FEDERAL INCOME TAX
A. The Income Tax and the United States Constitution
1.) Power to Tax – Art. 1, Section 8, Clause 1 gives Congress the “power to lay and collect taxes, duties, imposts, and excises…but all duties, imposts, and excises shall be uniform throughout the U.S.”
2.) Power to Tax Income – 16th Amendment states that “Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.”
3.) Direct v. Indirect Tax, Apportionment Among the States, Uniformity Among the States
B. The Tax Practitioner’s Tools, Tax Policy Considerations, The Road Ahead
II. Identification of Income Subject to Taxation
A. Gross Income: The Scope of Section 61 (KEY: Distinguish Income from Property) 1.) Introduction to Income
i.) Important Questions to Always Ask:
a.) What is income?
1.) Nothing is income unless realized – income vs. property.
2.) Character of income – capital vs. ordinary gain.
b.) When is it income?
1.) Accounting method.
2.) Accounting year.
c.) Whose income is it?
1.) Assignment of income.
d.) At what rate should the income be taxed?
ii.) Tax Liability = taxable income X applicable tax rates.
a.) Taxable Income = gross income less certain authorized deductions. 63(a).
1.) Gross Income = all income from whatever source derived.
2.) Deductions = itemized deductions, personal deductions, etc.
b.) Taxable Income = Tax Base (Gross Income – Adjusted Gross Income).
c.) Tax Credit = dollar for dollar offset of tax liability.
iii.) Formula and Steps:
a.) Gross Income – Section 62 Deductions = Adjusted Gross Income.
b.) AGI – Standard or Itemized Deductions and Personal Exemptions = Taxable Income.
c.) Taxable Income X Tax Rate = Tax Liability.
d.) Tax Liability – Tax Credits + Alternative Minimum Tax = Final Tax Liability.
2.) Equivocal Receipt of Financial Benefit
i.) Gross Income – “Except as otherwise provided…gross income means all income from whatever source derived” including but not limited to 15 items under Section 61(a):
a.) Compensation for services, including fees, commissions, fringe benefits, similar items
b.) GI derived from business, GI derived from dealings in property
c.) Interest, Rents, Royalties, Dividends, Annuities, Pensions
d.) Alimony and separate maintenance payments
e.) Income from life insurance and endowment contracts
f.) Income from discharge of indebtedness
g.) Distributive share of partnership GI
h) Income in respect of a decedent, income from an interest in an estate or trust. 61(a).
ii.) GI includes “gains derived from dealings in property” but not property itself (income v. property – no income from property until there is a gain, so a final transaction).
a.) Moment of realization is when tax consequences on income occurs (but watch out for SOL – 6 years), so once TREASURE TROVE is found, it becomes income, according to state common law regarding property stating that finder of treasure trove has rights over the world except true owner (Cesarini v. US – P found cash in piano 7 yrs after purchasing piano and cash became income); Regs.1.61-1, -2(a)(1), -2(d)(1), -14(a).
b.) Treasure trove is GI for taxable year in which it is reduced to undisputed possession.
c.) Exclusions – gross income does NOT include value of property acquired by gift, bequest, devise, and inheritance (102a), regardless whether greater value is found later.
iii.) GI also includes punitive such as exemplary damages for fraud and treble damages for antitrust, another person’s payment of TP’s income taxes, treasure trove. Reg. 1.61-14(a).
rn of capital, and
ii.) Not accompanied by a contemporaneously acknowledged obligation to repay, and
iii.) Not excluded by a specific statutory provision (so, first must ask whether there is income before determining exclusion).
2.) GI does not include value of property acquired by gift, bequest, devise, or inheritance. 102(a).
i.) The question of whether a transfer of money or property constitutes a gift is an issue of fact to be determined by the trial court.
a.) A gift proceeds from a detached and disinterested generosity out of affection, respect, admiration, charity, or like impulses, and the most critical consideration is the transferor’s donative intent, not recipient (see Commissioner v. Duberstein where a gift of a car was not a gift for tax purposes because it was in a business context, even though gift was made without expectation of services).
b.) To determine whether the gift is a bona fide gift or a method of compensation, examine the intent of the parties, the reasons for the transfer, and the parties’ performance in accordance with their intentions (see Wolder v. Commissioner where money given to lawyer in a will for the services provided throughout the testator’s life was considered compensation for legal services and not a devise, since there was relationship and K between client/lawyer).
c.) For gifts, look at donative intent and relationship, but for devise and inheritance, look at relationship (spousal, parental-child, EE/ER, lawyer/client) and state laws of descent and distribution.
d.) Cash is considered property.