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Federal Income Tax
University of Kentucky School of Law
Bird-Pollan, Jennifer

Federal Income Tax
Gross Income
·         Eisner v. Macomber: The appreciation in value of an asset is not income until the asset is sold, exchanged, or otherwise disposed
·         Commissioner v. Glenshaw Glass
o   Clear accession to wealth
o   Complete Dominion i.e. control over
o   Realization
·         Cesarini v. United States (Treasure Trove)
·         James v. United States: (Embezzled Funds)
o   Embezzled funds are taxable income; i.e. illegal income constitutes gross income
·         Old Colony Trust Co. v. Commissioner (Paid Income tax of president)
o   The payment of the tax by the employers was in consideration of the services rendered by the employee, and was again derived by the employee from his labor
·         McCain v. U.S. (All-Expense Vegas Trip for achieving sales goal)
o   The reward was clearly compensation for the services she had rendered
·         U.S. v. Gotcher (Husband/Wife Trip to tour Volkswagen in Germany)
o   The economic benefit will be taxable to the recipient only when the payment of expenses serves no general purpose
·         Commisioner v. Kowalski (State Trooper cash allowances for food)
o   Cash allowances are to be included in gross income
·         Adams v. U.S. (House provided to President of Japanese business)
o   Satisfied §119(a) requirements because of the employer benefit provided
·         Commissioner v. Duberstein
o   Whether or not something is compensation or a gift is a fact oriented finding
·         Olk v. United States (Tips to Casino Dealers)
o   “Receipts by taxpayers engaged in rendering services contributed by those with whom the taxpayers have some personal or functional contact in the course of the performance of the services are taxable income when in conformity with the practices of the area and easily valued.”
·         Wolder v. Commissioner
o   The attorney made an agreement to render services for the decadents lifetime in exchange for a bequest of stock
·         U.S. v. Kirby Lumbar Co.
o   Cancellation of debt is a freeing of assets to the borrower
o   Would receive double benefit if gain not recognized
·         Zarin v. Commissioner (Discharged Gambling Debt)
o   In order to bring a taxpayer within the sweep of the discharge of indebtedness rules, the IRS must show that one of the § 108(d)(1) prongs is met
·         Helvring v. Bruun
o   A landlord does realize a taxable gain when he repossesses property improved by a tenant
·         Philadelphia Park Amusement Co. v. United States
o   The value of two properties exchanged in an arm’s length transaction are either equal in fact, or are presumed to be equal
o   It is only in the rare and extraordinary cases that the value of the property exchanged cannot be ascertained with reasonable accuracy
§  Taxpayers basis is the FMV at the time of receipt
§  Every taxable year stands alone
·         U.S. v. Davis (Gave stock to settle divorce)
o   Yes, The amount realized from the exchange is the fair market value of the released marital rights, which in this case would be equal to the value of the stock transferred
·         North American Oil Consolidated v. Burnet
o   Claim of Right Doctrine
·         James v. U.S.
o   Money obtained by a taxpayer illegally was taxable income, even though the law might require that taxpayer to repay the ill-gotten gains to the person from whom they had been taken.
·         Commissioner v. Indianapolis Power & Light Company (Security Deposits)
o   Whether a payment constitutes income when received depends upon the rights and obligations of the parties at the time the payments are made
·         Lucas v. Earl (agreement to provide legal services for stocks at death)
o   There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it
·         Teschner v. Commissioner (Won a prize for daughter)
o   The taxpayer should not be taxed on the income because he never had the right to claim the prize according to the rules of the contest. Thus, he had not earned the income, even though he was the individual that performed the services that gave rise to the right to the income.
·         Helvering v. Horst (Gave coupon rights of bond to son)
o   The power to dispose of income is the equivalent of ownership of it.  The exercise of that power to procure the payment of income to another is the enjoyment and hence the realization of the income by him who exercises it
·         Salvatore v. Commissioner
o   Commissioner v. Court Holding Co.
§  The Incidence of taxation depends upon the substance of a transaction. The transaction must be viewed as a whole, and each step, from the commencement of negotiations to the consummation of the sale, is relevant.
§  At the time of conveyance the children held no property interest
·         This conveyance was merely an intermediate step in the transfer of legal title from petitioner to Texaco: Petitioner’s children were only “conduit(s) through which to pass title
·         Estate of Stranahan v. Commissioner (sold dividend rights to son)
o   The acceleration of income was not designed to avoid or escape recognition of the dividends but rather to reduce taxation by fully utilizing a substantial interest deduction which was available
·         Commissioner v. Banks; Commissioner v. Banaitis
o   A taxpayer's income includes the portion of the recovery paid to the taxpayer's attorney as a contingent fee.
Gross Income Exclusions
·         Amos v. Commissioner (Dennis Rodman)
o   Only the part of the settlement that can be attributable to physical injury can be excludable under § 104
·         Johnson v. United States
o   The taxpayer’s claim was based on discrimination and not on physical injury and therefore the award must be included in the taxpayer’s gross income
·         Estate of Longino v. Commissioner
o   Amounts received in settlement for damage to crops were income because they represented lost profits
·         Commissioner v. Idaho Power
o   Construction-related expense items, such as tools, materials, and wages to construction workers are treated as part of the cost of acquisition of a capital asset. Reasonable wages paid in carrying on of a trade or business qualify as a deduction from gross income, but when wages are paid in connection with construction or acquisition of a capital asset they must be capitalized and are then entitled to be amortized over the life of the capital asset so acquired
·         Fedex Corp. v. United States
o   Repairing the engine doesn’t substantially improve the value of the plane as a whole and can thus be expensed
·         Midland Empire Packing Company v. Commissioner (Concrete Lining Basement)
o   The expenditure served only to permit the petitioner to continue the use of the plant, and particularly the basement for its normal operations and thus can be treated as an expense
·         Mt. Morris Drive-In Theatre Co. v. Commissioner
o   It was obvious at the time when the drive-in was constructed, that a drainage system would be required to properly dispose of the natural precipitation normally to be expected, and that until this was accomplished, petitioner’s capital investment was incomplete
·         Indopco v. Commissioner
o   The expenses incurred in a friendly takeover do not qualify for tax deduction as “ordinary and necessary” exp

o   If you have control over income it constitutes receipt
§  It was the taxpayer’s choice to defer, no reasonable business reason to do so
(2) Deduction Items
·         Commissioner v. Boylston Market Association
o   Prepaid insurance for a period of three years may be easily allocated
o   It thus is clearly an asset having a longer life than a single taxable year
·         Zaninovich v. Commissioner (1-year lease starting in Dec y1 ending in Nov y2)
o   Under the “one-year rule” an expenditure is treated as a capital expenditure if it creates an asset, or secures a like advantage to the taxpayer, having a useful life in excess of one year
·         Grynberg v. Commissioner (Prepayments of Monthly Rent)
o   Three Prong Test for the Deductibility of Prepaid Items under § 162 and § 446(b)
§  There Must Have Been an Actual Payment
§  There Must Have Been a Substantial Business Reason For Making the Prepayment in the Year in Which it Was Made
§  It Must Not Cause a Material Distortion in the Taxpayer’s Taxable Income in the Year of Prepayment
o   No sufficient business reason given to explain the prepayment
The Accrual Method
(1) Income Items
·         Spring City Foundry Co. v. Commissioner
o   Doubt that arises subsequent to the time when all events have occurred that fix the right to receipt do not change when all events indeed did occur
o   When the right to receive an amount becomes fixed, the right accrues
·         Clifton Manufacturing Co. v. Commissioner
o   The debt should be accrued and reported as income when its collectability is assured
·         Flamingo Resort, Inc. v. United States
o   The right to receive income was sufficiently “fixed” when the credit was extended
(2) Deduction Items
·         Gold Coast Hotel & Casino v. United States
o   Gold Coast's deductions were proper, as its liability to members became fixed upon their accumulation of the minimum number of club points whether or not they chose to redeem them and because the amount of liability was known with reasonable certainty
·         U.S. Freightways Corp. v. Commissioner
o   The mere fact that Freightways is an accrual method taxpayer thus does not disqualify it from expensing the short-term items at issue here
Basic Elements of Tax
·         2 Elements of a Tax
o   Rate
o   Base
§  Rate * Base
·         The Federal Income Tax is a progressive tax rate
o   Two Goals
§  Efficiency
§  Equity
·         Vertical: The greater the income, the more the tax
·         Horizontal: Equal amounts tax equally
o   Pros
§  Ensures tax liability based on ability to pay
§  Wealthy Individuals should bear a higher % of total tax burden because they receive the most benefits
§  Redistribution of Wealth
o   Cons
§  Too Complex
§  Distorts taxpayers decisions
§  Inequities between similar situated taxpayers
o   Need to know a persons filing status to determine tax rate
§  Married Jointly
§  Head of Household
§  Unmarried/Single
§  Married Separate