Federal Income Tax – UCONN Law – Prof. Richard Pomp Spring 2011
General Things to Remember
– taxpayers prefer to postpone tax payments (TVM)
o converse: Treasury prefers to get tax payments sooner
– can’t have a basis and a deduction – double-dipping
– Always about deferring tax payment, usually never about total forgiveness of tax
I. Income and Income-in-Kind
– §61 – gross income means all income from whatever source derived….including but not limited to
o (1) Compensation for services
o (2) Gross income derived from business
o (3) Gaines derived from dealings in property
o (4) Interest
o (5) Rents
o (6) Royalties
o (7) Dividends
o (8) Alimony & separate maintenance payments
o (9) Annuities
o (10) Income from life insurance & endowment contracts
o (11) Pensions
o (12) Income from discharge of indebtedness
o (13) Distributive share of partnership GI
o (14) Income in respect of decedent
o (15) Income from an interest in estate or trust
o court interprets this broadly in order to exert full measure of taxing power
o seems somewhat circular in that it in includes in gross income all items of income
Definitions of Income
– Eisner v. Macomber – income defined as the gain derived from labor, capital or from both combined.
o Problem – does this mean that unless the factor of labor/capital present, this is not income (what happens if you find $100 on the street?)
– Glenshaw Glass Co. – Modern approach
o Income is any accession to wealth, which is clearly realized, and over which the taxpayer has complete dominion
o for instance, here punitive damages are taxable (even though no labor/capital)
– Items that are not income:
o Imputed Income (value of services one performs for oneself or family and the value of any property that one owns
§ taxation of imputed income raises seemingly insurmountable problems of valuation and liquidity à objectionable
§ bartering for exchange of services is taxable, but imputed income (same services within your own family unit) are not
o Capital Recovery – income on sale/exchange is profit on the transaction; entitled to receive his or her capital investment tax-free
o Loans – creation/repayment of loan is not a taxable event. Forgiveness/discharge of loan may generate income to debtor
Income in Kind
– Old Colony Trust Co – satisfaction of a taxpayer’s obligation (taxes) by another person constitutes an economic benefit, resulting in income to the taxpayer.
o in consideration for services to the company §61(a)(1)
o discharge of an obligation by a 3P is equivalent to receipt by the person taxed
Valuation Problem
– Turner – taxpayer wins radio contest – gets trip to Brazil
o Some amount should be included in income (esp because he was able to barter for a ticket that he preferred)
o problem of valuation – maybe the taxpayer’s value is less than the market value? (they would have never paid for the tickets to go if they did not get them for free)
o In taking the cruise, they received benefits
II. Meals and Lodging
– Benaglia – taxpayer could exclude the value of room & board from his gross income
o Was required to live in the hotel for the “convenience of the employer,” so advantage to him was merely incidental, even though it would relieve him of an expense he would otherwise bear
o reflects a willingness on the part of Congress & courts to take into account the possibility that the taxpayer’s rewards may be worth less to him than their market value
§ may have preferred to live more modestly and save some
§ restricted – not only forced to consume what he would rather save, but forced to consume particular goods
– §119 – Meals or Lodgings Furnished for the Convenience of the Employer
o (a) There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employers for the convenience of the employer, but only if
§ (1) in the case of meals, the meals are furnished on the premises of the employer
§ (2) in the case of lodging, the employee is required to accept lodging on the business premises of his employer as a condition of his employment
III. Fringe Benefits
– §132 Certain Fringe Benefits
o (a) Gross income shall not include any fringe benefit which qualifies as:
o (b) No Additional Cost Service
§ (1) Services offered for sale to customers in the ordinary course of business of the employer in which the employee is performing services
· line of business limitation designed to:
o limit loss of tax revenue
o prevent conglomerates from unfair advantage
§ (2) Employer incurs no substantial additional cost (including foregone revenue) in providing such service to the employee
§ No-discrim section applies – §132(j)
o (c) Qualified Employee Discount – limited to goods in the line of service
§ (1) Means any employee discount with respect to qualified property or services ot the extent that such discount does not exceed
· (A) Property – the gross profit % of the price at which the property is being offered by the employee to customers
· (B) Services – 20% of the price at which the services are being offered by the employer to customers
§ (2) Gross Profit Percentage
· (A) Means the % by which
o (i) the excess of the aggregate sales price of property sold by the employer to customers over the aggregate cost of such property to the employer, if of
o (ii) the aggregate sales prices of such property
· (Aggregate Sales – Cost of Goods Sold)/Aggregate Sales
§ Non-discrim section applies – §132(j)
o (d) Working Condition Fringe
§ any property or services provided to an employee of the employer to the extent that, if the employee paid for such property of services, such payment would be allowed as a dedux under §162 (trade/business expenses) or §167 (depreciation)
§ Examples: employer supplies professional journal (employee would otherwise deduct if she bought herself), office furniture/equipment, meals, lodging, transportation while on business trips
o (e) De Minimis Fringe
§ any property or service the value of which (after taking into account the frequency which similar fringes are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impracticable
§ Examples: occasional parties, coffee, occasional sports/theater tix, etc
o (f) Qualified Transportation Fringe
§ transportation in a commuter highway vehicle if such transportation is in connection with travel between employee’s residence and place of employment
§ any transit pass
§ qualified parking
§ 132(f)(2) – caps the exclusion for qualified transportation (limites are indexed for inflation) à $175/month
o (g) Qualified Moving Expense Reimbursement
§ any amount received (directly or indirectly) by an individual from an employer as a payment for (or reimbursement of) expenses which would be deductible as moving expenses under §217 (moving expenses) if directly paid or incurred by the individual
o §117(d) – Qualified Tuition Reduction
§ amount of any reduction in tuition provided to an employee of an organization for the education (below the graduate level) at such an organization
o 132(h) – Certain Individuals Treated as employees for Purposes of Subsections (1) and (2)
§ (1) Retired and Disabled Employees and Surviving Spouse of Employee Treated as employee
· (A) formerly employed in line of business and who separated from service by reason of retirement or disability
· (B) widow/er of any individual who died while employed by employer in such line of business
§ (2) Spouse & Dependent Children
§ (3) Special Rules for Parents in the Case of Air Transportation
o 132(i) – Reciprocal Agreements – any service provided by an employer to an employee of another employer shall be treated as provided by the employer of such employee if (for the purposes of no additional cost services)
§ (1) such service is provided pursuant to a written agreement between such employers and
§ (2) neither of such employees incurs any substantial additional costs (including foregone revenue) in providing such service of pursuant to such agreement
§ has to be in the same line of business so it fulfills the “primary line of business” requirement for the no-additional cost services
– Fringe benefits that do not qualify for exclusion are fully includible under §§61 and 83 and are includable in wages for employment tax
n favor of Annual Accounting à Previously Deducted Losses
o Facts: Dredging company. Reported payments as income and deducted expenses. Most years has a net loss – profit in one year. Abandoned the work and sued for breach of warranty. In 1920, taxpayer received damages of $176,271.88 that were measured by the total of the taxpayer’s expenses over the income from the project
§ Taxpayer: cant be income b/c experienced a loss on the entire contract in the previous years
o Issue: Was the whole $176k includible as income in the year 1920?
o Holding: $176k was fully includible in 1920 – under the annual accounting system, events of previous years are irrelevant for determining tax consequences for the particular year
§ Congress responds with NOL (below)
o each accounting period must be regarded as a discrete unit for tax purposes
o income under the constitution refers to accessions taking place solely within the taxable year
o courts unwilling to increase the burden of the administration by keeping tax returns alive
– §446. General rule for methods of accounting —
o (a) General rule—Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.
o (b) Exceptions—If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does reflect income.
o Accrual method v. Cash Receipts Method
§ accrual method generally regarded as a better match of expenses and revenues (and therefore is harder to distort)
– §172. Net Operating Loss (NOL) Deduction – BUSINESS ONLY (no longer an averaging device for individual taxpayer)
o (a) Deduction allowed—There shall be allowed as a deduction for the taxable year an amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus (2) the net operating loss carrybacks to such year. For purposes of this subtitle, the term “net operating loss deduction” means the deduction allowed by this subsection.
o (b) Net operating loss carrybacks and carryovers—
§ (1) Years to which loss may be carried—
· (A) General rule—Except as otherwise provided in this paragraph, a net operating loss for any taxable year—
(i) shall be a net operating loss carryback to each of the 2 taxable years preceding the taxable year of such loss, and
(ii) shall be a net operating loss carryover to each of the 20 taxable years following the taxable year of the loss
o to mitigate the effects of the annual accounting rule
– Examples:
o NOL Carryforward (20 years allowed): Loss of $100 in Year 1 (start-up of business). Since first year, can’t carry it back. Year 2 = $60 profits (so use $60 of loss to shield income from tax); Year 3 = $30 profit (so use $30 to shield income); Year 4 = $15 (use last $10 of NOL to reduce taxable income to $5
o NOL Carryback (2 years allowed): Year 1 = $60 profit; Year 2 = $30 profit; Year 3 = $110 loss.
§ If you decide to carry back must go to year #2 first.
§ Take $60 of NOL and file for a refund of your tax in year 1 (already been filed, so now you get a refund b/c you have overpaid your tax on now $0)
§ The Year 2 – must use as much NOL as you can to wipe out the $30
§ Then carry forward the $20 to year 4 (as long as you need of the 20 years)
– Note: You cannot skip to high marginal tax years (cannot skip to game the system)
