BASIC INCOME TAX– OUTLINE I. INTRODUCTION – CHAPTER 1 o A) Judicial Resolution of Tax Issues – Two Options 1) If the commissioner of the IRS asserts a deficiency in income tax, i.e., claims that the taxpayer has failed to pay all that is owed, the taxpayer may: a) Refuse to pay the tax and petition the Tax Court for a redetermination of the deficiency; OR b) Pay the deficiency, file and administrative claim for a refund, and upon denial of the claim, sue for a refund in federal district court or the US Court of Federal Claims o B) Courts to Sue in for Tax Concerns – Advantages/Disadvantages 1) Tax Court “Poor Persons” Court – b/c taxpayer commences action for redeterminiation of a deficiency without first paying the deficiency Court has original jurisdiction over tax matters 2) Federal District Courts Court has jurisdiction in any tax case against the US seeking a refund of tax, regardless of the amount involved. Actions for refund in the federal district courts are commenced only after the asserted deficiency has been paid. 3) US Court of Federal Claims Court has jurisdiction throughout US and over all tax suits against the US regardless of amount Actions for refund in the US Courts of Federal Claims are commenced only after the asserted deficiency has been paid. o C) Determining Tax Liability of Taxpayer – Two Questions 1) What is the applicable tax rate? – IRC §1(a) 2) What is the tax base the tax rate is applied to? o D) Gross Income Concepts / Limitations (§ 61, Cases) 1) §61 a) General definition.–Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:o (1) Compensation for services, including fees, commissions, fringe benefits, and similar items;o (2) Gross income derived from business;o (3) Gains derived from dealings in property;o (4) Interest;o (5) Rents;o (6) Royalties;o (7) Dividends;o (8) Alimony and separate maintenance payments;o (9) Annuities;o (10) Income from life insurance and endowment contracts;o (11) Pensions;o (12) Income from discharge of indebtedness;o (13) Distributive share of partnership gross income;o (14) Income in respect of a decedent; ando (15) Income from an interest in an estate or trust. 2) Reg. § 1.61-1(a) Gross income includes income realized in any form whether in money, property, or services. Gross Income includes income derived from whatever source. Generally any accession to wealth is included in Gross Income. Gross Income can be realized in any form 3) Reg. § 1.61-2(d)(1) 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, the fair market value of such other services taken in payment must be included in income as compensation. If the services are rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary If there is an exchange in property for services in an amount less than the FMV, the difference between the FMV and the amount paid is included in the taxpayer’s Gross Income. a) Fair Market Value Definedo Fair market value is generally defined as the price a willing buyer would pay a willing seller, with neither under a compulsion to buy or sell, and both having reasonable knowledge of relevant facts. 4) Eisner v. McComber Interest earned from capital is included in Gross Income. 5) Glenshaw Glass Punitive damages are included in gross income. 6) § 451; Reg. § 1.446-1(c)(1)(i) – Cash Method Taxpayers If a taxpayer is owed money from clients for work performed during the current year, that amount of money is not included in their gross income. The taxpayer has not actually or constructively received any of the money in their gross income 7) § 61(a)(4) Interest income is includable in gross income The management fee will not be deducted when arriving at gross income. 8) Other Forms Employer/employee situations, the employee is likely being compensated in some form (sells $500 worth of stocks to the employee for $100, then the $400 is income included in gross income.) §1.6-2 Income from an illegal business Discharge of indebtedness. Mitch sold stock for 3,000 and gave it to a creditor for a 5,000 debt. Mitch has income. Treasure trove is included in gross income the year it became undisputedly possessed. Cesarini If someone else pays an obligation for you it is included in gross income. The discharge of an obligation is not likely to be considered a gift if it arises out of an employer/employee relationship. Old Colony Trust §1.61(8)(c) and Old Colony, anytime you pay off something for another it has to be income for the person who should have rightfully paid. Seminar or vacation? Court held that the seminar was a vacation and the employee had to be taxed for the FMV of the trip. McCanno Look at the facts of the situation – assume all the expenses were paid by the employer, did the employee still have to be there? If yes, then it’s a business purpose. Coming out ahead in a deal on a house or etc., is not included in gross income. Pellar o E) Adjusted Gross Income – § 62 – ABOVE THE LINE DEDUCTIONS (Used to Determine AGI) 1) § 62 Adjusted Gross Income is G
Gain derived from capital, labor, or both combined, provided it be understood to include profit gained through the sale or conversion of capital assets. 3) U.S. Kirby Lumber Discharge of corporate debt for an amount less than the face of the debt resulted in income to the debtor. 4) Glenshaw Glass Punitive damages included in gross income because they are designed to compensate the victim for losses suffered, rather they are a bonus on top of those damages designed to make a victim whole. “Where you have instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion, even if the payments were extracted from the wrongdoers as punishment for unlawful conduct, these accessions are taxable income to the recipients.” 5) Cesarini v. US Treasure trove is included in gross income the year it became undisputedly possessed 6) Old Colony Trust Payment of the tax by the employers was in consideration of the service rendered by the employee and was a gain derived by the employee from his labor 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 given that the payment for services, although entirely voluntary, was nevertheless compensation. If someone else pays an obligation for you it is included in gross income. The discharge of an obligation is not likely to be considered a gift if it arises out of an employer/employee relationship. 7) McCann v. US The Supreme Court has said that Congress intended by the statutory provision of section 61(a) to tax ALL gains, except those specifically exempted, and that the term “income” includes any economic or financial benefit conferred as compensation, however accomplished Court held that the seminar was a vacation and the employee had to be taxed for the FMV of the trip. Therefore, the reward to Mrs. McCann, although not in the from of money, was clearly compensation to her for the services that she had rendered to Security during 1972, and was within the meaning of income, as that term is used in section 61(a). 8) Pellar v. Commissioner