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Income Taxation
University of North Carolina School of Law
Polsky, Gregg D.

 
POLSKY – INCOME TAXATION OUTLINE – FALL 2013
 
 
I.                  Terminology
Gross income- defined in §61 as encompassing “all income from whatever source derived” except as otherwise provided by the statute.  This may include wages and salaries, dividends, interest and rents, and gains from the sale of investments such as securities and real estate, annuities, pensions, etc. 
Deductions- include the taxpayer’s business expenses, etc
Capital Gains (long term) – gains from sale of capital assets (property) which is calculated by subtracting the cost of the property (basis) from the amount received from the sale of the property (amount realized)
Taxable income – gross income that has been reduced by allowable deductions
Progressive tax – aka graduated tax is tax that increases with income
Marginal rate – the applicable rate of tax at each bracket level
 
II.               Characteristics of Gross Income
Non-Cash Compensation
§ 119(a), 1.119-1, 132, 61(a), 1.61-1(a)
§119 – Meals and lodging furnished for the convenience of the employer – shall be excluded from the gross income of the employee.  This includes any of these benefits provided to employee’s spouses or dependent children.  The meals must be furnished on the business premises of the employer and lodging must also be on the premises or as a condition of employment.
Treasury Reg. §1.119-1 – Meals and lodging
§132 – Fringe Benefits – the following may be excluded from gross income:
no-additional-cost service, qualified employee discount, working condition fringe, de minimis fringe, transportation, moving, retirement planning, etc
Banaglia – F: employee (B) is the manager of a hotel and he is given food and lodging plus a salary.  B does not report the food and lodging as income on his tax returns.  IRS wants their money. H: ct said that value of lodging and meals provided to B was for the employers convenience and was ∴ not taxable as part of B’s gross income.
Charley – case where the horse urine tester used his FF miles to upgrade and takes case for the 1st class ticket.  Ct said that mileage came from his business travels and was income under §61.  The IRS does not currently enforce this law.
 
B.      Imputed Income
§1.61-2(d)
Revenue Ruling 79-24:  (based on §1.61-2 (d)(1)) says that if services are paid for other than in money the fair market value ( the value of that service in the area) of the property or services taken in payment must be included in income.  Ex: a lawyer provides advice in exchange for the person painting his house.
§121 – gives up to $250,000 of gain on the sale of a house tax free
§163(h) allows a deduction for home mortgage
Imputed income is often not taxed for issues of valuation and liquidity
 
C.     Windfalls, Gifts & Transfers of Property by Gift/Bequest
§102, 274(b), 1014(a), 1015(a), 1014(b)(6), 1014(e), 1016(a)(1),(2)
1.  Punitive Damages
Glenshaw Glass (1955) – Glenshaw Glass received money from a company as a result of an anti-trust suit.  They received 2 amounts first was for lost profits which they are not disputing.  The issue is whether or not tax should be paid on punitive damages.  In 1920 Eisner v. McComber defined income as gain derived from capital, labor or both and the D wanted to use this b/c the punitive award was not derived from capital or labor.  The ct defined income as an undeniable accession to wealth, clearly realized and over which the tax payer has complete dominion.
2.  Gift: The Basic Concept
When it comes to gifts the rule is that there is no deduction for the donor and no inclusion in income  for the donee (the donee gets the money tax free but the money is taxed).
§162 allows for itemized deductions for individuals and corporations but it does not allow for personal deductions.
Duberstein (1960) – Duberstein was given a Cadillac as a “gift” for providing references to a business.  Burnham (B) deducted the Caddy and D got audited.  In Santon v. US he was given $20k.  the gov’t said a xfer w/I a business arrangement is not a gift esp. in an employer/employee setting.  Ct also said that each case should be judged on a case by case basis even though the gov’t wanted a bright line rule.  The ct determined that it was not a gift.
Ct said to look at donor intent i.e. the gift should come from detached and disinterested generosity.
Welfare assistance payments are not taxable
§102 addresses employer/employee gifts (c) says that gifts from employer to employee should not be treated as a gift
§274(b) does not allow business deductions for gifts (provides items that are not deductible)
3.  Transfers of Property by Gift/Bequest
Taft v. Bowers
A purshases 100 shares or stock for $10/share
Shares are now worth $20/share and A gives shares to B
Shares now worth $50/share and B sells
§1001 (a) addresses gains and losses
issue: whether the basis was 1000 or 2000 for all the shares
§1015 – says that the tax payers basis should be the same as the donors or the last preceding owner by whom it was not acquired by gift
ct determined that basis was 2k (the basis in the hands of the previous owner)
§1014 – if you acquire property by bequest the basis (stepped up basis at death) is the FMV at the date of the decedent’s death.  You want to hold on to appreciated property
 
Answers to Problems on p 126:
1.  (a) $2500  (b) $500
2.      §1015(a) exception for loss – if original basis is more than FMV at the time of the gift then for the purposes of calculation of loss the basis is the FMV
(a)    carry over basis is $2000, $2500 realized \$500 gain
(b)   loss of $500
(c)    you have no gain and no loss you only have gains if sold for above $2000 and a loss if sold below FMV of  $1000 anything in between = no gain or loss
3.      (a) he should give her to sell b/c she currently has zero income
(b) sell the stock himself and give her money
(c)    give her the $80k from savings account
(d)   sell the loss profits stock and take the deduction (accelerate the deduction)
§121 gives up to $500k above basis in profits tax free for joint returns
 
D.     Recovery of Capital
§72(a), (b), (c), 101(a), 165(a)-(d), (h), 264(a), 161-6 (esp. example 2)
1.  Easements, Life Insurance, Gambling, Annuities
Recovery of capital is the acknowledgment that when you invest in capital and sell it you receive your basis back essentially tax free b/c you are entitled to recovery of capital.
Hypo:
I pay $5k for a series of 8 $1k payments over 8 years.  What is your year 1 income?
Option 1 – zero income until year six and then tax on the 3 remaining years
Option 2 – income first approach where $3k of income is recognized for the first 3 years and then zero income for the other 5 years.
Optio

er receives earnings under a claim of right w/o restrictions as to its disposition tax is owed.  Taxable when received b/x they had a right to use it at that time (in 1917).
United States v. Lewis
Employee gets $11000 bonus in 1942 and then in 1946 he was told to pay it back.  Issue: what is the tax implication when it is paid back. He wanted to have his taxes for the year when he paid taxes recomputed and ct said no.  The ct stuck to the annual accounting system and said that taxes must be paid on income when it is accrued.  The ct said that he would get a deduction in the year that he had to pay it back even though the tax rate in that year was higher. 
§1341 was in response to Lewis and provides for computation adjustments
2.      The Tax Benefit Doctrine
§111 explicitly incorporates an exclusionary tax benefit and implicitly incorporates an inclusionary tax benefit rule. 
§111 only allows a deduction if it did not reduce your taxes form the prior year.  It does not consider differentials in tax rates.
F.       Recovery for Personal and Business Injuries
§104(a), 105(a)-(b)
Injury to property (ex: recovery for broken ice cream maker) is treated as a forces sale and no tax once the money received for the item is reinvested in the business.
Punitive damages are taxable.
§104 – allows for a deduction for amounts received for personal injuries (other than punitive damages).
G.    Income from the Discharge of Indebtedness (COD income)
1.  Loan Proceeds Not Income; Debt discharge
§61(a)(12), 108(a)-(d), (e)(2), (5), (f)
ex: if you borrow $8k and later pay $5k back you have to pay taxes on $3k of income
US v. Kirby Lumber Company (1931)
Kirby sold its own bonds for over $12m and later bought them back for less than par.  The ct said the difference was income and that they had to pay taxes on it. This was called COD = cancellation of debt income.
Zarin (1990) – Z gambles an excess of $3M the state told the resort not to give more credit to him but they did anyway.  He had previously paid off a $2.5M debt in full.  He could not pay this amount and they settle for $500k.  See §165(d)
Ct said it was not income because the definitional requirement of §108(d)(1) – indebtedness for which the tax payer is liable and subject to which the taxpayer holds property.
The ct said he is not liable for the debt b/c it was incurred in violation of the order given to the casino.  Additionally, the ct said when he paid he got chips which are not property that be sold they are just accounting devices.  The ct also said there was a question about how much money was owed and since there was a settlement it shows that there was some doubt about the exact amount owed.