Federal Income Taxation by Bankman, Shaviro, Stark (16th edition, Aspen 2012)
Gross Income (§61)
Above the Line Deductions (§62(a))
——–Adjusted Gross Income (§62)————
Below the Line Deductions
(i.e., Either the standard deduction §63(c) or itemized deductions, §63(d))
Deduction for Personal Exemptions (§151)
Taxable Income (§63)
Taxable Income x Rates = Tax – Credits – Tax Paid = Refund or $ to IRS
*Exam: if she does not say “do not classify the gain” then you should classify the type of gain in your answer
II. Some Characteristics of Gross income
§61 provides that gross income includes “all income form whatever source derived.” Includes:
· Wages, interest, dividends, rents, gains dealing in property
Commissioner v. Glenshaw Glass: income was defined much more broadly to include all “accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”
A. Haig-Simons Definition of Income
Income equals the sum of (i) the taxpayer’s personal expenditures plus (or minus) (ii) the increase (decrease) in the taxpayer’s wealth. This includes gains on property and interest.
B. Noncash Compensation: Fringe Benefits [§61(a)(1)] Noncash (“in-kind”) employer-provided benefits such as medical care and life insurance may constitute a significant part of employee earnings. Some forms of fringe benefits are included in gross income in full, some are excluded entirely, and others are excluded subject to certain requirements and limitations.
§61(a)(1) – provides that gross income includes “compensation for services,” including “fringe benefits.”
Income in Any Form
Regulation §1.61-1(a) – “gross income includes income realized in any form, whether in money, property, or services”
FMV of Property is Income
Regulation §1.61-1(d)(1) – if services are paid in property, the fair market value of the property taken in payments must be included in income as compensation
Example: Joe is a self-employed automobile mechanic. In 2013, he repaired the brakes on a customer's car and billed the customer $1000. The customer was short of cash, and offered to settle the bill by selling Joe a motorcycle at a discount. The motorcycle was valued at $5000, but the customer offered to sell it to Joe for only $4000. Joe accepted the offer, paid $4000 in cash and received the motorcycle. In the following year (2014), Joe sold the motorcycle to a third party for $5500. How should Joe report these transactions on his tax returns for 2013 and 2014?
In 2013, Joe should report $1,000 as income. In 2014, Joe should report the capital gain of $500. The basis is $5,000 because it is how much he “paid” for the motorcycle. $5,500 is the amount realized (AR), so subtract the basis to get $500 in gain.
i. Employer-Provided Meals and Lodging [§119] Code section 119(a), (b)(4)
Regs. 1.119-1(a)(1) and (2); (b); (c); (f), ex. 1, 2, 3, 5, 6, 9
§119 – allows employees to exclude from income the value of employer-provided meals and lodging
· Intended to cover situations in which he employee is constrained in his choice of food or eating places
Excludes meals if:
i) The employer furnishes the meals to an employee, her spouse, or dependents
ii) The meals are provided for the convenience of the employer
iii) The meals are provided on the business premises of the employer
Excludes lodging if:
i) It is furnished on the business premises by the employer to an employee, her spouse, or dependents
ii) It is provided for the convenience of the employer
iii) The employee is required to accept the lodging as a condition of her employment (must accept)
a) Cannot have a choice between this or money
Does not cover amounts reimbursed for meals (no cash meal allowance)
· See Kowalski – cop required to eat at public place within patrol area, was not allowed to deduct meal allowance in income
o Was not “furnished” – it was reimbursed
o Was not “on the business premises of the employer”
o Was not “for the convenience of the employer”
Business Premises Requirement
In some cases, courts have held that the employer’s business premises include homes that were located near but not on the property where the employer conducted most of its business.
· See Linderman – held house across the street from the employer’s place of business was on the employer’s business premises because the employee who lived in the house performed some of his duties there.
· But see Anderson – held that the business premises of a motel did not include a home for the motel manager, which was located two blocks from the motels, because the employee did not perform a significant portion of his duties there.
Convenience of the Employer Requirement
Other cases have revolved around the “convenience of the employer” requirement. Generally, a taxpayer can establish that the meals and lodging were provided for the convenience of the employer by showing that the employee is required to be on-call even when the employee is working.
· See Benaglia – manager of a luxury hotel in Hawaii was permitted to exclude the value of meals and lodging provided at the hotel because the manager was required to be on duty continuously
o Although the meals and lodging were quite valuable, held that they were provided so that the manager could perform his duties – thus, excludable
Beneficiaries of §119: Employers, Employees, and Consumers
· Employers may be able to offer tax-free benefits at lower salaries
How do you decide if you want to take advantage of a benefit? If the value of it to you is more than the tax you would have to pay, then you would take the benefit. It becomes more complicated when you are choosing between a benefit and cash.
ii. Employee Fringe Benefits/Other Fringe Benefits §132
Code: 106(a); 162(a); 132(a)-(d), (e)(1), (f), (h)(1)-(3), j(1), (j)(4)
Regs 1.132-1(b)(1); 1.132-2(a)(1), (2), (5)(i) and (ii); 1.132-3(a)(1), (2), (6); 1.132-3(e); 1.132-4(a)(1)(i), (ii), (iii) and (iv)(A); 1.132-5(a)(1)(vi); 1.132-6(a), (c), (e) and (f)
1) Model Answer: Cleary X has enjoyed an economic benefit, which was due to X’s being employed by Y. The question, then, is whether §132(a) allows X to exclude the [amount] or any part of it from her gross income. From X’s standpoint, the best result – complete exclusion – would be achieved if she could bring [the benefit] within §132(a)(1) (“no additional cost service”) (a)(3) (“working condition fringe”) or (a)(4) (“de minimis fringe”). Subsection (a)(2), which excludes “qualified employee discounts,” is subject to a percentage limitation and is therefore less favorable to X.
Employer Fringe Benefits [§132] · Must be provided to the taxpayer-employee
· §132 cover miscellaneous fringe benefits that are not covered by other specific exclusion sections
· §132 excludes from income the following categories of benefits:
i) No additional cost services
ii) Qualified employee discounts
iii) Working condition fringe benefits
iv) De minimis fringe benefits
v) Qualified transportation fringe benefits
Cafeteria Plans: A “cafeteria plan” is a plan under which an employee may choose among a variety of noncash taxable benefits or may choose to take cash (which is taxable). §125 limits the fringe benefits that can be included in a cafeteria plan and imposes a nondiscrimination rule. The permissible benefits include group-term life insurance, dependent care assistance, adoption assistance, excludable accident and health benefits, and elective contributions under a qualified cash or deferred arrangement. The use-it-or-lose-it rule applies. Under this rule, if an employee elects at the beginning of the year to tak
ntire 30% discount is taxable as income. The 20% discount is not taxable, however.
Non-Discrimination Provision §132(j)(1)
Model Answer: 132(j) allows the exclusion only if the discount is offered to employees on a non-discriminatory basis, not just to the highly paid. Assuming either (a) that X, though well paid, is not among the highly compensated, or (b) that X is highly compensated but the employer offers that same fringe benefit to its non-highly compensated employees, the this exclusion will fit within this section.
· Both the qualified employee discount and no-additional cost services are conditioned upon compliance with a nondiscrimination provision.
· Generally requires that the benefit be made available to a wide cross section of employees, included non-highly compensated employees (§414 = definition of highly compensated)
· If they offer a 10% discount to all and 20% to highly compensated, then highly compensated must include the entire 20%, not just the 10%
· If there is discrimination then the fringe benefit must be offered on substantially the same terms to all employees, or if the group that receives some benefits that others don’t, then they can't be the most highly compensated employees. (1.132-8)
Working condition fringe benefits [§132(d)] Model Answer: A “working condition fringe” is defined by 132(d) as a service the cost of which would be deductible by [the employee] as a business expense if paid by her directly
Generally defined as an item that could be deducted as a business expense under §162 or §167 if paid directly by the employee
· §162 – allows taxpayers to deduct all the “ordinary and necessary” expenses paid or incurred during the taxable year in carrying on any trade or business (thus a trade or business deduction)
o Thus, an employee who would be able to deduct costs of a subscription to a professional journal if she bore them herself is not taxed if her employer supplies the journal free of charge
· §167 – allows taxpayers to take depreciation deductions on property used in a trade or business or held for the production of income
Example: Avery, an associate with a law firm, is often required to work through the evening. The firm will pay for the cost of dinner for lawyers working late and a taxi home. Is there any inclusion to Avery? Does it matter that the policy is limited to lawyers and doesn’t include other staff?
No inclusion because the dinner and taxi fall under trade or business expenses §162.
Occasional meal and transportation money is allowed under Reg. §1.132-6(d)
Occasional meal and transportation does not require not discrimination.
De Minimis Fringe Benefit [§132(e)] Model Answer: A “de minimis fringe” is defined by 132(d) as a service whose value is “so small” that accounting for it is impracticable.
Defined as any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable
· Examples: occasional parties, occasional theater or sporting event tickets, coffee, doughnuts, soft drinks, and local telephone calls [Regulation §1.132-6(e)] · Cannot be cash [§132(e)]