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Federal Income Tax
University of South Carolina School of Law
Quirk, William J.

FORM OF RECEIPT

1. Income tax (IT) generally
a. Where does tax come from?
i. “No direct tax shall be laid except in proportion to census”
ii. 16th allows IT—The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, w/o apportionment among the several States, and w/o regard to any census or enumeration.
b. 3 types of tax
i. Progressive
ii. Flat (sales)
iii. Regressive (social security)
c. If a transaction produces no “income” for a TP, no amount will be included in GI, and the transaction will not generate tax for TP.
d. §61àGI means all income from whatever source derived…
i. The courts interpret this language broadly, in order to “exert the full measure of [Congress’] power under 16th A to Constitution.
2. Old Colony Trust Company v. Commissioner
a. Facts—ER corp paid tax owed on salaries for some of its executives; commissioner assessed a deficiency against the EEs, arguing that ER’s payment of their taxes constituted additional salaries, which was taxable.
b. Issue—whether EE, having induced 3P to pay his income tax or having acquiesced in such payment as made in discharge of an obligation to him, may avoid the making of a return thereof and the payment of a corresponding tax (NO)
c. Holding

i. ER paying its executive’s taxes in itself is a form of taxable compensation, whereupon additional tax is due; if someone pays your obligation, it is as if you had received $ as income. You get an economic benefit.
1. Form of payment irrelevant; if in consideration of rendered services, then compensation, and therefore, taxable.
2. Immaterial that taxes were directly paid to gov
ii. Did the payment by ER of the IT assessable against EE constitute additional GI to EE? YES!

3. 3P payments
a. Boston & Maine R.R.—payment by a lessee of the taxes of the lessor held to be rental income to the lessor
b. Baylin—damage award that pay legal fees are benefit to TP and income.
c. Cotnam—allowed exclusion of portion of damages award paid directly to his lawyer
d. Glenshaw Glass—receipt of economic benefit from 3P is income.
e. Sachs—penalties for tax fraud in connection w corporate IT returns imposed on president-shareholder were paid by the corp; payment held to be taxable income to the president-shareholder
i. § 7201—most important provision in code; penalty for attempting to evade or defeat tax
1. Fined $100K; or
2. 5 yrs in prison; or
3. Both; plus
4. Costs of prosecution (about 70% of fine)
f. Huff —corp paid a civil fine imposed on EE; payment held to be taxable income
g. O’Malley—uncompensated trustee of a pension trust was convicted of conspiracy to use trust funds for bribery had his legal fees paid by the trust; legal fees not primarily expenses of the trust and benefit wasn’t incidental, so legal fees held to be GI to TP
4. Reuben rule (derivative suit): corp’s payment of $ in full settlement of claims against corp resulting in release of claims against TPs who were stockholders was not a taxable distribution of a dividend by the corp to stockholder bc company was pursuing its own ends. Stockholders received indirect/incidental benefit.

a. Hypo—shareholder brining a derivative action on behalf of corporation against the corporation and the dominant shareholders, saying they were looting company. Ct held this was not the same as Old Colony. Affixing a number to X’s liability would be arbitrary. No income to TP.

5. The tax on a tax
a. Hypo—ER agrees to pay EE, all in 2007, 100 for salary plus any IT on payments made by ER;
i. If EE is married, has no other income, and has 20 for deductions and personal exemptions, his TI is 80 and tax is approx 12.
ii. 112 (100 cash salary + 12 tax paid) – 20 deductionsàtax for this is approx 16
iii. BUT 100 of after-tax salary is the equivalent of 120 of before tax on which a tax liability is 20 would be incurred.

6. Hypo
a. Clemson pays off TP’s obligation to Tulane in order to get him—treated as TI (treat it as a loan instead of income)
b. You agree to work for a big law firm, and the firm pays off your tuition debt (50K).
i. Viewed as compensation to you followed by your payment of the loans; include 50K in GI
ii. TP receives an economic benefit, even if not cash or property, it’s income.

7. Receipt of cash and property
a. Income is the value of economic benefits received by TP. A benefit includes inflows of both cash and noncash items that result in the TP being “better off” as a result of the receipt.
b. Cesarini—husband and wife found $5000 inside old piano they had purchase
i. TPs must include the $5k in their GI in the year they found the $$
ii. Reg. 1.61-14(a) requires TPs finding treasure to include it in GI when reduced to undisputed possession.
c. Glenshaw Glass
i. TPs received exemplary damages for fraud and treble damages for antitrust violations by other companies
ii. Issue: were the exemplary/treble damages includable in GI?
1. Yes, treble damages under anti-trust law and exemplary damages for fraud are included in recipient’s gross income.

iii. Held/Rule: Yes; undeniable accessions to wealth, clearly realized, and over which the TPs have complete dominion are includable in GI
1. Source of income is irrelevant – the question is one of simple enrichment.
2. All gains are taxable, and income tax is source blind.
3. Key words: Undeniable accession to wealth + fairly realized + complete dominion

d. The receipt of cash or property (whether tangible or intangible) is the receipt of an economic benefit by TP. The source of the cash or property is not important to this determination, so even receipts from unusual sources constitute “income.”
i. Usual economic benefitsàpayments for goods or services, gifts, and transfers of property
e. Barter of services: if TPs exchange services, each has income = to FMV of services received
8. Receipt of intangible benefit
a. If TP receives something that constitutes an economic benefit to the TP, it is income
b. Drescher—ER paid $5k for an annuity K naming EE as the annuitant; ER retained possession of the K until EE reached age 65; EE had no assignable rights in the K and no cash

i. Held: EE must include an amount in GI equal to the value of the K
ii. EE received economic benefit for services rendered to his employer, thus receiving compensation. The absence of assignability or surrender value did not render the benefit valueless.

9. § 1.61(2)(d)àCompensation paid other than in cash.
a. FMV of the property must be included in income as compensation if services are paid for with property.
b. Page 909 in supplement

WHAT IS INCOME?

GROSS INCOME

v § 63 taxable income (TI)—gross income (GI) – deductions (other than standard deductions)
Ø Standard deduction
§ $4,000 for single ppl
§ $7,000 for married (joint)
Ø § 151 personal deduction
§ $2,000 for single ($2,700 adjusted for inflation); $5,000 total combining §§ 61 and 151; the rest is inflation adjustment
Ø Rule—combination of standard and personal deductions is threshold of when to file
§ Standard + personal = filing floor; if below, don’t file
§ If you make more than $6,400, must pay taxes
Ø Rates for a single individual w TI of $22,100—VERY HIGH total %

Income tax

28%

Social security on EEs

7.5%

What goes to the state

8%

Total

51%

Ø Top 20% of the population makes $50K or more and pay 75% of the total IT collected.
§ No need to tax ppl making less than $30K
§ Families w less than $50K income make up 50% of the total population and pay only 7% of the taxes.
§ Top 1% pays 41% of the taxes.
§ 2/3 of the taxes com from ppl making over $100K (10% of the total population)
v Art. I, § 9 forbids a direct tax except in proportion to population (no direct tax on property).
Ø Pollock—gov couldn’t impose IT bc it was a direct tax.
Ø 16th passed in 1913 in reaction to Pollock allowing gov to impose IT; still can’t tax on wealth or property

FOUR BASICS OF PREPARING TAX

v § 61 gross income
Ø All income from whatever source derived, including (but not limited to) the following items:
§ Compensation for services
§ GI from doing business
§ Gains derived from dealings in property
§ Interest
§ Rents
§ Royalties
§ Dividends
§ Alimony and separate maintenance payments
§ Annuities
§ Income from life insurance and endowment Ks
§ Distributive share of partnership GI
§ Income in respect of decedent
§ Income from an interest in an estate or trust
§ Income from discharge of indebtedness
Ø Eisner v. Macomber—income may be defined as the gain derived from labor, from capital, or from both combined.
§ A rather narrow def of income—what if no labor or capital involved?
§ So then, what about prizes, awards, subsidies, damages, and found property, etc?
§ Discarded in a later decision
Ø Glenshaw Glass Co.—TPs received treble damage awards under antitrust laws.
§ 2/3 as penalties for violating law and 1/3 for loss of profits (TP argued only this 1/3 portion was taxable)
§ Held the entire judgment was taxable bc it’s an undeniable accessions to wealth, clearly realized, and over which TPs have complete dominion
§ Set up the principle that all gains are taxable if clearly realized.
§ So the categories questioned under Macomber would now be recognized as taxable.
Ø 3 Qs raised after Glenshaw Glass—since income includes all “gains” that are “clearly realized” regardless of “source,”
§ What constitutes a “gain”?
· Measurement of TP’s personal wealth or change therein
§ When is income “clearly realized”?
· Gain from sale of securities for cash is obviously realized, but mere property apprecia

write-up, so they aren’t giving them to you to be generous.
Ø You are going to the games for pleasure. They are not a tool of the trade, and you can give them away if you want to.

REALIZATION

A. Important to emphasize notion of gain—appreciation in value isn’t a gain from trees growing or increase in stock values (definition, p194, Eisner, “Income may be defined as ‘gain derived from capital, from labor, or from both combined,’ provided it be understood to include profit earned through a sale conversion of capital assets.”)
1. § 1001 says that the entire amount of gain or loss on the sale or exchange of property must be recognized, unless some other Code section provides otherwise.
B. Helvering v. Bruun
1. Facts—the landlord leased out land and a building on it for a 99yr term. The tenant removed the existing building and erected a new one. The lease was terminated due to the tenant’s default, and it was determined that, as of the cancellation date, the FMV of the new building exceeded that of the old one by more than $50K. The commissioner determined that this amount represented realization of a gain subject to IT in the year of the lease cancellation. This determination was reversed by the Board of Tax Appeals, whose judgment was affirmed by the CoA.
2. Issue—whether the new building TP landlord acquired thru a default on a lease constitutes a realized gain that is taxable

3. Holding—ct rejected TP’s contention that the new building was an improvement that became indistinguishable blended w the realty and therefore no gain could be realized until the realty was sold. Rather, ct held that realization of a gain didn’t have to be in cash derived from the sale of an asset but rather could include profit realized from the completion of a transaction. Here, as a result of a business transaction, TP received back his land w a building on it that increased its value, and gain was thus realized.

4. Discussion
a. No longer has to be severable (as in Eisner).
b. If he had exchanged building for another, there would be no question that this would be taxable, but Bruun owned the property the whole time.
(1) Value of improvements were realized when the forfeiture occurred.
c. Court finds this taxable.
(1) The fact that the gain is a portion of the value of property received by TP in the transaction does not negate its realization.
(2) Realization need not be in cash derived from sale of asset.
(3) Gain can occur from the exchange of prop, payment of the TPs indebtedness, relief from liability or other profit realized from the completion of a transaction.
(4) “It is not necessary to recognition of taxable gain that he should be able to sever the improvement begetting the gain from his original capital. If that were necessary, no income could arise from the exchange of prop; whereas such gain has always been recognized as realized taxable gain.”
d. § 109 – improvements by lessee on lessor’s property – reversed result in Bruun (and passed as a result of Bruun which was seen as an extreme case that was unfair).
(1) Says that gross income doesn’t include income (other than rent) derived by a lessor of real property on the termination of a lease, representing the value of such property attributable to buildings erected or other improvements made by the lessee.
(2) So § 109 lets landowner defer, so that it need not be taken in immediately under present law. But, as Chirelstein says, it is really just a matter of time.
(a) Relieve lessor of the need to raise cash, and to do it in a hurry
(3) GI does not include income (other than rent) derived by the lessor of real property on the termination of a lease, representing the value of such property attributable to buildings erected or other improvements made by the lessee.
C. Eisner v. Macomber
Facts—π stockholder received certificates for additional shares issued by the corp as stock dividends. Δ US treated those shares as income, and π TP paid a tax under protest on the same. Π TP bought an action against Δ to recover the tax contending in imposing such a tax, the Revenue Act violated the Con which