Federal Income Tax
Hickman, Fall 2009
Basic Formula for Federal Income Tax
Income (broadly conceived)
$ xxx,xxx
Less: exclusions (income that is not subject to tax)
(xx,xxx)
Total Income (income that is subject to tax)
$xxx,xxx
Less: Above the line deductions (taken in the computation of AGI)
(xx,xxx)
Adjusted Gross Income
$xxx,xxx
Less: itemized or standard below the line deductions and personal exemptions
(xx,xxx)
Total Taxable Income
$ xxx,xxx
Gross Income
Definition of Income
· Haig/Simons Definition of Income
o Consumption + Enhancements to Wealth = Income
o But…what do we tax?
· Eisner v. Macomber
o Income may be defined as the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets
o BUT…what about other accessions to wealth?
· § 61. Gross Income Defined
o General definition – except as otherwise provided in this subtitle, gross income means all income form whatever source derived, including (but not limited to) the following imtes
1. Compensation for services, including fees, commissions, fringe benefits, and similar terms;
2. Gross income derived from business
3. Gains derived from dealings in property
4. Interest
5. Rents
6. Dividends
7. Income from discharge of indebtedness
o Related Treas. Regs.
§ 61
Treas. Reg
61(a): income from whatever source derived
1.61-1
61(a)(1): compensation for services
1.61-2
61(a)(3): gains derived from dealings in property
1.61-6
61(a)(4): interest
1.61-7
61(a)(5): rents
1.61-8
61(a)(7): dividends
1.61-9
61(a)(12): income from discharge of indebtedness
1.61-12
Compensation for services
Taxes Withheld
· Treas. Reg. § 1.61 – 2(a)(1): Wages and salaries…are income to the recipients, unless otherwise excluded by law
· Old Colony Trust Co. v. Comm’r
o Discharge by a third person of an obligation to him is the equivalent to receipt by the person taxed
o The taxes were paid upon valuable consideration, the services rendered by the employees as part of the compensation thereof (the employer wouldn’t have paid the taxes except that the taxpayers were employees performing services
o Treas. Reg. 1.61-14: another persons payment of the taxpayers income constitutes gross income to the taxpayer unless excluded by law
· Compensation for services not limited to cash paid directly to you
o Gross income can include discharge of a taxpayer’s obligation to a third party
o Discharge of an obligation not likely a gift if that discharge arises out of an employer-employee relationship and Is considered to be a discharge made in connection with performance of services
Bonuses
· § 61(a)(1): lists compensation for services among items of income
· § 1.61-2(a)(1): bonuses (including Christmas bonuses) are income to the recipient unless excluded by law
· Bonuses are not a gift because they are in recognition of quality of work – explicitly link payemtn to services performed
Compensation Paid Other than In Cash
· § 1.61-2(d)(1): if services are paid for in property, the FMV of the property taken in payment must be included in compensation
· § 1.61-2(d)(2)(i): If property is transferred by an employer to an employee…for an amount less than its FMV, then regardless of whether transfer is in the form of a sale or exchange, the difference between the amount paid for the property and the amount of its FMV at the time of the transfer is compensation and shall be included in the gross income of the employee
o Depends upon circumstances of the sale
Rewards (i.e. Trips, etc.)
· § 1.61-2(d)(1): if services are paid for in exchange for other services, the FMV of such other services taken in payment must be included in income as compensation
· McCann v. United States
o Facts: only employees who accomplished certain sales goals were invited to seminar, not required to make trip if they didn’t want to, while there formal programs minimal
o Holding: cost of trip income to Mrs. McCann as compensation for services performed
o Rationale: court focused particularly on fact that trip was reward for increased sale
· Fact specific analysis: required to go, formality of the programs, reward for doing a good job
Frequent Flier Miles
· Announcement 2002-18, 2001-1 C.B. 621: IRS recognized that frequent flier miles raised many complicated issues and said they wouldn’t accuse any taxpayer of understanding income on his or her return from using frequent flier miles accumulated as result of business travel
o When would frequent flier miles be realized? – this would be an administrative nightmare
Compensation Paid in Property/Services
· § 1.61-2(d)(1) Compensation paid other than in cash includes exchange of services
o If services are paid for in property, the FMV of the property taken in payment must be included in income as compensation
o If services are paid for in exchange of other services, the FMV of such other services taken in payment must be included in income as compensation
o If services are rendered at a stipulated price, such price will be presumed to be the FMV of the compensation received in the absence of evidence to the contrary
· Barter Clubs (= Exchange of Services)
o Rev. Rul. 79-24: exchange of services taxed at FMV of services (relies on § 1.61-2(d)(1))
o Rev. Rul. 83-163: holds that the value of services received in a services-for-services barter club is income in the year that services are received, even if the services given in return are given in a later year
Miscellaneous Income
Bargain Purchases
· Pellar v. Comm’
whether you have a loan or not
Claim of Right
· What is the proper tax treatment of money (or other property) received subject to a contingent repayment obligation?
· North American Oil Consol. v. Burnet
o North American Oil paid money over to receiver during litigation. When litigation was over and NA oil won, receiver returned income. When is income realized?
o ‘Claim of Right Doctrine’ – recognize income when you can claim a legal right to that income, even if there is a possibility that you may have to return it
· Not always clear what it means to have a claim of right
· Look at narrower precedents that have fact patterns similar to the situation that you are dealing with
· Offsetting Deduction – If taxpayer subsequently required to return the money, has a right to a deduction in the year he is required to pay the money
o NA Oil allows for offsetting deductions, but not necessarily a specific code provision that supports the deduction
o United States v. Lewis – taxpayer recognized income in one year and paid part back in another. Wanted to go back and amend the initial return then take the deduction in the later year. Court didn’t allow him to do that under the claim of right doctrine
· § 1341 – adjusts tax computation to mitigate consequences of tax bracket changes where taxpayer restores substantial amount held under claim of right – response to US v. Lewis
o §1341(a): tax liability for repayment year is the lesser of
· The tax for the repayment year computed in the normal fashion after deducting the repayment, or
· An amount equal to they hypothetical tax for the repayment year without the deduction, less the decrease in tax that would have resulted for the year in which the income was originally recognized if the repaid amount had been excluded from that year’s income
o Special rules
· §1341 only applies to deductions over $3000
· According to limitations in §1341(b):
§ The crediti is refundable
§ Trade or business sales refunds are excluded = in retail sales, people bring stuff back all the time, this is supposed to be a ‘little guy’ type provision
§ If you take credit under 1341, you do not take the deduction
· Final Note: §67(b)(9) makes clear that a deduction under §1341 is an itemized deduction NOT subject to the 2% of AGI floor
