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Income Taxation
University of South Carolina School of Law
Boyle, F. Ladson

Income Tax Outline
 
–          current statutory income tax document is the Internal Revenue Code of 1986
–          U.S has a self-assessing system à you have an obligation to file a return and you are responsible for telling the IRS what you made and what you think is deductible
o    If what your file never gets audited, it was right
o    Statute of limitations runs on a return after 3 years (6 yr if more than 25% of income is not reported)
–          2 types of audit
o    Office audit – bring your records to IRS and justify return
o    Field audit – IRS sends someone to you; usually only happens to businesses
–          After Audit
o    Group supervisor
o    30 day letter – IRS seeks to change your tax liability and you have 30 days to respond in an Appellate Conference, have to provide evidence of why you think the IRS is wrong
§ Appellate Conference
o    90 day letter – in 90 days they will assess the tax if you do not agree or file a petition in tax court
§ Once the tax gets assessed, you owe the money and have to pay
·         If you pay you can still sue for a refund to try to get money back
o    Can sue in district court (jury) or in claims court (non-jury) (specialty court in Washington that hears nothing but claims for refund against the government (mostly tax, also condemnation))
o    District court citation will be to F. Supp.
o    Claims court citation will be to Cl. Ct.
o    Appeals from claims court go to Court of Appeals in D.C.
§ From S.C. both tax court and district court appeals would go to the 4th Circuit CoA
o    Tax Court – a prepayment court, specialty ct that hears nothing but tax cases (non-jury)
§ Ex) P.64 Charley v. Commissioner – the “v. Commissioner” tells you that the case went through the tax court
§ Ex citation) 82 T.C. 413
–          Government legislates social policy through the tax code
o    Ex) charitable deductions
–          Government will sometimes encourage economic goals through tax policy
o    Ex) rebate checks for economic stimulus
 
–          Revenue Rulings are just the opinion of the IRS – it tells you how they will likely view something and the actions they will likely take, but they may still be challenged in court
–          Treasury Regulations – these are presumptively correct, but may still be challenged in court
o    i.e. higher precedential value than revue rulings
 
Calculating Income
 
–          ** gross income – deductions = taxable income **
o    Taxable income determines person’s tax bracket (i.e. NOT gross income)
o    Permanent tax brackets: § 1(a)(2)
o    Temporary tax brackets: § 1(i)(2)
 
Gross Income
 
–          gross income = gain
o    investments are not income – increases in stock value is not a part of gross income à when sold the amount of gain above basis would be gross income
o    § 61 – gross income = “all income from whatever source derived”
§ The legislative history of this section defines “income” in its constitutional sense (16thA)
–          If the IRS claims something should be income – the burden is on the taxpayer to prove that it is not income
–          Test for Gross Income (p.67): Gross income includes the receipt of any financial benefit which is:
o    (1) Not a mere return of capital
o    (2) Not accompanied by a contemporaneously acknowledged obligation to repay, and
o    (3) Not excluded by a specific statutory provision
§ Note: explicit/specific provision trumps general definition of gross income
–          Ex) if debt is repaid for less than was borrowed – the excess amt borrowed is income
 
Cesarini v. United States – Northern District of Ohio 1969 à “treasure trove” case – guy found money while cleaning a piano, treasure trove is a part of gross income that should have been reported
–          unless something is specifically excepted from inclusion in gross income – there is a broad interpretation of income
–          Treas. Reg. § 1.61-1(a) – “gross income includes income realized in any form, whether in money, property, or services . . .”
o    Basis for the broad interpretation of gross income
–          Treasure trove = money found and “reduced to undisputed possession” – finding the item is the realization event, therefore income is from the point of finding
o    The finder has title against all but the actually owner of the found item
o    “Treasure trove” is actually expressly included as gross income by Treas. Reg. § 1.61-14 (though neither party cited it in this case)
o    Treasure trove is taxed at the fair market value – what a willing buyer would pay a willing seller
§ FMV is best determined by the immediate sale
 
Old Colony Trust v. Commissioner – U.S. Supreme Court 1929 à company agreed to pay employee’s income tax, the payment of income tax is includable as a part of gross income
–          payment of income tax was in consideration for services rendered
–          “The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed.”
o    Discharge of obligation = receipt by the taxed
 
Prob. 3 P. 63: car given to the spouse of an employee is still part of employee’s gross income
–          property in kind given as compensation for services (e.g. stocks) = gross income
–          this is an inducement to the employee (i.e. compensation for services) = taxable
o    (for wife this would likely be an excludable gift)
–          Income realized = base salary + FMV stocks + FMV car
 
Commissioner v. Glenshaw Glass Co. – U.S. Supreme Court 1955 à 2 consolidated cases determining that punitive damages are includable as a part of gross income
–          the intent of Congress was to tax all gains except those specifically excluded
o    actual damages are taxable – it would be inconsistent to exclude punitive damages from income tax without a clear congressional intent
–          taxable income = “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion”
o    taxable income = (1) undeniable accession of wealth + (2) clearly realized + (3) over which the taxpayer has complete dominion
o    e.g. loans are not considered income bc there is no accession to wealth
 
James v. United States – U.S. Supreme Court 1961à illegal gain is income even despite a legal obligation to make restitution
–          when Cong. amended the Income Tax Act, the word “lawful” was removed, demonstrating an intent to tax illegal gains
–          one rationale for this rule is the gov’s desire to increase sanctions
–          side note – reporting illegal gains may raise 5thA self-incrimination issues
 
Prob. 5 P.63: Owner agrees to rent to Tenant for $4,000
–          (a) if T pays $1,000 & does $3,000 in improvements – O realizes $4,000 in income
–          (b) if T does all work himself for $500 – O still realizes $4,000 – the FMV of the improvements
o    i.e. $1000 direct rents + $500 materials + $2,500 labor of T = $4,000 income
–          (c) what are tax consequences of (b) to T?
o    O accepts $2,500 in labor as rent – this is taxable income for T
§ Labor accepted in exchange for discharge of monetary obligation
 
Helvering v. Independent Life Ins. Co. – U.S. Supreme Court 1934 à holds that a taxpayer need not include the rental value of a property he owns and resides in as part of gross income
–          a party is allowed to make use of his own property without tax liabilities
o    use of your own property ≠ income
o    (contrast this w/ Dean v. Commissioner)
 
Revenue Ruling 79-24
–          2 situations presented: (1) house painter painted lawyer’s house in exchange for legal services & (2) artist received rent-free use of apartment for 6 months in exchange for a work of art
o    (1) FMV of services received by attorney and painter must be included in their gross incomes
o    (2) FMV of the work of art and the rental value of 6 months rent must be included by the landlord and painter in their gross incomes
–          Treas. Reg. § 1.61-2(d)(1) – if services are paid for in other than money, the fair market value of the property/services received must be included in gross income
 
Dean v. Commissioner – 3rd Cir. 1951à taxpayers must include the rental value of the property where they reside when this property is owned by a corporation and the taxpayers reside rent-free (the taxpayers are the sole shareholders of the company)
–          taxpayer’s legal obligation to provide a home for family was satisfied by the corporation = income
–          the fact that corporation was just a means through which taxpayer and his wife carried on business does not change the analysis
o    here the bank likely forced the Dean’s to put property in a corporation to limit liability, in so doing they created a tax problem
 
Prob. 1(d) p.66 – two parties each exchange $100 worth of their goods for $100 of the other’s à both have $100 in gross income
–          exchange of goods is income
–          § 1.61-2(d)(1) – if services paid for other than in money, FMV of property or services = income
 
Prob. 2 p.66 – lawyer does tax return in exchange for a physician giving him a physical checkup
–          (a) each taxed $200 – swap of services is income
o    § 1.61-2(d)(1) – if services paid for other than in money, FMV of property or services = income
–          (b) lawyer fills out his own tax return – not taxed, services for self

) de minimis fringe
§ 132(e)(2) – employee eating facilities are specifically mentioned as a de minimis fringe
·         §132(e)(2) – Nondiscrimination rule applies to employee eating facilities
o    (5) qualified transportation fringe
o    (6) qualified moving expense reimbursement
o    (7) qualified retirement planning services
§ 132(m)(2) – nondiscrimination rule applies
o    [note – this is not all the possible excludable fringes, our code book leaves some out] o    [note – nondiscrimination rule may apply to other sections, but that’s all I’ve found so far] o    132(h) – for purposes of this section “employee” also includes retired and disabled ex-employees, and surviving spouses of employees or retired or disabled ex-employees; any use by a spouse or dependent child is also treated as use by the employee
–          Policy behind exclusion – employers have legitimate reasons for giving these benefits – it should be recognized that they are not just a replacement for compensation
–          Nondiscrimination Rule – under a number of fringes recognized in 132(a) there is a nondiscrimination rule which provides that benefits given to officers/highly compensated employees only qualify as a fringe if they are available to all other employees on substantially equal terms
o    Reg § 1.132-8(a)(2) – If a benefit is discriminatory – it may not be excluded by the highly compensated employees BUT it may still be excluded by other employees as a fringe
o    Must look to the respective §s for each type of fringe to determine if the nondiscrimination rule applies
–          No Additional Cost Services – §132(a)(1) [defined in §132(b)] – services provided by employer to employee
o    Requirements:
§ (1) must in employer’s same line of business
·         Reg §1.13204(a)(1)(iv)(A) – if the employer is a conglomerate, can only exclude services received from the line of business in which he works (if he works for multiple lines of business then he may exclude benefits from multiple lines of business)
§ (2) the employer must incur no substantial addition cost in providing the service to the employee
·         E.g. a hotel might offer a room to an employee assuming it has vacancies
§ (3) nondiscrimination rule applies
o    §132(i) – Reciprocal Agreements – if multiple company’s are in the same line of business, they may contract to offer excludable fringe benefits to the other company’s employees on a reciprocal basis
–          Qualified Employee Discount – §132(a)(2) [defined in §132(c)] o    Requirements:
§ (1) nondiscriminatory rule
§ (2) same line of business
§ (3) applies to purchased or property and services
§ (4) may be either a price reduction of a rebate
o    Ceiling on the amount of exclusion:
§ Services – exlusion may not exceed 20% of the price at which the services are offered to customers
§ Property – maximum exclusion is the employer’s gross profit percentage
·         (Aggregate sales price – cost) / aggregate sales price
o    E.g.: total sales for year – 800,000; total cost of goods – 600,000
§ (800,000 – 600,000) / 800,000 = 25% (gross profit percentage)
§ Employer normally sales good for 1,000 – the employee may receive good at any price above 750 and exclude the whole amount, if price paid by employee is less than 750, the rest of the discount must be included as gross income
–          Working Condition Fringe – § 132(a)(3) [defined in §132(d)] o    Employee may exclude any property or services provided by an employer that would have been deductible by the employee as a business expense (162) or depreciation deduction (167) if the employee had paid for it
§ E.g. use of company car or airplane for business purposes
–          De Minimis Fringe – § 132(a)(4) [defined in §132(e)]