Federal Income Tax – Fall 2008
Introduction
· If the goal is to be fair with two components
o Horizontal equity – ppl who are in the same position should be treated the same à fairness
o Vertical Equity – if I pay $1 in taxes and Warren Buffett pays $1 that is unfair. People in different positions should be treated differently
· 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.
· Terminology
o Gross receipts – everything that comes in
o Gross Income – most everything that comes in less what you already have (costs)
o AGI – subtract other things
o Taxable income – subtract things like having kids
§ Reduce further by tax credits
· Goals:
o Fairness, Efficiency and Practicality
Characteristics of Income – Ch 2
· Statutes
o § 1.61-1(a): Gross income includes income realized in any form, whether in money, property, or services.
o § 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.
· Meals and Lodging provided to employees
o Old Colony Trust: The Court held that an employer’s payment of federal income taxes on behalf of its employees constituted income to the employee
o Benaglia v. Commissioner: B was a hotel mgr and lived and ate in the hotel. He did not include this in his income. The court found that it did not have to be because it was necessary and/or for the convenience/benefit of the employer. B had to live in the hotel to properly perform his job.
§ Is income but not practical to tax it.
§ Rule: Meals and lodging not taxed b/c done for the benefit of the employer
§ Code: same rule in section 119\
· Other Fringe Benefits
o Section 132 Fringe Benefits
(1) No additional cost services – pilots getting free airline tickets
a. Doesn’t cost the employer any substantial additional cost
b. There must be idle capacity
(2) Qualified employee discounts (dept stores)
a. Different from the top b/c in this one the employer forgoes revenue.
(3) Working condition fringes (company car, magazine)
a. Something that if you did it yourself you would be able to deduct it
(4) De minimis fringes – sufficiently low, no reason to acct
(5) Qualified transportation fringes (parking)
(6) Moving expense reimbursement
(7) Retirement planning services
(8) Gyms and athletic facilities
(9) Qualified military base realignment and closure fringe
Limitations
(1) If the company has two lines of business only get the discount in the line of business you working in. ie: company has dpt store and airline, only ppl who work for airline get discount on tickets
(2) Doesn’t apply to highly paid employees if they are the only ones that get the discount
(3) May be provided tax free to spouse, surviving spouse, or dependent children, not to same sex domestic partners.
o Cafeteria Plans – giving employees the option of taking salary payment in another form. Ie: employee can either take 5k in salary or take 5k in child care services (tax free) offered by the company.
§ Section 125 makes this a use it or lose it. So at the end of the year cant say “well I only used 4k in child care services so can I get my 1k in salary back”
o Health insurance – employers can deduct the cost and employees don’t have count it as taxable income.
§ Self employed get a deduction, but if your employer doesn’t give you insurance you only can deduct amt over 7.5% of you AGI
· Another Approach to Valuation à Subjective (not MV)
o Turner v. Commissioner T won two first class round trip tickets on a steam ship. He reported 520 in income from the tickets but the C said he should have reported 2220. T ended up trading the two first class tickets for 4 coach tickets so he could take his sons. The court ends up taxing him on 1400. The issue in the case is that the tickets were not transferable, nor sellable, so not worth 2220 to a man who only reported 4500 in taxable income that year. The tickets were worth something so the court assigned them the 1400 value.
§ The default rule is FMV – this is an Exception
· Imputed Income – benefits of services that one performs for oneself, like preparing their own tax returns à Not taxed
o Deadweight loss – when tax incentives cause ppl to do things that are not the most beneficial to society (or the amt society places on their work)
o Revenue Ruling 79-24 – The fair market value of the property or services taken in payment must be included in income. If the services were 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.
§ Ex: House painter paints lawyers house in exchange for legal services. Both must report income
o Basic Unfairness of Not Taxing Imputed Income
§ People who can’t produce imputed income are taxed on the money they make to pay for the same services. There is no horizontal equity because on an after tax basis you get more cash if you have imputed income than if you have actual cash income and have to spend after-tax dollars to buy the services.
§ Not taxing imputed income also leads to the inefficient allocation of resources.
· Windfalls and Gifts
o Commissioner v. Glenshaw Glass co.: Two cases consolidated into one where the taxpayer won a suit against a company for antitrust violations and are awarded punitive damages. They pay tax on the part of the damages that represent lost income, but don’t pay taxes on the part of the damages that represent punitive income. The court finds that punitive damages should be taxed. It doesn’t make sense that money given to an individual shouldn’t be included in taxable income when money given for lost wages should be.
§ Income: accessions to wealth, clearly realized and over which the taxpayers have complete dominion.
Gifts
o Generally – Donee takes over the donors basis
§ Earn 100k and give son 30k
· Giver taxed on 100k, son not taxed
· No income tax consequences on the transfer
o Commissioner v. Duberstein D did business with M and they had a friendly relationship. M asked D to recommend customers to him and D did so because it didn’t hurt his business. M then sent D a car which D didn’t expect, want, or need. M deducted it from taxable income as a business expense. not a gift, done for the past services and to induce future services. The court does say that it will look to the donor’s intent, look for detached disinterested generosity. The court does say that because each situation has to be looked at independently that the trial court’s decision should be given more weight and only overruled if they were “clearly erroneous”
§ Look for Donors Intent à detached disinterested generosity à GIFT
§ $25 limit on business gifts
o United States v. Harris K was an old man who liked young women. Over a number of years he “gave” money to two twin sisters, H and C. The court looks at a number of cases which support a rule that as long as the relationship is more than just sex, which this one appeared to be, the money is classified as a gift. The court found that because of the uncertainty in the tax liability it was not proper for H to be prosecuted with c
pending on the transaction.
§ Case stands for the importance of accounting periods. Today would use NOL carryfowards
Claim of Right
o North American Oil v. Burnet The taxpayer received 171,979 in 1917. The money was for oil land profits from 1916. However, the money was being held by a receiver because the government was claiming the land and trying to oust North A. Oil. The government lost its case in 1917 and the money was given to the taxpayer. The government’s final appeal was dismissed in 1922. The income earned in 1916 and impounded by the receiver in that year was not taxable to him because he was the receiver of only a part of the properties operated by the company. When the receiver is not in control of the entire business, the corporation is supposed to report the income itself. The net profits were not taxable to the company as income in 1916 because the company was not required to report as income an amount which it might not ever receive. The company did not become entitled to receive the money until 1917 when the court decree was entered. The net profits should have been reported as income in 1917 and not in 1922. If a taxpayer receives income under a claim of right and without restriction on disposition, he has received income which he is required to report on his return even though he still might be adjudged to return it. If the government had prevailed in 1922, the taxpayer would have been entitled to a deduction in 1922. Tax payer want to report earlier b/c tax rate was much lower.
§ Rule: If you have a claim of right on money then you have to pay tax
o US . Lewis L received a bonus in 1944 of 22k. He reported it on his income but in 1946 he had to return 11k of as a result of litigation with his employer. The Court, flowing Burnet, found that L must take a deduction in 1946, not 1944.
§ Section 1341, had it been around, L would have reduced his tax bill for 1946 by the “tax cost” of including the item in 1944
· Calculate if you are better off taking the deduction in 1946 or a recalculation of the tax in 1944. Here you would take the tax refund from 1944. à taxpayer gets what’s best.
Tax benefit Rule à Opposite of the claim of right cases
o Taxpayer claims a deduction in an earlier yr, and then in a later yr the deducted amt is in some sense recovered or regained. An example is when a taxpayer writes off an amount for theft that is returned in a subsequent year
Exclusionaryà Under 111 if (or to the extent that) a deduction did not reduce the taxpayers tax liability for any yr AND any loss carryovers resulting from it have expired without being used the recovery of the amt deducted need not be included in income. However, unlike § 1341, § 111 does not provide the taxpayer with relief if the tax rate was 1% in the previous year but is 99% in the current year. However, it does permit the taxpayer to gain from favorable rate swings e.g. the tax rate was 99% in the previous year but 1% in the
