Income Taxation
Prof. Hellwig
1) Introduction
a) A Brief History of Federal Income Tax
b) The Tax Practice
c) Resolution of Tax Issues Through the Judicial Process
i) Trial Courts
(1) The Tax Court
(2) Federal District Courts
(3) The United States Court of Federal Claims
ii) Appeals
iii) Selection of Forum
d) Analysis of the Computation of Tax Liability of Mr. and Ms. Taxpayer
i) Basic Questions Addressed by an Income Tax System
ii) Evaluating Mr. and Ms. Taxpayer’s Tax Liability
(1) Gross Income
(2) Adjusted Gross Income
(3) Deductions
(4) Calculating Adjusted Gross Income
(5) Taxable Income
(6) Tax Rates
2) Gross Income
a) The Search for a Definition of Income:
i) The current definition for gross income is provided in § 61(a). Gross income is “all income from whatever source derived.”
ii) Economic benefità Under this approach, income is the value of economic benefits received by the taxpayer. A benefit is broadly defined to include inflows of both cash and non-cash items that result in the taxpayer being better off.
b) Income Realize in Any Form:
i) Reg. § 1.61-1(a)à Regulations explicitly provide that gross income may be realized in any form, whether money, property or services.
ii) Reg. § 1.61-2(d)(1) à If services are paid for in property, the FMV of the property is the measure of compensation; if paid for in the form of services, the value of the services received is the amount of compensation.
iii) Reg. § 20.2031-1(b) à FMV is generally defined as the price a willing buyer would pay a willing seller, with neither under a compulsion to buy or sell, and both having reasonable knowledge of relevant facts.
iv) Cash payment serves as a very convenient measure of the amount of income; measurement may be much less certain when valuation of goods or services is necessary, but the difficulty of measurement should not obscure the fact of payment.
v) Frequent Flyer Miles: A taxpayer, who accumulates frequent flyer miles as a result of business travel paid for by her employer, is not required to report any gross income as a result of the receipt of the frequent flyer miles or her use of those miles for personal travel.
c) Realization, Imputed Income and Bargain Purchases:
i) The Realization Requirement: §1001(b)
(1) We do not tax on mere appreciation in value of property, because it has not been realized. Reg. § 1.1001-1(a) says gain or loss is realized “from the conversion of property into cash or from the exchange of property for other property differing materially either in kind or in extent.”
(2) Policy reasons:
(a) Measuring the appreciation (and, presumably, depreciation) in all of the property of every taxpayer every year would present enormous administrative problems for taxpayers and the IRS.
(b) It is often claimed that it would be fundamentally unfair to treat unrealized gains as income because taxpayer might well lack the cash to pay resulting taxes and might thus be forced to sell assets – perhaps at artificially low prices, given the need for cash – to pay the tax.
ii) Imputed Income: This is the FMV of the taxpayer’s performance of services for his or her personal benefit and the value of the taxpayer’s personal use of property that he or she owns. The value of any service one performs for oneself, and the rental value of any property that one owns constitutes imputed income.
(1) Household services à the value of housework and child care performed by stay-at-home spouses is an important type of imputed income.
(2) Owner-occupied housing à the rental value of the home owned by the occupier is also an important type of imputed income.
(3) Policy reasons:
(a) Fairness – some argue it is unfair to exclude because exclusion result in taxpayer with similar abilities to pay tax being treated differently.
(b) Administrative practicality – it’s difficult to measure value, but it is not impossible.
(c) Economic effects
iii) Bargain Purchases: Assume the FMV is greater than the price paid for it. These will only be included in gross income if it occurs in the employment setting. It would presumably be administratively unworkable to require taxpayers and the Service to look behind every acquisition to determine whether one of the participants received a taxable bargain, and if so, in what amount.
(1) Reg. § 1.61-2(d)(2)à If property is transferred as compensation for services in an amount less that its FMV, the different between the FMV and the amount paid is gross income.
(2) Be careful not to apply the realization requirement in connection with a compensatory bargain purchase that constitutes gross income. When property is given to an employee as compensation for services, it is the FMV of that property that must be used in order to measure the compensatory element in the transaction.
d) Commissioner v. Glenshaw Glass Co., 348 U.S. 426, U.S. Sup.Ct., Warren, 1955
i) FACTS: Glenshaw (∏) settled a lawsuit for $800,000, a portion of which it sought to exclude from gross income as punitive damages for fraud.
ii) RULE: Money received as punitive damages must be included as gross income. Undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion will be considered gross income.
iii) APPLICATION: The definition of gross income, promulgated by Congress, begins from an all-inclusive standpoint. Receipts are assumed to be gross income unless an exclusion removes them from the category. In this case, Glenshaw has an undeniable accession to wealth. The fact that the payments were extracted from wrongdoers as punishment for unlawful conduct does not detract from the characterization as gross income. Reversed.
iv) NOTES:
(1) §§ 71-90 à items specifically included in gross income
(2) §§ 101-140 à provides rules of what is excluded in gross income
e) Eisner v. Macomber (pg. 28): This case defined income as “the gain derived from capital, from labor, or from both combined.”
f) Cesarini v. United States, 296 F.Supp. 3, Northern District of Ohio, Young, 1969
i) FACTS: The Cesarinis (∏), after finding money in a piano and declaring it on their taxes, filed an amended tax return which removed the funds in question from gross income.
ii) RULE: Unless expressly excluded by law, gross income includes all income from whatever source derived.
iii) APPLICATION: Section 61(a) of Title 26 U.S.C. is the starting point for determining what should be included in gross income. The definition of gross income is expansive, limited only by express exclusion of specific items. The Sup.Ct. has frequently held that such all-inclusive language defining gross income was intended by Congress to reach the full measure of its taxing power under the Sixteenth Amendment. In this case, the Cesarinis increased their wealth by the discovery of treasure trove. They argue that since Congress recently enacted code sections that expressly included the value of prizes and awards in gross income computation, and specifically exempted gifts, the intent was to place treasure trove in the category of gift, making treasure trove nontaxable. But this argument overlooks the basic principle that unless an explicit exemption can be identified, income from any source is included in gross income calculation. The Cesarinis’ claim is denied.
iv) NOTES:
(1) The statutory scheme is that income can be taxed even if there is not an express provision taxing it, however, to exclude it, there must be an express exclusion.
g) Old Colony Trust Company v. Commissioner, 279 U.S. 716, U.S. Sup.Ct., Taft, 1929
i) FACTS: The Commissioner (∏) sought to tax, as additional income to the employee, the amount of his federal income taxes which were paid on his behalf by his employer.
ii) RULE: The payment by an employer of the income taxes assessed against his employee constitute additional taxable income to the employee.
iii) APPLICATION: The payment of the tax by the employer was in consideration of the services rendered by the employee and was a gain derived by the employee from his labor. The form of payment is irrelevant. The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed. Further, the taxes were paid upon a valuable consideration, namely, the services rendered by the employee and as part of the consideration for such services. Nor was the payment of taxes a gift. Even though the payment was entirely voluntary, it was nevertheless compensation. Affirmed.
iv) NOTES:
(1) It doesn’t matter how compensation is awarded, you still must pay taxes on it. A discharge of an obligation can be included in taxpayer’s gross income.
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ht never receive it and has no right to demand payment.
iii) APPLICATION: First, the income was not taxable to the Receiver in 1916 because he was only in control of a portion of North American’s property. This is consistent with long-standing treasury regulations. Next, the income could not be taxed to North American in 1916, because it might never receive the funds. The first time North American had an unqualified right to the funds was after the district court awarded them to it in 1917. At the time the receivership was vacated, North American had a claim for the money and actually received it. The fact that the case was not ultimately settled until 1922 is immaterial. If North American had lost, it would have repaid the funds out of current assets and taken a deduction for that amount. The funds received in 1917 should have been reported as income for that year. The decision of the court of appeals is affirmed.
iv) NOTES:
(1) This case is settled under the claim of right doctrine.
(a) The money became income to the company when the court decided that they were entitled to the money and they received it.
(b) The issue arises because the other party appealed the judgment meaning that it still may be claimed that they must restore money to the other party.
f) James v. United States, 366 U.S. 213, U.S. Sup.Ct., Warren, 1961
i) FACTS: James (∏) embezzled in excess of $738,000 during the years 1951 through 1954, but he did not report these amounts in gross income.
ii) RULE: All unlawful gains, including embezzled funds, are to be included in gross income in the year in which the funs or other property are misappropriated.
iii) APPLICATION: Expressly overruling Commissioner v. Wilcox, all unlawful gains, including embezzled funds, are to be included in gross income in the year in which the funds or other property are misappropriated. Congress has extensive powers to levy taxes. Nowhere in the expansive tax code has there been a suggestion that the Congress intended to treat the law-breaking taxpayer any differently from the honest one. At one time, this Court held in Wilcox that embezzled money did not fall into the category of gross income since the embezzler was under an unqualified duty to repay the money to his employer. But the same can be said of any misappropriation. Whether the transfer of legal title occurs or not, the individual has increased his or her wealth. Loans are distinguishable since they must be repaid over a certain period; misappropriated funds might never be detected and recovered. In this case, James gained control over the embezzled funds. Thus, in the applicable years, he should have reported this income on his taxes. However, James’s conviction was a felony for willfully failing to account for his taxes. Since the Wilcox exception for embezzled funds was in effect at the time of the embezzlement, the element of willfulness could not be proved. Reversed and remanded for dismissal of the indictment.
iv) CONCURRENCE AND DISSENT: (Black) The embezzler has the same funds he was entrusted with as an employee. He has gained no title through the embezzlement. By allowing the funds to be subjected to a tax, the United States is taking a preferential claim on Money that ought to be restored to the rightful owner. It seems that there is no answer to this argument. It appears that the only result of the holding in this case, which erroneously overrules Wilcox, is to place the federal government in the business of prosecuting embezzlers under the guise of tax evasion.
