Answer directly the question asked. Explain you answers. Include citations of authority or calculations in support of your explanations if they facilitate, simplify or clarify your answer. Merely quoting the applicable section or authority does not answer the question. Answer the question first, then cite authority. Where possible, you should try to organize your answers in the order the issues are presented in the problem. 650 words for each answer
I.Is it income?
A. IRC Sec. 61 (a) gross income = all income from whatever source derived; defined broadly:
i) “undeniable accession to wealth” econ benefit–Glenshaw sees any increase in net worth, regardless of source, as income
ii) “clearly realized over which taxpayer has complete dominion” capital recovery–Macomber says capital invested in property is not income until it is realized, i.e. taxpayer gets separate benefit from it.
iii) Economic Benefit approach:
(1) Commissioner v. Glenshaw Glass Co., Supreme, 1955 pg. 56 Holding: Congress’s language in §61 was intended to define income to the full extend of its taxing power, therefore it includes pun dmg as income.
(a) Definition of income by SCT: “Undeniable accessions to wealth, clearly realized, and over which taxpayer has complete dominion”
(i) Held to include treasure trove (Cesarini piano case), lottery, free books sent to educators, mineral royalties to Eskimos, etc. All transx are taxable
(2) Indirect Receipts: Old Colony Trust v. Commissioner, Supreme, 1929 pg. 60 Holding: Where corp paid its officers income taxes, this is also taxable b/c Satisfaction of a TP’s obligations (taxes or debt) by a third party constitutes economic benefit for TP and is therefore income. Not gift b/c IRS assumes consideration for services based on circum.
(a) Rule “Form of payment is expressly declared to make no difference”
(i) Pyramiding—ER in this case paid ee’s income taxes, so ee owed tax for the payment of his obligation. This layering of tax is called pyramiding (comes to finite end).
iv) Capital recovery not income:
(1) Eisner v. Macomber, Supreme, 1920 pg. 64 Holding: Where shareholder’s dividends paid in stock instead of cash, this is not income because the profit is not realized by shareholder who has same amount of wealth, just divided differently.
(a) realization rule: Gains or losses must be realized—received by TP for his separate use and benefit—by TP in order to be GI.
(i) 16th A removed apportionment among the states burden from congress, but did not extend taxing power. Cong can’t redefine 16th A’s definition of income.
(ii) Macomber allows TP to defer tax until eventual sale instead of paying tax on yearly appreciation, big advantage in long-term investment.
(iii) §305 now allows tax on stock dividends, but SCt’s reasoning was that shareholder’s stock was transferred from surplus to capital. Antiques road show not profit until sold.
1. if taxpayer could choose b/t cash and stock, then gain is realized no matter what he chooses.
(2) Helvering v. Bruun, Supreme, 1940 pg. 68 Holding: Where lessor receives property back from lessee with improvements that increase value of property, that gain need not be separate for benefit of taxpayer to be included as income, otherwise no exchange of property (barter) would be taxable.
(a) Fact that an increase in value from exchange in property is just a portion of property’s value does not negate realization of taxpayer’s gain.
(b) Bruun distinguished Macomber, said it only applied to stocks.
(3) *Exam tip: in question about capital recovery explain how Macomber or Bruun might apply, and do counter-analysis.
v) Imputed income (exchange of svcs) FMV of TP’s svcs for his or her personal benefit and value of TP’s personal use of property he or she owns. Not included in GI. Policy: encourages ownership of property/creation of wealth
(1) II calculated: what TP would have paid to outsource his own svc or hire use of property he owns.
(2) Does not include Barter, II is services for oneself, barter svc for another.
(3) Eg: farmer consumes milk from cows—imputed food; I move in w/ anne—imputed rent (use of property for self that I would pay rent on otherwise)
B. Non-cash transaction: GI is income from any source, Old Colony said form of payment makes no difference, so how to you rate non-cash transactions?
i) IRC § 83(a): Prop transferred in connection w/ perf of svcs, as soon as the beneficial interest in the prop is transferable and not suj to sbtl risk of forfeiture, is included as income at FMV minus amount paid for the property.
(1) eg. I get stock from company, but can’t trade it for 4 years as guarantee I’ll stay with company that long. In fifth year, stock is reported as income be/ no risk of forfeiture.
(2) Congress now allows deferred compensation under “qual. Plans” 401K, 403B
ii) Rule: IRC § 61(a) and CFR 1.61-2d(1)à when services or property other than cash are exchanged for goods and services, the income of the recipient is measured by the Fair market value of the service or property received
iii) Special cases:
(1) §119(a) Meals and lodging furnished for convenience of the employer are not income.
(a) Meals must be furnished on premises,
(b) Lodging must be required as cdtn of employment
(2) Rooney v. Commissioner, Tax CT, 1987 pg. 80 Holding: CPA must record in-kind payment from client as FMV even though he would not have used client svc given his druthers. Value of a svc is obj, not suj whenever possible.
(a) Rule: FMV determined by obj means where possible. CFR 1.61-2(d) adopts Estate Tax def’n of FMV: “price at which prop would change hands if willing buyer and seller would pay if neither were under any compulsion and knew relevant facts.”
(i) Gray area: TP can dispute which “market” should be used in FMV. Some markets have a little compulsion in them. In Turner, winner of trip had no free market in getting value, paid less than FMV.
(3) US v. Drescher, 2nd CA, 1950 pg. 86 Holding: Deferred compensation is income when acquired by ee. Where ee given annuity but lacks full control over this investment, ee must include value of the economic benefit of the deferred compensation as gross income, and burden of proving he did not receive full value be/ he lacked assignability and surrender value is on TP.
iv) Fringe benefits–§132 Nutshell: value of certain types of fringe bennies excluded from GI, otherwise the TP must report FMV of Fringe under §61.
(1) Exclusion from gross income: GI does not include any fringe bennie which qualifies as:
(a) no-additional-cost service: Er usually provides same svc to customers and is in same line of biz, can provide to ee w/o much add’l cost or driving off paying customer.
(b) qualified ee discount: selling price of property multiplied by er’s gross profit %. Ceiling at 20% retail cost for services.
(c) working condition fringe: Applies to good/svc ee would be able to deduct under 162 if er didn’t provide it (uniform, room & board for chief).
(d) de minimis fringe: so small that accounting for it is unreasonable or impracticable
(e) qualified transportation fringe: parking/transit pass/co shuttle thingy ltd to $ 100 ($175 for parking).
(f) qualified moving expense reimbursement,
(g) qualified retirement planning services, or
(h) qualified military base realignment and closure fringe
(2) Definitions for fringes to qualify as exclusions
(a) Employee: There must be ee-er relationship, or parent, spouse and kids, or surviving spouse.
(b) Non-discrim §132(j)(1) (Applies to NAC and discount, not de minimis and work cdtns): If bennie to one class of ee is different to other ee, then it is included as GI. Eg. If cashier gets 20% and mgr gets 30% discount, this is income.
(c) Reciprocal arrangements§132(i): BK and McD share ee discount
(d) line of business
(3) §106: Other bennies excluded for social policy reasons:
(a) Health and accident insurance: §105-6 exclude health and accident bennies, but not sick pay; overrules Waller which included it as GI.
(b) $50K group term life ins §79: Life ins premiums paid by er’ for any life ins under 50K are excluded from GI.
1. if Er is beneficiary of policy
2. if ins carried after ee has terminate employment and is disabled
3. non-discrim requirement
(ii) Insurance premiums paid by er on life of ee are taxable esp where ee’s family is beneficiary.
(c) Educational assistance: §127 excludes Up to $5,250/year in edu assistance (tuition, books, etc).
(i) §117(d) covers tuition remission plans for ee’s of a uni.
(d) Dependent care assistance: § 129 excludes $5K from er to ee’s disabled dependents per year.
(e) Adoption assistance: §137 excludes amounts paid to adopt from GI up to 10K, more for special needs.
v) § 102. Gifts and inheritances General Rule: GI does not include amounts acquired by gift, bequest, or inheritance
(1) Gift= “transfer made with detached and disinterested generosity; consider total circumstances, including mainsprings of human conduct” –Duberstein USCT, 1960.
(a) Does not apply to income from gift (interest, dividends, etc. §102(b).
(b) Does not apply to er-ee transfers. §102(c)
(3) Related Material: Basis of property received §1015
(4) Caselaw: Commissioner v. Duberstein, Supreme, 1960 pg. 119. Holding: The intent rule is obj, not suj, based on tribunal’s understanding of human nature and totality of circumstances
(a) Rule: Intention test: Payment is a gift if the primary reason for the transfer was detached and disinterested generosity.
vi) IRC 101: Life insurance death benefits
(1) General Rule: Amount received from life ins policy paid for reason of death is not gross income.
(a) Term life: mortality gain not income (proceeds minus premiums paid)
(2) Life Insurance Kon= promise by insurer to pay, upon death, an amt to designated beneficiary in exch for premiums.
(a) Applies to terminally/chronically ill patients receiving death bennies early §101(g).
(a) transfers of Ins Kon for valuable consideration §101A2 limited to buyer’s purchase price of kon. If the insured takes cash surrender value which exceeds basis, then excess not excludable.
vii) IRC 74:Prizes: General Rule: GI includes prizes and awards
(1) Prize, Award= contests with no effort, door prize, employee prize
(a) Nobel§74 (b): Awards for scientific, civic, etc merit where winner
(i) took no action to enter
(ii) is not required to provide svc as cdtn t
. Comish, Tax CT, 1983 pg 233 Holding: Decedent’s bonus taxed as decedent’s income since his participation in GM’s bonus program was regular and dependent on decedent’s past econ activities.
(a) Rule: Halladay test for decedent’s legal right to income: where evi shows that bennies related to decedent’s past econ activities are sbtlly certain to be paid to heirs on death, then bennies taxed as income to whoever receives it, not untaxed as bequest.
v) IRC 118; IRC 362(A),(c): General rule: When corp rec’vs money in xch for stock, it does not recognize income (§1032). When shareholder makes additional contrib w/o getting stock, still no income.
(1) This is consistent with idea that transfer is xchange in form of ownership of property contributed for stock
E. Chapter 9: Dmg Awards & sttlmt & Insurance recovery
i) General rule: compensation for loss of taxable income is taxable. Compensation for loss of capital not taxable. A recovery that includes lost income, stolen property restitution, and unrealized appreciation is now complex tax problem.
(1) Clark v Comish, Tax app ct, 1939 pg 291 Holding: Where TP gets compensation for a loss incurred by another’s negligence, this compensation is not income or accession to wealth, but a nontaxable restoration of capital.
(2) Raytheon v Comish, 1st CA 1944 pg 292 Holding: Biz good will = capital when biz recovers for tort that destroys good will. In Raytheon case, which was driven out of biz by anti-trust activities, the recovery was a conversion of capital into cash, and therefore a realization event. Raytheon must subtract basis from recovery and pay tax on gain. If basis impossible to determine, gain is conjectural.
ii) IRC § 104: Gross income does not include recovery for dmg flowing from physical injury or sickness. Payments can come from health insurance, tort, settlement, wrkr comp.
(1) Can include emot distrs/loss of consort flowing from pers inj.
(2) Or amount of emot distr dmg not in exces of amt paid for med care (prozac, hosp time compensated, crying is not).
(a) pun dmg
(b) interest on award
(c) ins payments which were previously deducted
iii) IRC 123: ins payments comping person for living expenses due to loss of principal rez not included in GI to extent that living expenses exceed TP’s normal expenses.
iv) Miscellaneous exclusions:
(1) §103 excludes state and local bond interest from Gross Income.
(2) §121 sale of principal residence excluded from Gross Income.
(a) Sale must be w/in 5 years of using house as principal residence for 2+ years
(b) limited to 250K.
(3) §105: GI does not include amounts rec’vd by ee thru health insurance
(4) §106: gross income does not include er provided coverage under accident or health plan
F. Income from cancellation of debt:
i) IRC § 61(a)(12): Cancellation of debt is GI: When debtor obtains forgiveness of debt absolutely or for a payment below the face amt of the debt, the extent of debt forgiven is GI to the debtor.
ii) Rationale: US v. Kirby Lumber co., Supreme, 1931 pg 310, Holding: Buying back bonds at less than par value is taxable discharge of debt be/ discharge frees up assets of debtor, even if TP only realized gain on paper and not actual accession to wealth.
(1) Alternate rationale: TP got consideration in form of reduction of valid claims against TP’s interests, therefore TP can enjoy loan proceeds w/o the offsetting obligation which is econ benefit.
iii) Exception IRC § 108: Some debt discharge excepted from gross income. But TP must reduce tax attributes or property basis by same amount.
(1) Bankruptcy108a1A: Title 11 cases
(2) Insolvency 108a1B: discharge of debt is not included as income to the extent that TP is insolvent.
(a) Insolvent (108(d)(3)): excess of liabilities over FMV of assets. This measured from position immediately be-4 discharge.
(3) Farm Debt 108a1C: Qualified farm debt (108g2)
(4) Real Property Debt 108a1D: If TP not a C corp and debt discharged is qualified real prop biz debt (108g3C)
iv) Definitions of debt: §108(d)
(1) Indebtedness of TP= liabilities of TP or sbj to which TP holds property.
v) IRC §108(b): hierarchy of attributes to be reduced: