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Federal Income Tax
University of Mississippi School of Law
Davis, Samuel M.

INDIVIDUAL INCOME TAX
Adler (Davis) Fall 2004
Paige McDowell
 
I)                   INTRODUCTION (Ch. 1)
A)    Deficiency Process (Audits)
1)      Three levels of audits
(a)      correspondence audit (they mail you stuff; lowest level and most common)
(b)      office audit (you go to them)
(c)      field audit (they come to you; most complex and invasive)
2)      Possible outcomes of the audit
(a)      taxpayer is right; receives a “no change” letter
(b)      settlement
(c)      taxpayer receives 30-day letter
(i)                 formal notice that IRS is asserting that the taxpayer owes money
(ii)               sets forth proposed changes and gives taxpayer 30 days in which to agree (and have add’l taxes assessed) or to request an administrative conference
(iii)             this happens if an agreement can’t be reached
3)      What a taxpayer may do upon receipt of a 30-day letter
(a)      give up and pay
(b)      request administrative appeal
(i)                 evaluated by IRS appeals office
(ii)               less expensive and less formal than dealing w/ an agent
(iii)             if case is not resolved at Appeals division, the IRS will issue a 90-day letter
(c)      do nothing: if you do nothing, the IRS will issue a 90-day letter
4)      90-day letter
(a)      you have 90 days to appeal to a tax ct
(b)      tax ct is the ct of original jdn for deficiency claims; no juries
(c)      if you don’t bring the claim in 90 days, you lose your right to litigate the issue and the IRS can start collection processes
(d)      if you lose in tax ct, you can appeal to regular circuit ct
5)      Statute of Limitations
(a)      You are at risk of audit for:
(i)                 3 years from date of filing
(ii)               6 years if you underreport by more than 25%
(b)      if you don’t file or commit fraud on the return, the SOL never runs out
(c)      insufficient returns
(i)                 this is where you file a tax protester return and fill in zeros or something
(ii)               SOL doesn’t begin to run; you have to file sufficient return for SOL to kick in
(d)      IRS can ask you to extend the SOL
(i)                 if you don’t say yes, they will assert a deficiency based on the best info available when SOL runs out (it will be the ceiling amt they can ask for)
(ii)               usually IRS will ask for blanket SOL extension, but try to get them to agree to limitations as to amt of time or items they will look at (they will usually agree)
B)     Refund Claims
1)      if you believe you have overpaid your taxes you can file for a refund
(a)      if refund is disputed, ask for administrative appeal hearing
(b)      if appeals officer still denies your refund, you can litigate
(c)      these cts go to district cts or claims cts; if you lose, can appeal to circuit ct
2)      How long do you have to file for refund? 3 years from date of filing or 2 years from date of pmt, whichever one is later
C)     Forum Shopping: you can convert a deficiency case into a refund case
1)      if the law is better in district ct than in tax ct, you could convert your case from deficiency to refund by paying under protest and then requesting a refund
2)      you can’t convert a refund case into a deficiency case (duh)
3)      if the circuit ct has already decided the issue, the law will be the same for dist. cts and tax cts; it is only when circuit ct hasn’t ruled yet that forum shopping is an option
D)    Hierarchy of Sources of Tax Law
1)      Statutes: Congress can impose whatever statutes it wants as long as they are const’l
2)      Regulations
(a)      come from Treasury Dep’t
(b)      are binding on both IRS and taxpayers unless taxpayer can show the regulation is contrary to the statute
3)      Revenue Rulings and Revenue Procedures
(a)      come from IRS; are binding on IRS
(b)      2 kinds:
(i)                 Private Letter Rulings
*           taxpayer requests a ruling on the tax treatment and gives a proposed analysis of how the law applies
*           the IRS will then respond either yes, no, or won’t express a ruling
*           if the IRS says “yes”, the taxpayer can rely on that ruling even if it turns out later that IRS was wrong
*           these letters have no precedential authority for other taxpayers
(ii)               Judicial Decisions: explain or put a gloss on the statute
E)     Methods of Accounting
1)      Cash Accounting Method
(a)      you have income when you have actual receipt of money
(b)      you are entitled to a deduction when you actually make a pmt
2)      Accrual Accounting Method
(a)      you have income when you have a right to receive pmt
(b)      you are entitled to a deduction when you have an obligation to pay
II)                 GROSS INCOME (Ch. 2)
A)    In general
1)      § 61 (p. 57): Gross income is all income from whatever source derived
2)      Glenshaw Glass (1955):
(a)      3-part test for GI
(i)                 there must be an accession to wealth
(ii)               it must be clearly realized (must come into taxpayer’s possession or taxpayer must receive a b’fit from it)
(iii)             taxpayer must exercise dominion over the income
(b)      S. Ct. in Glenshaw held that punitive dmgs awarded were GI under this test
3)      The Realization Requirement:
(a)      Cesarini v. U.S. (1969)
(i)                 ps buy old piano and later find $5K inside. Is it GI? If so, when does it become GI?
(ii)               ps must include the $5K in their gross income – Reg. § 1.61-14(a) requires taxpayers finding treasure to include it in gross income when reduced to undisputed possession
(iii)             S. Ct. says the year the money comes into “known possession” is the realization event
(iv)             the realization req’t is not a const’l req’t; it is a rule of administrative convenience
(b)      Example of Realization rules:
(i)                 1998: I buy stock for $1000 and by end of year it has FMV of $1500
*           no GI; mere appreciation of ppty is not a realization event
(ii)               1999: Stock FMV now $2000; I decline a sale
*           no GI; offer to purchase at a stated price does not trigger realization
(iii)             2000: FMV now $2500; I borrow $2000 and uses stock as a security
*           no GI: using the ppty as security is not a realization event b/c there is an equal and offsetting obligation to repay)
(iv)             2001: FMV now $3000: I repay loan; also, fire destroys stock certificates and company issues me new ones
*           no GI: new certificates or repayment of loan not realization; if you get back to exactly where you were before, no GI (Macomber v. Eisner)
(v)               2002: FMV now $3500; I owe a 3d party creditor $3500 and give the stock to her in satisfaction of the debt
*           GI: sale or disposition is a realization event
*           Amt of GI would be $2500: $3500 (amt realized – means what you get for ppty you are giving up) – $1000 (adjusted basis – keeps track of your investment in the ppty) = $2500 (GI)
4)      The Dominion Requirement
(a)      it isn’t GI until you exercises dominion over it
(b)      look at substance of transaction, not form – it doesn’t matter that the b’fit may not go directly into person’s hands
B)     Intangible b’fits (something other than cash or ppty right): GI if there is economic b’fit
1)      Old Colony Trust Co. v. Commissioner (1929)
(a)      Employer pays the taxes of its employee
(b)      Ct says this is GI to the employees; paying the obligation of a taxpayer is economic b’fit (GI) to the taxpayer
2)      McCann v. U.S. (1981)
(a)      employee gets to go on an all-expenses-paid trip to Vegas for selling a certain amt of burial insurance. Is the value of the trip GI?
(b)      Ct says yes:
(i)                 value of trip was GI to employees b/c it was a reward for services rendered
(ii)               If the trip were available to all employees and there were mandatory business meetings, this would not have been GI b/c it would have been for the employer’s b’fit
C)     Settlement $$ (GI): Roco v. Comm’r (2003)
1)      Roco got $1.5M in settlement from qui tam action but didn’t report it as income
2)      Ct says receipt of settlement proceeds is GI
3)      Roco has to pay a penalty of 20% of the underpayment attributable to substantial understatement of income (§ 6662(a) & (b)(2))
4)      How to get out of paying such a penalty?
(a)      An understatement is reduced to the extent that it
(i)                 is based on subst’l authority or
(ii)               is adequately disclosed on the return (or in a statement attached to the return) and there is a r’ble basis for the tax treatment of that item
(b)      Taxpayer may be relieved of liability for the accuracy-related penalty if taxpayer shows that he had a r’ble cause for the understatement and acted in good faith
D)    Ppty for Compensation (GI)
1)      Regulations
(a)      Income may be realized in any form, whether money, ppty or services (Reg. § 1.61-1(a))
(b)      If services are paid for in ppty, the fair market value of the ppty is the measure of compensation; if paid for in the form of services, the value of the services received is the amt of compensation (Reg. § 1.61-2(d)(1))
(c)      Fair market value is gen’lly defined as the price a willing buyer would pay a willing seller, w/ neither under a compulsion to buy or sell, and both having r’ble knowledge of relevant facts. (Reg. § 20.2031-1(b))
2)      Example: I work for someone who, in lieu of pmt, gives me a car w/ FMV $10K. GI = $10K
3)      Bartering
(a)      each person has performed services for the other and has gross income in the amt of value of svcs obtained
(b)      Revenue Ruling 79-24:
(i)                 You can’t avoid income tax liability by doing direct exchanges of ppty and services rather than purchasing add’l ppty and services
(ii)               The amt of income will be the fair mkt value of the goods or svcs (Reg. § 161-2(d)(1))
E)     Imputed Income (not GI)
1)      Imputed income is the fair mkt value of the taxpayer’s performance of svcs for his or her personal b’fit and the value of taxpayer’s personal use of ppty that he or she owns. Imputed income is not included in GI.
2)      From ppty: the rental value of home owned by the occupier
3)      From services:
(a)      the economic b’fit

r disposition of ppty is the amt realized less the adjusted basis (AR – AB = GI)
1)      Amt realized: AR equals the money rcvd plus the FMV of any other ppty rcvd (§ 1001(b))
2)      Adjusted basis:
(a)      basis = cost or amt paid for an item (§ 1012 – this is called cost basis)
(b)      basis must be adjusted to reflect any recovery of t/p’s investment or any add’l investment made in the ppty
D)    Tax Cost Basis
1)      if you receive ppty as compensation for svcs rendered, you report its FMV as GI
2)      when you sell the ppty, the amt you reported is your basis, even though you actually paid nothing out-of-pocket for the ppty
3)      this kind of basis is called a tax cost basis
E)     Impact of Liabilities
1)      On basis
(a)      if t/p takes out a loan to pay the purchase price, the basis is still the purchase price
(i)                 b/c of the obligation to repay, t/p is entitled to include the amt of the loan in computing his basis
(ii)               the loan is part of t/p’s cost of the ppty under § 1012
2)      On amt realized
(a)      if buyer assumes the seller’s liabilities (amt left to pay), this is included in seller’s amt realized
(b)      AR = cash paid + any other ppty rcvd + amt of liability assumed
F)      Ppty acquired in a taxable exchange
1)      the cost basis of ppty rcvd in a taxable exchange is the FMV of the ppty rcvd in the exchange, not the amt given (Philadelphia Park Amusement Co. v. U.S., 1954)
2)      this standard applies where the properties exchanged differ in value; if they have the same value, it doesn’t matter if you use given or rcvd b/c they are the same anyway
V)                GIFTS, BEQUESTS & INHERITANCE (Ch. 5)
A)    § 102: GI does not include the value of ppty acquired by gift, bequest, devise, or inheritance
1)      When is something a gift?
(a)      Comm’r v. Duberstein (1960)
(i)                 the “most critical consideration” is the motive of the donor
(ii)               “a gift in the statutory sense proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity or like impulses”
(iii)             decision of the issue must “ultimately be based on the application of the fact-finding tribunal’s experience w/ the mainsprings of human conduct to the totality of facts in each case”
(b)      § 102(c)(1): negates gift status for amts transferred by an employer to, or for the b’fit of, an employee
(c)      Reg. § 1.102-1(f)(2): § 102(c) does not apply to amts transferred btwn related parties if the purpose of the transfer can be subst’lly attributed to family relationship and not to the circumstances of their employment
(d)      §274(b): does not allow deduction for gifts made by businesses to individuals in excess of $25
(i)                 if business characterizes the transfer as compensation, business is entitled to deduction, but individual is denied § 102 exclusion
(ii)               if business characterizes transfer as a gift, business is denied the deduction, but individual can exclude under § 102
(iii)             § 274(b) applies only to items excludable as gifts under § 102
(e)      Goodwin v. U.S. (1995): contributions to minister by congregation (not individual members) thru highly structured process are not gifts
(f)       Olk v. U.S. (1976): tips given to a casino dealer are not gifts b/c they are not acts of detached and disinterested generosity
2)      When is something a bequest or inheritance?
(a)      if it wasn’t actually left to you in the will, but you got it anyway thru an agreement settling a contest of the will, it is still excludable under §102 (Lyeth v. Hoey, 1938)
(b)      Wolder v. Comm’r (1974)
(i)                 Issue: were amts rcvd by an atty under terms of a client’s will compensation for svcs rendered during client’s lifetime, or did they constitute a bequest?
(ii)               Ct said compensation (and thus GI):
*           to be a bequest, it must be a charitable concept
*           if it is pmt for svcs, being in the will doesn’t change its nature
3)      Statutory limitations on the exclusion (found in § 102(b)
(a)      income from ppty exclude