Federal Income Taxation-Chapter Two Some Characteristics of Income
What is income?
(1) You look at fairness, efficiency, and practicality.
(2) § 61-gross income is all income from whatever source derived
a. Gross Receipts-Gross receipts are not “income” as we will define it.
b. Gross Income-§ 61-Gross receipts less COGS is gross income.
c. AGI-AGI is gross income reduced by business expenses or expenses of producing income.
d. Taxable Income-AGI less allowable personal expenses (medical, charitable, etc) less personal exemptions is taxable income.
(3) Gross income is economic benefit; however, the Code allows us to exclude some economic benefit from gross income.
(4) Eisner v. Macomber, 1920, defines income as “the gain derived from capital, from labor, or from both combined.
(5) Glenshaw Glass, 1955-“Congress applied no limitations as to the source of taxable receipts, nor restrictive labels as to their nature.”
(6) Haig-Simons Definition-“Personal income may be defined as the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and the end of the period in question.
A. Noncash Benefits
I. Statutes
a. § 1.61-1(a): Gross income includes income realized in any form, whether in money, property, or services.
b. § 1.61-2(d)(1): If services are paid for in property, the fmv of the property taken in payment must be included in income as compensation.
II. Meals and Lodging Provided to Employees
a. Salaries could be replaced with noncash compensation, e.g. rent, if such benefits were not part of gross income.
b. Old Colony Trust, 1929-The Court held that an employer’s payment of federal income taxes on behalf of its employees constituted income to the employee. The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed.
c. In-kind benefits often present severe valuation problems.
d. Benaglia v. Commission, BTA, 1937-The petitioner was employed as a hotel manager and he and his wife lived in a suite and ate meals at the hotel for the benefit of the employer. The petitioner’s salary was not dependent on the value of the meals and lodging. The IRS wants to add the FMV of the meals and lodging to the taxpayer’s gross income. The court finds that the petitioner lived at the hotel solely because he could not properly perform his duties otherwise. The corporation’s books carried no accounting for the petitioner’s meals, rooms, or service. Under such circumstances, the value of meals and lodging is not income to the employee. The food and lodging was clearly for the benefit of the employer. Dissent-Arnold: He thinks that the K for employment shows that living quarters and meals were understood to be compensation in addition to cash salary. He would have had to have paid for living quarters and food if they had not been provided for him. If his living there were for the convenience of the employer, what about the other hotel that he managed but did not live at?
i. The food and lodging was income because it was economic benefit. The income was exclude because of administrative difficulties. You look at fairness for the taxpayer, fairness for all taxpayers, and economic feasibility. The taxpayer would not have spent the FMV of the motel for his lodging. The taxpayer would have had a difficult time calculating the cost to the hotel of the room. The court could have required the taxpayer to include the cost of alternative housing.
e. Statutory Aftermath to Benaglia:
i. § 119 ended the common-law “convenience of the employer cases.” The provision is very similar to Benaglia. However, the seemingly simple provision has caused a lot of litigation. The following words have been called ambiguous:
(1) “Meals”
a. Tougher, TC, 1969-The court held that groceries from an on-site commissary were not meals.
b. Jacob, 3d, 1974-The court said groceries and toiletry items were within the meals exclusion.
(2) “Furnished”
a. Kowalski, US, 1977-The Court held that meal allowance payments to patrolmen were not excludable because the meals were not “furnished.”
b. Sibla, 9th, 1980-The court allowed a fireman to deduct the amount he paid to participate in an obligatory organized mess at the station house.
c. Ron Phillips, TC, 1986-costs of firefighters’ nondeductible where the union, rather than the employer, organized the mess.
d. Christey, 8th, 1988-state troopers’ meal expenses were “ordinary and necessary” business expenses under 162(a).
(3) “Convenience of the Employer”
a. § 119(b)(1)-“the provisions of an employment K shall not be taken as determinative of whether the meals or lodging are intended as compensation.”
b. The employer’s convenience is usually established by proof the employee is “on call” outside business hours.
(4) “Business Premises of the Employer”
a. Barrett, 5th, 1963-Every state road and highway and adjacent restaurants are the business premises of a patrolman’s employer.
i. Other circuits say otherwise.
b. Lindeman, TC, 1973-The business premises of a hotel were held to include a house across the street occupied by the hotel manager.
c. Anderson, 6th, 1966-A house two blocks from a hotel does not qualify.
d. The White House and governor’s mansions qualify.
(5) “Employee”
a. A person can be an employee of a corporation even if he owns all the shares. The corporation may be able to deduct the cost of providing the lodging and meals to the owner-employee who is receiving the meals tax-free.
b. J. Grant Farms, TCM, 1985-A farmer was able to form a corporation and transfer the farm house to it so that it could be depreciated without having to include the value of the housing in his gross income.
f. § 119
i. Reasons for Rule: (1) Forced Consumption (2) Ease of Administration
ii. Problems with Rule: (1) Lack of Fairness Across Taxpayers (2) Skews Incentives Toward Receiving Exempt Income
III. Other Fringe Benefits
a. Fringe benefits raise problems of valuation, enforcement, and political acceptance. Over the years some benefits have been excluded from income because of the Service’s inaction or acquiescence. § 79 excludes 50k worth of group term life insurance and §§ 105(b) and 106 exclude medical insurance and payments. § 129 excludes dependent care assistance. Finally, Congress enacted § 132
b. § 132 Excludable Fringe Benefits:
(1) 132(b)-no additional cost services
(a) There must be idle capacity and no marginal cost of providing the service. The service must be in the employee’s line of business. (There is no horizontal fairness. It is not efficient to fly an empty plane. The exclusion is practical because valuation would be difficult. The exclusion was politically acceptable).
(2) 132(c)-qualified employee discounts
(a) Political acceptability is the only real justification for the exclusion.
(3) 132(d)-working fringe benefits such as business use of a car or a magazine subscription
(a) This category includes property or services provided to an employee of an employer to the extent that, if the employee paid for such property, the payment would be deductible. The justification for
is what are the economic effects of a tax system under which the employee is taxed on the cash payment but not on the noncash benefit? Assume the parking is worth only $40 to the employee. If the tax rate is 40%, the employee would have $30 left after taxes, so he would take the parking with the $40 benefit. The parking cost the employer $50 so there is $10 in deadweight loss. If the benefit was taxable, the employee would take the cash and there would be no deadweight loss. If only $40 of the parking were taxable, the employee would still take the cash even because a $4 increase in tax would be offset by a $10 increase in benefit. It is difficult to imagine that in this era of traffic congestion Congress would adopt a provision that would increase the private use of automobiles.
V. Another Approach to Valuation
a. In-kind benefits tend either to be wholly excludable (as under §§ 119 and 132) or included at their fmv without regard to any argument that they were worth less to the taxpayer. The following case takes a different approach.
b. Turner v. Commissioner, TCM, 1954-The question is the amount to be included in the taxpayer’s income because of the winning of steamship tickets by answering a question on a radio program. Reginald Turner won two steamship tickets from NY to Buenos Aires on a radio quiz show. The tickets were nontransferable and good for only one year on pre-approved sailing dates. The IRS wanted them to include $2,220 in income as the retail price of the tickets. Reginald gave the steamship his two first class tickets and $12.50 in exchange for four tourist tickets so his children could go too. The value of the tickets to the Ds was not the retail price. However, the court must arrive at some figure and sets $1,400 as the value.
c. The problem with the arbitrariness of the court’s determination is less that it was unlikely to be exactly correct, than that it provided little guidance as to what value taxpayers should report in similar circumstances in the future.
d. McCoy v. Commissioner, TC, 1962-The D won a Lincoln worth $4453 and traded it after ten days for a Ford worth $2600 and $1k cash. The court said $3,900 had to be included in income.
e. Rooney v. Commissioner, TC, 1988-The court required members of an accounting firm who had reluctantly accepted payment in the forms of goods and services in payment of fees to include the items at their fmv saying the Service should not base tax administration on the state of mind of the individual.
f. The Kid Who Catches the Historic Home Run Ball-The IRS said that a fan who catches a ball and returns it does not have taxable income. However, tax implications may be different if the fan retained the ball for sale. The IRS has traditionally not taxed income of commercial fishermen, big game hunters, prospectors, miners, and salvors until they turn their bounty into cash or cash equivalent. However, §1.61-14 states, “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.”
