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Federal Income Tax
SUNY Buffalo Law School
Lazar, Stuart G.

Federal Income Taxation
Process For Determing Taxes
 
1. Determine Gross Income (GI)
 
§61
(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:
(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;
(2) Gross income derived from business;
(3) Gains derived from dealings in property;
(4) Interest;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Alimony and separate maintenance payments;
(9) Annuities;
(10) Income from life insurance and endowment contracts;
(11) Pensions;
(12) Income from discharge of indebtedness;
(13) Distributive share of partnership gross income;
(14) Income in respect of a decedent; and
(15) Income from an interest in an estate or trust.
 
2. Next determine adjusted gross income (AGI) which is:
 
§62 gross income less certain deductions
 
Deductions:
-Deductions begin with § 161 (usually allowed to deduct the costs incurred in producing income
-Every deduction must be authorized by a specific Code Section
 
Two categories of deduction:
            1. Above the line-the taxpayer may consider in determining his AGI
            2. Below the line-deductions a taxpayer may consider after AGI has been determined
 
3. Calculating Taxable Income
 
AGI (GI-Deductions)
-Itemized deductions (below the line deduction)
-Exemptions
____________
=Taxable Income
 
4. Determine Tax Rate
§1(a)-(i) determine six different tax rates/brackets which Taxable Income is taxed at.
 
5. Determine Tax Credits,
-Final Step, must determine if there are any tax credits which may be taken against the tax.
 
Chapter 2: What is Gross Income?
 
16th Amendment “Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration
 
So what is Income?
 
Commisioner v. Glenshaw Glass Company
Facts: Company receives punitive damages as part of a settlement and does not report them as income.
Issue: Do punitive damages constitute GI?
Decision: in defining GI Congress intended to exert the full measure of its taxing power.
-The punitive damages represent an undeniable accessions to wealth, clearly realized and over which the taxpayers have complete dominion.
-this become the standard in determining what constitutes GI
 
Realization of Income:
 
-income is realized when a certain event occurs that, by explicit rule or common practice, causes the tax system to take account of that income
ex. G buys stock for $100, at the end of the year it is worth $150
-although G is wealthier he has not realized income on the stock. Only when G sells the stock will he realize an accession to wealth clearly realized.
 
Eisner v. Macomber
Facts: Taxpayer received additional stock as a dividend
Decision: No gain had been realized by receiving stock. States that realization is a constitutional requirement and Congress could not constitutionally tax unrealized gain.
 
Imputed Income:
-considered technically income from self help activities, things that you do for yourself like mowing the lawn or repairing a leaky pipe.
-Imputed income is NOT TAXED, no exclusion in Code but rather an administrative practice (too difficult to keep track and value so not taxed).
Two forms of Imputed Income
1. Imputed Income from Property-ex. J owns property which has a rental value of 25K. No income is realized.
2. Imputed Income from Services- ex. J mows his own lawn which the going rate for is $50. J has no taxable income.
 
-Problems often arise with Imputed income with self employment activities
Morris v. Commissioner-farm products consumed by owner are not income. Similar to rental value of home.
Commissioner v. Daehle & Commissioner v. Minzner-cases where brokers received commissions for selling property to themselves was NOT income.
 
Bargain Purchases:
-Taxpayer purchases an asset for less than the fair market value (FMV)
Ex. M buys house for 275K. The house is worth 300K. Assuming M bought the house at an arms length transaction there is no income although M may be “richer”. Would be impossible for Service to determine this in an everyday scenario.
-However, same rule does not apply if the transaction is not arms length
Ex. M buys a house for 275K worth 300K from her a client. The seller sold her the house at a discount to settle a debt. Here the bargain purchase represents GI.
 
Pellar v. Commissioner
Facts: taxpayer purchases house under contract for less than what it cost to build.
Decision: Purchase of property for less than its value does not give rise to the realization of taxable income.
-if the bargain price is a substitute for services/income then the income is the difference between the FM and the amount paid.
 
Treasure Trove:
 
Cesarani v. United States
Facts: Taxpayer bought piano and years later discovers 4K inside the piano. Amended his tax return to not include the $ as income
Decision: Finder of treasure trove is in the receipt of taxable income to the extent of its

axpayer is $1000 insolvent and has $1200 of debt discharged, $200 will be treated as income, $1000 is not.
 
3. Tom Hanks wants to open a video store in Southern California catering to people
that only watch movies that have a liberal agenda. Tom borrows $500,000 from
Silicon Valley Bank, and uses the funds to purchase inventory, store fixtures and
to hold a grand opening celebration (that features Martin Sheen and Michael
Douglas as guest celebrities). After two years, the business fails and Tom is
forced to close the store. Because of Tom’s precarious financial situation, Silicon
Valley Bank accepts $300,000 in full satisfaction of the loan.
 
a. Assuming that Tom had sufficient assets to repay the loan in full, what are
the tax consequences to Tom and the bank as a result of the loan
repayment?
 
            -Tom recognizes $200,000 as gross income under §61 (a)(12). By accepting only $300,000 of the $500,000 debt the bank has discharged $200,000
 
b. Assume instead that, at the time the loan is repaid, Tom’s total assets
equaled $600,000 and his liabilities equaled $650,000. What are the tax
consequences to Tom and the bank as a result of the loan repayment?
 
            -Tom would recognize 150K as gross income. Tom is insolvent 50K; he has 200K of discharged debt. Under §108 the amount over his insolvency will be treated as income.200K-50K(amount insolvent)=150K of gross income.
            -However under 108a(1)(a) if Tom was in bankruptcy the entire discharge would not be treated as income because the bankruptcy exception takes precedence.
 
c. What would be the result to Tom and the bank if the entire $500,000 were
repaid by Warner Brothers in exchange for Tom’s agreement to star in Big
2?
 
            -Here there is no cancellation of debt. The studio is paying the debt in full. However, Tom will recognize compensation income under §61 for 500K because his employer, the studio, is paying the debt as compensation for starring in BIG 2.
 
d. What would be the result to Tom and the bank if the entire $500,000 were