I. Identification of Income Subject to Taxation
a. Gross Income
i. Introduction to Income
1. Taxable income is gross income less certain authorized deductions
2. Sec. 61 defines gross income as “all income from whatever source derived.”
ii. Equivocal Receipt of Financial Benefit
1. Cesarini v. United States
a. Taxpayers discover money in piano and file amount on tax return. Taxpayers now seek to recover that amount, claiming it was not includable in gross income under Sec. 61. Taxpayers also claim that even if it qualified as gross income, it was due in the year the piano was purchased, and the statute of limitations and elapsed.
b. Government asserts that the amount found in the piano is includable in gross income and that it was taxable in the year it was actually found.
c. Court concludes that the amount should be included in gross income.
i. The broad all-inclusive language of Sec. 1.61-1(a) of the Treasury regulations was used by Congress to exert the full measure of its taxing power under the Constitution. Income from all sources is taxed unless the taxpayer can point to an express exemption.
ii. Taxpayers didn’t have ownership of the money until the date when they found it, and therefore, the statute of limitations did not bar the government from taxing them on it.
2. Old Colony Trust Co. v. Commissioner
a. Taxpayer’s employer paid his income taxes for him.
b. Issue: whether the income taxes paid by the Taxpayer’s employer were additional income to the Taxpayer.
c. Holding: The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed. The payment of the tax was not a gift because it was in consideration of his services.
3. Glenshaw Glass
a. Issue: whether money received as exemplary damages for fraud or as punitive damages must be reported as gross income
b. Rule: the language of Sec. 61 was used by Congress to exert the government’s full measure of taxing power
c. Income includes instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.
i. Under this rubric, loans are not included in gross income because taxpayer does not have complete dominion over them.
ii. Money received through embezzlement was initially not taxed as gross income because the embezzlers achieved no accession to wealth. Now illegal gain is income despite a legal obligation to make restitution.
4. Gross Income Factors:
a. Raise revenue
c. Reasonably simple and easy to administer
iii. Income Without Receipt of Cash or Property
1. Helvering v. Independent Life Insurance
a. Issue: whether a taxpayer must include in gross income the rental value of a building owned and occupied by the taxpayer.
b. Holding: the rental value of the building used by the owner does not constitute income.
2. 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.
a. E.g., in exchange for legal services performed by a lawyer for a housepainter, the housepainter paints the lawyer’s home. The fair market value of the services received by the lawyer and the housepainter are includible in their gross incomes under Sec. 61.
b. E.g., an owner of an apartment building received a work of art in return for rent-free use of an apartment for six months by the artist. The fair market value of the art and the six months fair rental value of the apartment are includible in gross income.
3. Dean v. Commissioner
a. Taxpayer and wife are sole shareholders of the Nemours Corporation. Their home was formerly owned by the wife but was then transferred to the corporation. The parties continued to occupy the home after the transfer.
b. Issue: whether the fair rental value of the residence should be included in the taxpayer’s gross income
c. Holding: It was the taxpayer’s legal obligation to provide a family home and if he did it by the occupancy of a property which was held in the name of a corporation of which he was president, the fair rental value of the home was income to the taxpayer.
i. Occupation of real estate is an accession to wealth. Ordinarily, as was the case in Helvering, such occupation is not included in gross income because the government wants to encourage investment in real estate.
b. The Exclusion of Gifts and Inheritances
i. Rules of Inclusion and Exclusion
1. Gross income includes the receipt of any financial benefit which is:
a. Not a mere return of capital, and
b. Not accompanied by a contemporaneously acknowledged obligation to repay, and
c. Not excluded by a specific statutory provision.
1. The Income Tax Meaning of Gift
a. Sec. 102(a): Gross income doesn’t include the value of property acquired by gift, bequest, devise, or inheritance
b. Commissioner v. Duberstein
i. Facts: Taxpayer, Duberstein, received a Cadillac from Berman to thank him for referring customers to him.
ii. Issue: whether the car was a gift or was compensation for services rendered by the taxpayer
iii. Holding: the transfer of the car was recompense for past services and was therefore properly included in gross income
iv. Facts: Taxpayer received a retirement gift.
v. Issue: whether the money received by the Taxpayer was a gift or payment for services
vi. Government’s Proposed Test:
1. Gifts should be defined as transfers of property made for personal as distinguished from business reasons
vii. Court’s Test:
1. A gift in the statutory sense proceeds from a detached and disinterested generosity out of affection, respect, admiration, charity, or like impulses. The most critical consideration therefore is the transferor’s intention.
2. The conclusion whether a transfer amounts to a gift is one that must be reached by the trier of fact on a case-by-case basis in consideration of all the factors.
a. Appellate review must follow a clearly erroneous standard.
2. Employee Gifts
a. Sec. 102(c) – An employee shall not exclude from gross income any amount transferred by or for an employer to, or for the benefit of, an employee.
i. The fair market value of an employee award is includible in the employee’s gross income under Sec. 61 and is not excludible under section 74 or section 102.
iii. Bequests, Devises, and Inheritances
1. Lyeth v. Hoey
a. Facts: Taxpayer, an heir, receives portion of what was bequeathed to him in will after settlement.
b. Issue: whether property received by Taxpayer from the estate of a decedent in compromise of his claim as an heir is taxable as income
c. Holding: Taxpayer obtained the amount sought to be taxed because of his standing as an heir and of his claim in that capacity. Therefore, the exemption applies.
2. Wolder v. Commissioner
a. Facts: Attorney works for client in exchange for client bequeathing payment to him at death
b. Issue: whether the bequest of payment for services is excludible from gross income
c. Lawyer’s argument: Under Merriam, a bequest to an executor was excluded from gross income.
i. Court holds that Merriam is inapplicable because an executor and a lawyer are different occupations and the case is outdated.
d. Holding: This is income because it’s delayed compensation for services
c. Employee Benefits
i. Exclusions for Fringe Benefits
1. If an employee benefit is not specifically excluded from gross income, its value must be included within gross income under Sec. 61.
2. Sec. 132
a. Excludes fringes provided to “employees.”
i. Persons currently employed
ii. Retired and disabled ex-employees
iii. Surviving spouses of employees or retired or disabled employees
v. Dependent children
i. No-additional-cost services
1. Offered for sale to customers in the same line of business as that in which the employee is already performing services.
a. Exception where companies have a written reciprocal agreement
2. Employer incurs no substantial additional cost in providing the service to the employee
3. Provided on a non-discriminatory basis, i.e. denies highly compensated employees an exclusion for fringes unless fringes are provided on substantially the same terms to a broad group of employees.
4. Exclusion applies whether services are provided free of charge, at some partial charge, or under a cash rebate program
ii. Qualified Employee Discounts
1. Offered for sale to customers in the same line of business
2. Provided on non-discriminatory basis
3. Discount may take for of price reduction or rebate
4. Ceiling on amount of exclusion
a. In case of services, discount may not exceed 20%
b. In case of property, the maximum discount for property is the employer’s gross profit percentage, i.e., (aggregate sales price – cost)/aggregate sales price
ore for the larger gain; the appreciation of property during the donor’s ownership is income accessable against the taxpayer
i. Facts: Spouse signed ante-nuptial agreement waiving her marital rights in exchange for stock
ii. Issue: What is the basis of the stock that the wife sold?
iii. Government argues that the basis of the stock is carry-over basis because it was a gift.
iv. Holding: Court finds that because spouse gave valuable consideration for the stock in waiving her marital rights, the basis is the value of property of what she received in exchange for waiving those rights.
3. Property Acquired Between Spouses or Incident to Divorce
a. Sec. 1041: No gain or loss should be recognized on a transferred property between spouses or former spouses where the transfer is incident to a divorce.
i. Congress considered it inappropriate to tax transfers of property between spouses or former spouses because it believed that a husband and wife are a single economic unit, and the tax laws governing transfers of property between spouses and sometimes between former spouses should be as unintrusive as possible.
ii. Sec. 1041 accords almost complete tax neutrality to transfers of property between spouses and between former spouses if the transfer is incident to divorce, i.e., no gain or loss is recognized.
iii. In the case of any transfer of property between spouses or former spouses, the transferee is treated as if the property were acquired by gift, and the basis of the property in the hands of the transferee is the same as the basis of the property in the hands of the transferor.
iv. Unlike the gift basis rule, the Sec. 1041 transferee spouse or former spouse always takes a transferred basis, even for computing loss.
4. Property Acquired from a Decedent
a. Under 1014(a), property acquired from a decedent generally receives a basis equal to its fair market value on the date on which it was valued for federal estate tax purposes.
i. The effect of this basis rule is to give property that appreciated during the decedent’s ownership a “stepped-up” basis with no income tax cost to anyone. A “stepped-down” basis results without deductible loss of property declined in value during decedent’s ownership.
ii. Section 1014 applies not only to property held by decedent at death, but also to some property that decedent transferred during life if the value of the property is nevertheless required to be included in decedent’s gross estate for federal estate tax purposes.
iii. Although appreciated property is fully subjected to the estate tax, the appreciation itself entirely escapes the income tax.
iv. To prevent abuse, if appreciated property is acquired by a decedent within a one-year period ending on the decedent’s death, and if the property passes from the decedent back to the donor or the donor’s spouse, the basis in the property is the adjusted basis of the property in the hands of the decedent immediately before death.
1. E.g., son owns some land purchased for $20k, which is worth $100k. He gives the land to his ill mother, who dies within a year devising the property back to the son. Upon reacquisition, son’s basis in the land is still $20k rather than $100k.
iii. Amount Realized