INCOME TAX – Fall 2013 – Dilley
INTRODUCTION
A. Development of the Income Tax
1. Intro
i. Primary Method of income for the US Government
ii. Other types of tax
a. VAT as opposed to income tax
iii. Sales tax is popular because it encourages savings
a. Person earns 20K a year, spends all of it by necessity
iv. Income tax is also a kind of consumption tax.
2. Constitutionality of the Income Tax
i. Taxing power is enumerated in Article I, Section 8
a. Must be uniform
b. Must be in proportion
3. Hellerman v. Commissioner
i. Facts: the Petitioners bought suit for sale of property and were taxed on its gain, which was attributed to solely inflation. Taxpayer argues it wasn’t a gain.
ii. Issue: Is inflation gain?
a. Argument: 16th Amendment allows taxes on income, but it shouldn’t allow tax for gain.
iii. Holding: this is a constitutional exercise of Congress’s power. Establish the unit of value. Got more dollars when they purchased, even if they represent less than they used to. Congress can makes laws as to what income is and what money is.
4. Perry v. Commissioner
i. Facts: the commissioner was not allowing the Perrys to claim a loss greater than 3000 on their income tax return. Deduction of losses up to 3,000 allowed, no more than that. They claimed that this was causing them to be taxed on income that does not exist.
ii. Congress can pass any tax as long as the tax is uniform among the states and, if a direct tax, it is apportioned among the states based on population
iii. IF not a direct tax or if it is an income tax, then apportionment does not apply!
B. The Structure of Tax Law/Tax Handout
1. Realization and recognition administrability
i. No point in assessing the tax at a time when the taxpayer cannot pay it
a. Taxing in installment if payment in installment
2. There should be as little tax collection bureaucracy as possible
i. Adam Smith – Wealth of Nations
ii. Not classic tax policy considerations but they are important
a. We have a voluntary tax system – relies on self reporting
b. Most taxes are withheld from wages, low level of interference
c. Employer has the burden to deposit taxes
d. Income tax was put in place before WWI but withholding right before WWII. SS came into being then.
C. The Taxing Formula
1. (Gross income – §62 deductions) = adjusted gross income
2. AGS – standard deduction or itemized deduction – personal exemption = taxable income
3. Taxable income x tax rate = tax liability
4. Tax liability – credits + additional taxes = final liability
THE CONCEPT OF GROSS INCOME
a. Section 61(a) – all income from whatever source derived
1. Eisner v. Macomber – income may be defines as the gain derived from labor, from capital, or from both combined.
i. Problems – this definition didn’t include prizes, awards, scholarships, punitive damages, and discovered wealth.
2. Commissioner v. Glenshaw Glass Co. – income includes any undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.
3. Questions to ask
i. What items are included in gross income?
ii. What is the amount of such inclusions?
iii. To whom?
iv. When must an accession to wealth be included?
b. Forms of Gross Income
1. Compensation for Services and Sale of Appreciated Property
i. Receipt of compensation for services – 61(a)(1-2)
a. Includes fees commissions, fringe benefits, and similar items
b. IRS will closely scrutinize a transaction between an employer and employee
ii. Gains derived from dealings in property – 61(a)(3)
a. Gain from a property transaction, which is defined in §1001, is computed by subtracting the adjusted basis of the property sold from the amount realized by the taxpayer on the disposition.
b. Adjusted basis – represents the taxpayers cost of acquiring the property while amount realized represents the total economic benefit received in exchange for the property.
c. 2-1. Isaac Jackson’s salary for the year, pursuant to his contract with his employer, was 35K. He received monthly paychecks, which totaled $29K for the year – the differential attributable to withheld federal and state taxes. Ruth Jackson, his wife, received a salary that totaled $46,000, but her take-home pay was only $32,000 – the differential also attributable to withheld federal and state taxes.
a. What is the amount of the Jackson’s gross income?
i. Add up the money before the withholding: 35 + 46 = 81,000
b. What result if Ruth Jackson were offered a 10K bonus by her employer in recognition of her superior services, but she declined the offer? Does she have gross income?
i. She does not have additional gross income. Her wealth has not increased.
2-2. Harold Jones purchased an automobile for 9K. One year later, he sold the car for 10K and ten shares of publicly traded stock worth 1K.
a. What is the Jones’s adjusted basis for the automobile?
§1011(a) – AB is the basis adjusted for things in 1016
1012 – generally the basis of property shall be the cost of the property
So, AB = $9,000
b. What is the amount realized by Jones on the sale?
1001(b) – the sum of any money received plus the fair market value of the property other than money received
So, AR = 11,000.
c. What is the amount included in Jones’s gross income?
AR – AB = Gross income
11,000 – 9,000 = 2,000
2. Income without Receipt of Cash
i. The more interpersonal and less business based the relationship, the less likely it is that the receipt is compensatory in nature.
ii. Objective fair market value – the price that would be reached in a transaction between a willing buyer and a willing seller.
iii. McCann v. US
a. Facts: Mrs. McCann got a trip to LV for being a good salesperson paid by her employer.
b. Issue: should the value of the trip be included in gross income?
c. IRS argues: not monetary but still an accession of wealth so should be included in gross income
d. McCann argues: didn’t pay for the trip herself, not a monetary increatia of wealth.
e. Court: in a situation where an employer pays an employee’s expenses on a trip that is a reward for services rendered by the employee, the value of the reward must be regarded as income to the employee.
f. When services are paid for in the form other than in money, it is necessary to determine the fair market value of the thing received. Reg. 1.61-2(d)(1)
iv. U.S. v. Gotcher
a. Facts: Gotcher was a car dealer. He received an all expenses paid trip to Germany to tour a Volkswagen manufacturing facility. Commissioner wanted to tax him on the value of the trip
b. Court held that the trip was not includable in income.
a. 2 prerequisites to gross income
i. Economic gain
ii. Gain must primarily benefit the taxpayer personally
c. Difference from McMann:
a. This was a business trip
b. Is not compensation for something
c. Cost of doing business for VW
d. Also Gotcher was not employee of company providing the benefit, he was a prospective VW dealer that VW wanted to help start business to promote their own business.
2-3. In December, Matilda Smith received an automobile as a sales bonus from her employer. At the time, the list price of the car was $12,000?
a. Does she have gross income? If so, how much?
a. Under 1.61-2(a)(1), bonuses are income to the recipients unless excluded by law.
b. Under 1.61-2(d), if compensation is paid other than in cash, the fair market value of the property must be included in income.
c. So, $12,000.
b. What result if she sold the car one year later for $14,000?
a. 1001(a): AR – AB = Gross income
b. $14,000 – 12,000 = $2,000
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2-4. Geraldine Sikes worked for Raton Corporation, which owned a house in which it allowed Sike
hem. Also express language in 61(a) saying that gross income is not limited to the following fifteen examples.
ii. 1.61-14- Misc. items of gross income
1. In general. In addition to the items enumerated in section 61(a), there are many other kinds of gross income… Treasure trove, to the extent of its value in US currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession.
iii. Go through property law – undisputed possession until its actual discovery in 1964 and thus no bar by statute of limitations.
iv. Takeaway: You’re taxing the event, not mere possession. It’s knowing that you were possessing that puts a tax liability on it.
2-8. Lucinda Paskin was digging in her backyard when she found a gold brooch. A reputable appraiser estimated the value of the find to be $16,000. Two weeks later, at an auction, Paskin sold the brooch for $14,000. Does Paskin have gross income, and if so, how much?
Yes, she has gross income under 1.61-14(a) because treasure trove. 14,000 – fair market value – what a willing buyer would be willing to pay for it. (cite?)
2-9 Professor Harold Levi liked to browse through various bookstores in the cities that he visited. In one old bookstore in Paris he paid 850 for a rare first editions of Joyce’s Ulysses, which he knew was worth at least $2,000. When Levi returned to the US, he sold the book to a friend for 1,800.
a. Does Levi have gross income when he buys the book? If so, how much?
He does not have income; he made a bargain purchase.
b. Does he have gross income when he sells the book? If so, how much?
Yes, he has gross income of $950.
§61(a)(3)
§1001(a) – the gain for the sale is the excess from the adjusted basis. 1800 – 850 = 950
5. Prizes and Awards – Code §74
i. Prizes and awards represent an accession to wealth.
ii. 74(a) – prizes and awards are generally included in gross income
iii. 1.74-1(a) prizes and awards which are includable in gross income include but are not limited to amounts received from radio and television giveaway shows, door prizes, and awards in contests of all types.
iv. 74(b) – excludes prizes or awards from gross income if they are made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement and
a. The recipient was selected without any action on his part to enter the contest or proceeding.
b. The recipient is not required to render substantial future services as a condition to receiving the prize or ward, and
c. The prize or award is transferred to a governmental unit or certian charitable organizations.
v. Turner v. Commissioner
a. Facts: Couple wins a contest and gets first class tickets for cruise from NYC to Buenos Aires – worth 2220 dollars. Weren’t transferable and had to be used within a year. Changed the first class tickets to 4 tickets and they instead went to Rio de Janeiro. They reported 520.
b. Issue: How should the court value the tickets?
a. They don’t count what the taxpayers valued the tickets at
b. This is not something that they would have bought for themselves
c. They couldn't’ have sold them either
d. But, they did obtain such benefits from the winning so should be included in their tax liability.
