Income Tax Outline Karen Green Spring 2008
I. Introduction/Overview (Chapter 1)
a. What is gross income
i. Structure of the Income Tax Code- how do you derive Taxable Income
1. § 61- gross income (see below)
2. § 71- beginning of exclusions/inclusions
3. § 62- Adjusted Gross Income
4. § 63- Taxable Income- To arrive here, you can take itemized deductions OR the standard deduction.
ii. Income from whatever source derived
b. When is an item of income included in gross income?
c. What and when are deductions available?
i. § 161 begins deductions
ii. See also §§ 162, 166, 261, 469
d. How does the sale, exchange, or disposition of property affect tax liability?
i. Disposition of property is probably always taxable.
ii. Aquiring possession of property gives a cost basis, or the cost of acquiring the property. In order to gain tax liability, the sell or disposition of property must exceed the basis.
e. Whose income are you examining; who is the proper tax payer?
i. Assignment of income principals apply
ii. Example includes transfers of property so that income is taxed in a lower bracket
f. What is the character of the income?
i. Is there any special treatment, such as is the case in capital gains taxes?
ii. § 1221- disposition of capital assets taxed at 15% rate
g. What income items are exempted/deducted?
II. Gross Income: The Scope of § 61 (Chapter 2)
a. § 61- all income “from whatever source derived,” except for those incomes specifically excluded
i. Basic definition of income (p. 59)- instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion”
1. Accession to wealth
3. Complete Dominion
ii. Realization Event- included in income amounts
1. Mere appreciation in property value is NOT taxable.
2. There must be a realization event, a disposition of property, for gross income to exist.
1. Compensation can take the form of property, use of property, or cash; and
2. Can be a direct or indirect payment
iv. Income generated from our ownership in properties include:
1. Compensation for services- fees, commissions, fringe benefits
v. Double taxation of Corporations- Dividends are taxed to the corporations without deduction, while dividends are taxed to shareholders through income taxes.
b. In general, Gross Income includes:
i. Not a mere return of capital, and
ii. Not accompanied by a contemporaneously acknowledged obligation to repay, and
iii. Not excluded by a specific statutory provision
i. [Glenshaw Glass Co.]- punitive damages are taxable as income. This is because punitive damages are not compensation for anything, thus making the receipt of such damages a windfall if not taxed.
ii. [Shareholder Example]- Business issues 1000 shares which are owned by 10 people, so each person has 100 shares and owes 10%. When the company issues more 100 shares to existing shareholders, the company then has 1100 shares out, and the 10 people have 110 shares each, maintaining 10% interest. Because the same percentage interest is maintained, there is no accession of income, so there is no gross income.
iii. [Old Colony Trust]- Company paid one of their employee’s income taxes. Was the company’s payment of the employee’s income taxes gross income?
1. Yes, this was compensation for services rendered by the employee
2. The larger rule is that any discharge of another’s debt to a party creates tax liability as gross income.
3. § 83- anytime property is transferred in connection w/ the performance of svcs, it is income/compensation
iv. [Cesarini]- case where a woman finds the wad of $5000 cash in an old piano that she purchased for $15. She finds the money 7 years after it was placed there. Is the discovered cash income, and, if so, when should it have been taxed? Finally, if the cash is income, what form of income is it?
1. Income?— This is an accession to wealth, but is it undisputed (i.e. does the other owner lay claim?)
a. § 1.61-14- found property/treasure trove is income equal to the value of the property in US Currency
b. So, the taxable amount is the total amount of cash
2. In what year is it taxable?— The cash is income in the year the amount was reduced to undisputed possession
3. What type of income is this?— it’s not a capital gain, because there has been no disposition of property.
a. Bargain purchases results do not create tax liability based just on superior knowledge of one party over the other.
i. The IRS does not like to interfere w/ arm’s length transactions
ii. For example, if one party knows a piano is actually worth a lot, but the other party doesn’t know this, the benefit of the bargain goes to the knowledgeable party, and the smarter party, in the OCB, only gets taxed on the transactional tax.
b. Prizes and awards (whether based on merit or not) are gross income and are taxable. So, Property won (not cash) is based on FMV, not retail value. If you win a watch in a raffle, you only pay what you could reasonably get in your efforts to sell it.
v. [Revenue Ruling 79-24]- When the doctor and lawyer exchange their services, they both have income in the value of their gain from the service; however, they do have deductions.
1. 1.61-2(d)(1)- if services are paid in any form, other than money, the FMV of the property or services taken as payment must be included in income
2. Income, however, will NOT be imputed for services performed for oneself
vi. [Dean v. Commissioner]- Husband and wife are sole shareholders in a personal holding company which owns property. The corporation is a tax paying entity, and the couple uses the property rent free from the corporation. Was this gross income?
1. Yes, the fair rental value of the property is to be included in the taxpayer’s gross income
2. Look at the relationship of the parties:
a. Had this been family property, § 102 would view this as a gift
b. “Gifts” from an employer to an employee is almost certainly going to be considered compensation, so it is taxable income.
c. Certain benefits that a corporation gives to a shareholder are taxable as income. Example – Closely held corporation allows majority shareholder to use corporate property rent free. This benefit is taxable as income.
III. The Exclusion of Gifts and Inheritance (Chapter 3)
a. § 102- controls exclusions regarding gifts and inheritances
i. §102(a) – Generally, property acquired by gift or inheritance is not included in gross income.
1. Specifically, gross income does not include the value of property acquired by gift, bequest, devise or inheritance
2. But, this does not apply to the income earned from the property after transfer
ii. §102(b) – exclusion does not apply to the income gener
Non-discrimination rule- applies to both types of fringe benefits
1. Fringe benefits may be made available to highly compensated employees (i.e. directors, owners, etc…) only if the benefits are also provided on substantially equal terms to other employees.
2. Now, if an employee benefit is not specifically excluded from gross income, its value must be included within gross income under § 61
b. Fringe Benefits:
i. § 119- Deductions for meals or lodging furnished for the convenience of the employer
1. This section allows a taxpayer to exclude the value of meals/lodging provided to him, his spouse, and defendants provided by or on behalf of his employer if it meets the following conditions:
a. For the convenience of the employer
i. The policy here is that the employee is accepting these “benefits” as a work requirement. There is a substantial non-compensatory reason for the employer.
ii. Think of a motel manager. The manager can sleep at the motel because he must be there anyway.
b. On the premises of the employer- either at a place where the employee performs a significant portion of his duties or where the employer conducts a significant portion of his business
i. [Anderson]- place where employee performs a significant portion of his duties which seems to require the employee to be physically on premises
ii. [Lenderman]- does not require taxpayer to be physically on premises—adjacent or very close thereto is sufficient
c. The employee is required to accept the benefit as a condition of employment (lodging example on p. 104)-
i. Means that the employee must be required to accept the benefit in order to enable him to properly perform the duties of his employment
ii. Similar to the requirement of “convenience of the employer”
2. § 107- Minister of the Gospel- housing benefits are excluded from the minister’s gross income but they must be furnished to him as compensation
a. If you are a “minister of the gospel”, gross income does NOT include the rental value of a home furnished to him as part of his compensation (parsonage); AND
b. The rental allowance paid to him as part of his compensation, so long as the allowance does not exceed the FMV of the home.
ii. § 132- Exclusion of Certain Fringe Benefits
1. There was a concern that fringe benefits would be provided on a discriminatory basis, so the Code imposes some discrimination limitations on some of the benefits offered
2. 2 Categories:
a. No Additional Cost Services- Doesn’t cost the employer any more money to offer the services to the employee (most often seen in service industries like airline, hotel, & telephone svc industries)