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Tax
Temple University School of Law
Knauer, Nancy J.

I.                     USE 2002 outline for income cases
II.                    In general
a.        There is no definition of “income” in the Code or Regulations and the Courts have not produced an acceptable definition either
b.        Haig definition: the money value of the net accretion to one’s economic power b/t 2 points of time
c.        Plehn definition: wealth available for recurrent consumption (receipt, recurrence and expendability)
d.        Hewett definition: flow of commodities and services accruing to an individual through a period of time and available for disposition after deducting the costs of acquisition
e.        Simons definition (most widely accepted): the algebraic sum of
i.                     The market value of rights exercised in consumption and
ii.                    The change in the value of the store of property rights b/t the beginning and end of the period in question
iii.                  6. Posner definition: all pecuniary and non-pecuniary receipts, including not only leisure and other non-pecuniary income from household production but also gift, bequests and prizes
III.                  Compensation for services
a.        In General:
a.                    Includes: wages, salaries, fees, commissions, fringe benefits, and similar items
b.        It is not necessary that there be an employer-employee relationship; tips, legal and medical fees and jury fees are all compensation for services includable in gross income
c.        Form of payment doesn’t affect whether its income or not (stock, notes, or other property); the amount of income is the fair market value of the property
d.        Not all payments to employees are compensation; the question is whether the payment was compensatory in nature
e.        Form of receipt
a.                    Old Colony Trust Co. v. Com’r (ER pays tax for executive)
i.                     Company pays the income taxes of the CEO. CEO did not claim the money paid by the company as income
IV.                  The payment by an ER of the income taxes assessed against his EE constitute additional taxable income to the EE
V.                    TP’s wealth was increased by the payment, and the payment was compensation for his services to the ER; the payments were not a gift
VI.                  Policy à Congress and the IRS were concerned about the lack of vertical equity where people further up the tax ladder were receiving much more money in perks. The perks were shrinking the tax base and exaggerated at the higher income levels. So the higher income you had the greater percentage of fringe benefits you had because the higher up in the organization the more say you would have in your compensation package. This is why this type of fringe is disallowed
VII.                 Regs § 1.61-2(d) Compensation paid other than in cash
a.        In general. If services are paid for in property, the fair market value (FMV) of the property is included in income as compensation. If services are paid for in exchange for other services, the FMV of such other services must be included in income as compensation. If services are rendered at a stipulated price, such price will be presumed to be the FMV of the compensation received
b.        Property transferred to EE or independent contractor. If property is transferred by an ER to an EE or independent contractor, as compensation for services, for an amount less than its FMV, then regardless of whether the transfer is in the form of a sale or exchange, the difference b/t the amount paid for the property and the amount of its FMV at the time of the transfer is compensation and shall be included in the gross income of the EE or IC. Its basis shall be the amount paid for the property increased by the amount of such difference included in gross income
c.        Meals and living quarters.

d.        Fringe Benefits
a.                    Introductory note on fringe benefits
i.                     “In kind” benefits transferred to an employee
–                      Additional compensation
–                      Essential to the performance of the EE’s job (chalk for a teacher)
ii.                    Many fringe benefits are not subject to the income tax under current law – not because they are not income, but because Congress has chosen to treat them specially
iii.                  Up to 40% of compensation can be fringe
iv.                   Use by spouse and kids treated as use by employee [132(h)] v.                    no-additional cost service and employee discount must be available to all employees
VIII.               Note on fringe benefits
a.        Equity: Taxing those in the same economic position equally
b.        Efficiency: Failure to tax benefits induces ERs to offer, and EEs to select wage and benefit packages very different from those that they would obtain without the tax benefits
c.        Complexity: 
–                      Inherent difficulty in distinguishing in-kind compensation from goods or services related to an EE’s work
–                      Change is an additional source of complexity
–                      Congress’ unwillingness to accept the principle that all noncash compensation designed to reward the EE for services rendered should be subject to income tax
ii.                    Statutory Provisions: 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
IX.                  Work-related fringe benefits
a.        IRC § 132. Certain Fringe Benefits
(a)       Exclusion From Gross Income:
(1)       No additional-cost service,
(2)       Qualified employee discount,
(3)       Working condition fringe,
(4)       De minimis fringe,
(5)       Qualified transportation fringe,
(6)       Qualified moving expense reimbursement,
(7)       Qualified retirement planning services, or
(8)       Qualified military base realignment and closure fringe

–                      IRC § 132(b) No additional cost service (Ex: airline EE receiving free standby tickets): Any service provided by an ER to an EE for use by the EE if:
–                      The service is offered for sale to customers in the ordinary course of the line of business of the ER
–                      The ER incurs no substantial cost (including foregone revenue) in providing the service to the EE
–                      Policy: this is a much more restrictive formulation than was previously allowed. No additional cost helps address some horizontal equity issues and helped address the distortion of people going to certain industries

–                      IRC § 132(c). Qualified EE discount. Any EE discount with respect to property or services to the extent the discount does not exceed certain limits:
–                      Product: discount cannot exceed the diff. b/t the sales price and its cost to the ER
·          Cannot be real property or personal property that is held for an investment
–                      Service: discount cannot exceed 20% of the price at which services offered to customers
–                      Product or service must be offered for sale to customers in OCB of the ER
–                      Policyà People who work in a service or retail can get this discount whereas someone who works for a chemical company or the police can’t. This brings up horizontal equity issues.

–                      IRC § 132(d). Working condition fringe: Any property or services provided to an EE of the ER to the extent that, if the EE paid for such property or services, such payment would be allowable as a deduction to the EE under § 162

–                      IRC § 132 (e) De minimis fringe: Any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable
–                      The operation of any eating facility for EEs shall be treated as a de minimis fringe if:
·          The facility is located on or near the business premises of the ER; and
·          The revenue derived from the facility normally equals or exceeds the direct operating costs of the facility

–                      IRC § 132 (f). Qualified transportation fringe: This is qualified parking, transit passes, or transportation in a commuter highway vehicle provided by the ER to the EE

–                      IRC § 132(g). Qualified moving expense reimbursement: Any moving expenses received from an ER in reimbursement for moving expenses that would have been deductible under § 217 if they had been paid by the EE

–                      IRC § 132 (h). Certain individuals treated as EEs for purposes of subsections (a)(1) and (2): Retired and disable EEs, spouse and dependent children

–                      IRC § 132 (i) Reciprocal agreements: Any sercie provided by an ER to an EE of another ER shall be treated as provided by the ER if
X.                    Such service is provided pursuant to a written agreement b/t such ERs, and
XI.                  Neither of such ERs incurs any substantial additional costs

–                      IRC § 132 (j). Special Rules:
XII.                 No discrimination in favor of highly compensated
XIII.               On Premises Gym: 
·          Must be located on the premises of the ER
·          Must be operated by ER
·          Substantially all the use of which is by EEs/family members

–                      IRC § 132 (m). Qualified Retirement Planning Services. Excludes retirement planning services provided by an ER to its EE regarding a qualified ER retirement plan.
ii.                    United States v. Gotcher (VW dealer goes to Germany)
XIV.               Business travel – decided before Code §132
XV.                 The value of any trip that is paid by the ER or by a businessman primarily for his own benefit should be excluded from the gross income of the recipient
XVI.               Test of “taxable income”
·          There must be an economic gain
b.                    This gain must primarily benefit the taxpayer
XVII.              When an indirect economic gain is subordinate to an overall business purpose, the recipient is not taxed
XVIII.            No control or dominion over what he did
XIX.               Exclusion if
a.        legitimate business purpose
b.        incidental benefit
c.        inducement to buy aimed at that taxpayer
XX.                 The wife’s presence served no bona fide business purpose for her husband, therefore her expenses are taxable income
i.                     d. Business Meals or Lodging – §119
i.                     ER/EE exclusion for meals or lodging furnished for the convenience of the
–                      ER, on the business premises and required as a condition of employment
–                      extremely narrow provision
b.        Commissioner v. Kowalski (state troopers dinner $)
XXI.               Meals and lodging
XXII.              § 119 covers meals furnished by the ER and not cash reimbursements for meals
XXIII.            § 119 pre-empts the field and therefore the fair market value of meals and lodging which do not literally meet the test are income
XXIV.            Test for meals:
·          The meals must be furnished for the convenience of the ER;
·          The meals must be furnished on the business premises of the ER
XXV.              Moss v. Commissioner
–                      if chef on premises, could exclude
XXVI.            Notes:
XXVII.           Test for lodging: 
·          The lodging must be furnished for the convenience of the ER;
·          The lodging must be furnished on the business premises of the ER; and
·          The EE must be required to accept the lodging as a condition of his employment
–                      In-Kind requirement: cash payment or cash reimbursement to an EE is not excludable under § 119
–                      Convenience of ER Test: generally, a requirement that an EE be “on call” after business hours establishes that the lodging or meals are for the convenience of the ER; another way to pass the test, is to adopt a policy that precludes EEs from eating away from the ER’s business premises during reasonable meal hours

b.                    e.         IRC § 83
i.                     if employer pays in property and property has substantial risk of forfeiture and is
ii.                    non-transferable, don’t’ have to include in income (stock)
–                      don’t have to include in gross income until stock vests
ii.                    pro-taxpayer provision
–                      can choose to include FMV of stock in gross income when it is paid but not vested
–                      -done if you think stock will go up – only pay taxes at price it is when you get it
b.                    f.         Tax Expenditure Fringe Benefits
i.                     IRC § 106 excludes ER contributions to accident and health plans from the gross
–                      income of EEs
iii.                  If an EE purchases accident or health insurance himself, no deduction is provided, but
–                      the proceeds in the event of sickness or disability would not be taxed
iv.                   Social Policy – encourage employers to provide
–                      foregone revenue – government spending
b.        Interest-Free Loans
a.                    IRC § 7872(a)
i.                     foregone interest treated as transferred from the lender to the borrower and
–                      retransferred by the borrower to the lender as interest
c.        IRC § 7872(c)
i.                     below-market loans to which section applies
–                      gifts
–                      compensation-related loans
–                      corporation-shareholder loans
d.        IRC § 7872(e) – definition of below-market loans and forgone interest
e.        Any loan has to bear interest at applicable fed rate; if not, difference between applicable and 
i.                     what is charged on the loan will be taxable
XXVIII.         Foregone interest is deemed transferred from the lender to the borrower à
–                      compensation income
b.        If it is an interfamily loan IRS will generally allow the borrower to not include the forgone
i.                     interest as income. However, the lender will still take the forgone interest as income.
c.        C.                   Imputed Income
d.        The benefits derived from labor on one’s

ex. If passed down from great-grandmother to grandmother to you,
(1)       would be great-grandmother’s basis
–                      However, intervening testamentary basis can occur if G. grandmother
(1)       passed to grandmom in will. Then would be FMV when grandmom got.
–                      Don’t tax the accrued income at the time of the gift but to preserve the basis
(a)       so that the tax is triggered upon subsequent disposition
–                      If TP cannot establish the donor’s basis, then the donee must attempt to attain such facts from the donor and if impossible, the basis will be the FMV at the date the property was acquired by the donor (§ 1015(a))
–                      The basis is carry over EXCEPT if the carry over basis is greater than the
(a)       FMV of the property at the time of the gift THEN for the purposes of
(b)       determining loss the basis is the FMV
ii.                    Basis of Property Acquired from a Decedent – §1014
–                      Basis of property acquired from a decedent is the FMV of the property at the date of the decedent’s death (§ 1014 – “stepped up basis”)
iii.                  Changes to basis – §1016
–                      make adjustments for expenditures, receipts, losses, etc.
–                      Ex. Deck, roof – add cost to basis
–                      basis is value paid plus any after tax improvement
–                      Painting doesn’t count because it is ordinary repair [aluminum siding is basis] b.        Note on adjusted basis
i.                     Events subsequent to the acquisition of property may require “adjustments to basis” before gain or loss is determined
ii.                    Adjustments reflect the history of the asset in the hands of the TP or, of a person or asset whose basis has been “carried over”
c.        Note on allocation of basis
i.                     When a portion of property is sold, the basis must be divided among the parts (Regs § 1.61-6(a)); the gain or loss on each component part must be determined at the time of the sale of each part and cannot be deferred until the entire property has been sold
ii.                    In a part-gift, part-sale transfer, the transferor generally can allocate basis to the portion of the transfer that constitutes a sale
d.        Transactions involving borrowed funds
a.                    Introduction
i.                     A borrower does not realize income upon receipt of a loan, regardless of how the loan proceeds are used and he has no deduction when he makes principal payments on the loan (there is no change in the net worth of either party)
ii.                    If the debt is paid by another or it is cancelled for less than its face value, it is considered to be income (§ 61(a)(12) – Kirby Lumber Principle)
a.                    b.        Zarin v. Commissioner (compulsive gambler settles with Resorts casinos)
i.                     Discharge of indebtedness income
ii.                    A TP’s gross income includes all income from whatever sources derived, including cancellation of indebtedness
iii.                  Tax Court said: Legal enforceability of an obligation to repay is not determinative of whether the receipt of money is taxable
iv.                   Court of Appeals overruled and found that since TP’s loan was unenforceable under New Jersey law, Zarin, therefore, did not have income from the discharge of the debt
v.                    Court of Appeals applied “contested liability doctrine” under which, if a TP disputes the amount of a debt, a subsequent settlement is treated as the actual amount of indebtedness
vi.                   Only way he should get off from paying is under §108 – exceptions for cancellation
–                      of indebtedness when insolvent- these exceptions have emerged because of the
–                      assumed precarious financial position of a person who is canceling debts.
–                      108(a) when subject to bankruptcy or insolvent the taxpayer can exclude debt
–                      cancellation from income to the extent of his insolvency.
vii.                 Ex. taxpayer has liabilities of $20K which are satisfied for $12K = $8K of COD
–                      income
–                      insolvent immediately before the discharge because they have assets of $13K – $7K
–                      (negative)
–                      COD income exceeds insolvency by $1K
viii.                Rapid Refunds are loans – give $1100 for $1400 tax refund
e.        F.                    Illegal Income
XXXII.           Collins v. Commissioner (OTB gambler gets busted)
i.                     Facts: EE works for a OTB. Printed up 80k of tickets without paying for them. He won 42k 
ii.                    and lost 48k. He returned the 42k in restitution. EE had tax liability of 80k, but had a
iii.                  deduction for his restitution of 42k. A unilateral intention to pay is not considered a loan
iv.                   because there was no consensual agreement to make a loan.
b.        Where a TP has withdrawn from a corporation funds which he fully intends to repay and which he expects with reasonable certainty he will be able to repay, he believes that his withdrawals will be approved by the corporation, and he makes a prompt assignment of assets sufficient to secure the amount owed, he does not realize income on the withdrawals
c.        If an embezzler makes a bona fide arrangement with the victim in the same taxable year as the theft to repay the embezzled funds, the embezzler is either entitled to a deduction at the time the arrangement is entered into, or the arrangement converts the embezzlement into a loan – in this case, TP made no such bona fide agreement
XXXIII.         Notes