Federal Income Tax
Definition of Terms
Above-the-Line Deductions: The best kind of deductions. All of the deductions listed in IRC sec. 62(a) are above-the-line deductions because they are used in computing adjusted gross income. All taxpayers can claim the deductions listed in IRC sec. 62(a).
Adjusted Gross Income (AGI or “The Line”): The gross income minus 21 specifically identified deductions (IRC sec. 62(a)).
The amount realized from a sale or other disposition of property is the sum of any money received plus the FMV of any property (other than money) received. (Treas. Reg. sec. 1.1001-1; 26 USC sec. 1001(b)).
Basis: Under U.S. federal tax law, the tax basis of an asset is generally its cost basis.
Cost basis: the original cost of property, adjusted for factors such as depreciation.
Below-the-Line Deductions: Taken into account after the determination of adjusted gross income. Include either (a) the standard deduction in sec. 63(c)(2) + personal exemption in sec. 151; or (b) itemized deductions in sec. 63(d) + personal exemption in sec. 151.
Contingent Obligations (liabilities): liabilities that may be incurred by an entity depending on the outcome of an uncertain future event such as a court case.
Debenture: In corporate finance, a debenture is a medium-to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term “debenture” originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note.
Effective Tax Rate: Actual taxes paid (owed) divided by gross income (not AGI or TI)
Gross Income: All income from whatever source derived (IRC sec. 61(a)). Examples of gross income can be found in IRC sec. 61(a).
Gross-up: A payment that's made to “increase a net amount to include deductions such as taxes that would be incurred by the receiver.” It usually refers to an employer reimbursing workers for the taxes paid on some portion of their income, usually from a one-time payment such as relocation expenses.
Itemized Deductions: All deductions other than above-the-line deductions and personal exemptions (IRC sec. 63(d)).
Imputed Income: the accession to wealth that can be attributed, or imputed, to a person when they avoid paying for services by providing the services to themselves, or when the person avoids paying rent for durable goods by owning the durable goods, as in the case of imputed rent.
Private Letter Ruling (PLR) – Issued to one particular taxpayer. Give the government a huge document with a sum of money asking for a PLR. The IRS agrees to how something will be taxed before they do it. It is binding to that one taxpayer.
Progressive Tax: Individuals are taxed at a different percentage based on their income. The US uses a progressive tax.
Proportionate Tax (Flat Tax): Everyone is charged the same percentage to determine how much they have to pay in taxes.
Poll Tax: A tax system in which everyone pays the same x amount of taxes.
Revenue Ruling – Generally applicable to all parties. It is a broader ruling that can apply to anyone.
Standard Deduction: The amount set forth in IRC sec. 63(c) (adjusted for inflation annually in the Rev. Proc.). Comprised of a “basic standard deduction” and, where appropriate, an “additional standard deduction.”
Recourse Loan: lender allowed to collect from the debtor and the debtor’s asset in the case of default by borrower.
Regressive Tax: A tax system in which the less money you make, the more your tax percentage increases.
Non-recourse Loan: secured by a particular piece of property, the collateral. Borrower not personally liable for a nonrecourse loan.
Taxable Income (Tax Base): Gross income minus the deductions allowed in IRC sec. 63(a) other than the standard deduction.
Tax Units: The tax classifications in the United States based on relationship status. (a) Married filing jointly; (b) married filing separately; (c) Single; (d) Head of household.
Time Value of Money: The idea that individuals would rather have money now rather than later because they could invest it now and make more money and the money is worth more now that it will be later because of inflation. In the case of deductions, they would rather have it now vs. later because it would reduce more than that dollar later.
Top Marginal Tax Rate: The top tax that you pay in a progressive tax bracket
Total Income: Income minus excluded income
ALL income, by default, is gross income. For income to not be listed as gross income you must find a specific exclusion in the tax code (i.e. Gifts, frequent flyer miles).
“gross income means all income from whatever source derived . . . includes income realized in any form, whether in money, property, or services.” (Treas. Reg. §1.61-1(a))
Services/property exchange: “. . . if services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation. If services are paid for in exchange for other services taken in payment must be included in income as compensation.” (Treas. Reg. §1.61-2(d)(1))
NOTE: IRS does not care about your bargains, they just tax it. So, the exchange of services does not have to be equal as in the above example.
Miscellaneous items of gross income
(a) In general. In addition to the items enumerated in §61(a), there are many other kinds of gross income. . . . Treasure trove, to the extent of its value in its United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession. (Treas. Reg. §1.61-14)
Only gains from capital, labor, or both are taxable (note: does not include things like lottery winnings) – compare British model that does not tax lottery winnings
Shareholders do not have gross income from a “stock dividend” (a transaction under which a shareholder in a corporation receives additional shares of stock in the company based on the number of shares the shareholder already owns) because such a transaction does not represent a “gain derived from capital, from labor, or from both combined. This is not taxable because it is not income. (Eisner v. Macomber)
Limited income to “the gain derived from capital, from labor, or from both combined…” Eisner v. Macomber
Realization event: When there is an actual change in the ownership or form.
Income must be realized in order to be taxed (U.S. v. Kirby Lumber)
Ex. You have something and now you don’t or vice versa. I had a house, I sold it, I no longer have a house.
Substance OVER form: if in substance, something is income, you have to include it as gross income. Do not look at technical structure.
Although the 16th Amendment and 26 USC sec. 61 give a broad definition of “gross income”, there is no specific definition in the code to give a test or rule. The full definition of “gross income” is found in common law.
A taxpayer has income when they have received an undeniable accession to wealth clearly realized over which the taxpayer has complete dominion. – Commissioner v. Glenshaw Glass Company (1955)
Facts: Taxpayer argued that punitive damages did not represent “ gain from capital or labor” as would be required under Macomber
Court: Macomber was not the only test for gross income. punitive damages received by the taxpayer were part of the taxpayer’s gross income.
Glenshaw Glass Test for Gross Income: (must meet all parts)
(1) Undeniable accessions to wealth;
Value must go up
(2) Clearly realized; and
You have to do something to trigger it.
Ex. Land that goes up in value, you would need to do something such as selling it.
(3) Over which the taxpayer has complete dominion
Complete dominion over income: it is under your control and you can spend that money
Ex. A trust — You don't have complete dominion or control over a trust.
Treasure Trove/ Found Money:
Cesarini v. U.S. F.Supp. 3 (N.D. Ohio 1969)
Facts: Found cash in a piano and paid taxes on it. Then they wanted a refund saying they shouldn’t have to pay the taxes in 1964, but rather when they bought the piano. Statute of limitations would have run out and they would not have to pay taxes on it.
The finding of money in an old pia
e change from the amount that you did pay minus what you would have paid from the exclusion of such an item (what you would have saved in taxes if you had not included the income)) under this chapter (or the corresponding provisions of prior revenue laws) for the prior taxable year (or years) which would result solely from the exclusion of such item (or portion thereof) from gross income for such prior taxable year (or years).
This is a make/hold provision. We are going to be nice and give you value for already paying tax on money you thought you had and had claimed under Claim of Right Doctrine.
No consequence from a tax perspective unless, people treat something as a loan that is not truly a loan.
Substance v. Form. Is it really a loan? Look up to see if it has been litigated and something is considered a loan. For example, theft is not a loan (see James).
Theft if not a loan. – U.S. v. James
when a taxpayer “acquires earnings, lawfully or unlawfully, without consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money.”
Security Deposits are loans, not income, and therefore are not taxable at the time of receipt. (Indianapolis Power and Light).
Contingent Obligation – you find a Picasso worth $50M. Local law says that if the rightful owner claims it within 2 years you must return it.
Do you have to claim it as gross income for tax purposes?
PRAY that your state law says the police gets to keep it because otherwise you DO have to pay the tax liability. YOU MUST REPORT IT in THE YEAR YOU RECEIVE IT. You could take out a loan to pay the taxes on the painting, but you do have gross income and it will be taxed.
If someone claims it, you can get your tax dollars back as an offsetting deduction.
Claim of Right Doctrine
Defined: when someone has:
(1) received funds;
(2) treated the fund as its own; and
(3) conceded no offsetting repayment obligation.
When income is received under claim of right, there is no loan. YOU HAVE TAXABLE INCOME BECAUSE YOU EARNED IT! It is gross income.
A corporation earned income ($170,000) from an oil well in 1916. 1917 lower court decree. 1922 appeal affirmed. The income had to be included in the corporation’s income in 1917, the year of the lower court’s decree. North American Oil Consolidated v. Burnet
Taxpayer received the funds, treated them as their own, and conceded them as their own obligation. Court found that these three factors of the Claim of Right Doctrine were satisfies and thus North American Oil has income.
Treas. Reg. § 1.61-14 Miscellaneous items of gross income. (a) In general. In addition to the items enumerated in section 61(a), there are many other kinds of gross income. For example, punitive damages such as treble damages under the antitrust laws and exemplary damages for fraud are gross income. Another person's payment of the taxpayer's income taxes constitutes gross income to the taxpayer unless excluded by law. Illegal gains constitute gross income. Treasure trove, to the extent of its value in United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession.