defer the tax consequences until the employee has received the property
2. Amount & Timing of GI
    Amount of GI is FMV (determined w/o regard to any restriction other than a restriction which by its terms
    will never lapse), determined at 1st time TP’s rights in property are transferable OR are not subject to a SRoF
    whichever occurs earlier, over amount paid for property (GI = FMV – Amount Paid)
    >TP’s rights in property must be fully vested for it to become GI & for FMV to be determined
    >Transferability- TP’s rights in property transferable only if buyer’s rights in property are not subject to SRF
        -If transferred the transferee would not be subject to conditions ER put on the transferor
    >Substantial RofF §83c1- Rights of person in property are subject to SRF if person’s rights to full enjoyment
       of such property are conditioned upon future performance of substantial services by any individual
        -i.e. Qualifications on continued employment, unless TP made election
        -i.e. If ER makes TP return property at later point & gives back investment to EE
             >But not if ER will give employee the FMV at time he takes it back
        -Qualification on not committing crime- too remote to be considered SRF
 3. Computing loss/gain in subsequent sale:
       BASIS=Amount Actually Paid + GI reported as result of receipt. GI upon resale=AR on resale – Basis
         >RT- by allowing TP to include GI in basis, TP will not be taxed on amount again- avoids double taxation
 4. Character of GI- In year 83 transaction reported- taxed as OI, but GI from resale taxed as capital gain
 5. §83(b) Right of Election
      >EE may elect to include in GI for taxable yr in which property is transferred (may think stock will rise)
           GI= FMV at time of transfer – Amount paid for property
       >Must make election w/n 30 days of receipt of property
      >Closes out compensation part of transfer immediately- allowing increase in value to be capital gain,
       >Downside- Accelerates GI- TP pays gov that yr, not when restriction ends- loses time value of $  
        -If property goes down in value no deductions allowed for previously paid tax on GI reported
             >However, basis (amount paid + GI) will be more than decreased value- which is a benefit upon sale
        -OR if there is forfeiture- will not result in deduction to offset amount previously taken into GI, UNLESS       
             TP receives less than what he paid for stock (TP can deduct difference b/n what TP paid & got now)
 6. §83(h) Employer deduction- ER can report compensation as biz expense when TP reports it as GI
       >ER may not like that EE used right of election b/c if value increased by time TP’s rights in property
          vested, ER may be allowed to a larger deduction
       >If EE forfeits stock back to ER- then ER must give back deduction
  >Non-Qualified Stock Options
   -An option to buy stock at a lesser price than FMV at time of issuance
        >Incentive stock options produce different tax consequences (i.e. employer won’t get deduction)
        >Employee agreement can just have a provision- not treated as incentive stock option and it won’t be
       >When EE receive options, usually does nothing, exercises option if stock rises, if do nothing option lapses
    -Have to determine whether §83 applies at receipt or exercise of option
      1) If ER gives option to buy stock & it has Readily Ascertainable FMV- §83 applies upon receipt of option
           >FMV readily ascertainable if:
            1. Option is publically traded on securities market- not usually case for compensatory stock options OR
                     >If non-transferable, then can’t be traded
             2. That following 4 elements can be determined with reasonable accuracy:
                 a) Option is Transferable
                 b) Option is presently exercisable
                 c) Option right & stock to which it relates are not subject to restrictions that affect value of option
                 d) Value of option privilege (future appreciation value) at time of grant
                *Elements are hard to determine
      2) If option did not have RAFMV when granted, §83 applies when option was exercised (Reg 1.83-7)
          >If no RAFMV at time of option- no GI and cannot use election until exercise the option.
           -If option is exercised at time it is granted, §83 applies
             >BUT if stock further subject to SRF- GI delayed until restriction ends (or TP can elect to include GI)  
 
EXCLUSIONS
An item of financial benefit that is not GI because a Code provision says so- take priority over sec 61
Gift/Inheritance Exclusions
§102a- GI does not include value of property acquired by gift/bequest/devise/inheritance 
    >Exception- §102b- Income derived from gift property is not excluded from GI
     -Dad gives son building- son will not have GI. But if son then rents apa

time for ER to account, Reg. 132-6 lists some
             -Small Holiday Gift of Small Value 
             -EE’s Personal Use of Xerox Machine
            -EE Cocktail Party (occasional)
            -Small Cash Payments- work late & ER gives meal/taxi money to EE
      >Group Term Life Insurance Purchased for EE’s § 79
          -Cost for premiums up to $50Gs in coverage excluded from GI: ER provides EE’s w group term life ins.   
            >EE has to include premium amount in GI, only to extent cost provided exceeds 50Gs
       >Death Benefits § 101
          >Proceeds of Life insurance for Death excluded from recipient’s GI.
       >Meals & Lodging Furnished to EE § 11
          -Mealsand lodging furnished by ER to EE may be excluded from GI, so long as:
              >They are furnished for ER’s convenience AND on ER’s premises
       >ER Contributions to Accident & Health Plan § 106
         -No GI for EE if ER pays for accident/health plan premiums
            >Public Policy: we want EE’s to have health care.
 
PROPERY TRANSACTIONS
When there is a sale or exchange of property- need to determine gains or losses to be included in GI
§1001- TP will have a gain from sale/disposition of property to the extent that AR exceeds AB
>Gain = Amount Realized– Adjusted Basis
   -1001b-  AR= Amount of cash received + FMV of any property received
   -1012- Basis generally equals cost TP paid for item (able to recover cost tax free upon sale/disposition)
      >Assuming no adjustments to basis made under §1016, if got for 10Gs, sold for 16Gs- got 6G in GI
>Realization is some event that triggers GI (but AR will sometimes not be included in GI)
       -i.e. Non-recognition provisions- if can draft K of sale a certain way, or if death- stepped up basis
>Recognition of gain/loss §1001 c – means actually reporting it
>Character of Income
  -Ordinary income is all GI except capital gain, max rate is 35%
   -Capital gain- gain derived from sale/exchange of capital assets  (May be subject to lower tax rates:15%-28%)
      >All assets are capital assets except those listed in §1221 as not capital assets (i.e. stock TP held for < 1yr) Determining Basis  >Generally, the higher your basis, the lower your gain upon sale/disposition
 >Need to distinguish b/n costs that produces a basis or deduction for TP
   -Both produce tax benefits but generally timing of tax benefits is diff
      >Benefit from basis usually realized later -If asset/right acquired has expected useful life that extends
        substantially beyond yr of purchase, that cost is a capital expenditure & must use it as basis (buy building)
      >Benefit from deduction comes right away- If asset/right has a useful life of 1 yr or less, the cost produces
        immediate deduction (100 Gs for 1 yr lease- can deduct it, but will obtain no basis)
 >Concept of basis & deduction are mutually exclusive- don’t want to give taxpayer 2 benefits from 1 cost
Adjustments to Basis
§ 1016(a)—Basis Generally Adjusted in Two Ways:
 1. Expense for Improvement – T adds or improves property (positive adjustment)
       -“Ordinary repair” is considered biz expense (cost TP expends to keep property in current operating
          condition) which creates an immediate deduction (vs. a substantial improvement to property)
 2. Depreciation of Basis
  § 167. Only business property & income-producing assets are subject to exhaustion, wear & tear     
       >Gradual wearing out is additional cost of doing biz which reduces net income of Biz for given year.   
       >§1016a2- Each year T must reduce basis by amount of deduction (ensures TP gets tax benefit only once)
       >There is NO depreciation on: Personal Property OR Land (prop that doesn’t wear out)
       >Outside of depreciation, basis in determining GI is only significant when dealing w sale/exchange of prop
Basis=Cost (something more than just what was paid)
>Property Transactions: AB = Amount Paid PLUS amount TP had to include in GI as result of receipt of prop
    -Need to treat earlier GI as additional tax cost, otherwise taxed twice on same accession to wealth
    -TP would add to basis expenses incurred in acquiring property (closing att’s fees)  
Basis Rules for Exchanges of Property in arm-length transactions
    -Philly Park – taxable exchange of property, bridge for franchise K right. Ct used 2 to determine K right FMV
     >3 tier of general application in taxable exchange transaction
       1. Basis in prop received = FMV of property received, if it can’t be determined then assume that:
       2. FMV of property received = FMV of property given up, if cant determine either FMV, then assume that
       3. FMV of property received = AB of property that you gave up