Federal Income Tax
Madison
Fall 2015
Chapter 1: Introduction
History of Federal Income Tax
1913 à Sixteenth Amendment authorized income tax
Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration
Tax Policy
Horizontal Equity à persons similarly situated should be taxed in a similar fashion
Vertical Equity à persons whose situations are different should be taxed differently
Balance between maximizing tax revenues and minimizing the social costs of taxation
The tax system should avoid unnecessarily shaping economic behavior
Structure of the Current Income Tax System
Taxable Income
Gross income minus allowable deductions
Marginal Rate of Tax
The tax rate at each bracket of taxable income
Sources of Authority
Article 1: Congress has power to lay and collect taxes
Primary authority is always statutory
Title 26, USC (Internal Revenue Code)
Executive Branch
Treasury Department à Internal Revenue Service
IRS revenue rulings
These are the IRS’s statements regarding its litigating position
These do not carry the force of law; courts are not bound to follow them
Treasury Regulations
These do carry the force of law
Section 7805 à the Secretary shall prescribe all needful rules and regulations for the enforcement of this title
Judicial Authority
Deficiency Litigation
US Tax Court à first pay the asserted deficiency
Refund Litigation
US District Court; Court of Federal Claims; Court of Appeals; US Supreme Court
Cases
Mayo Foundation v. United States (2011)
Social security tax does not apply to … service performed in the employ of a school, college, or university … if such service is performed by a student who is enrolled and regularly attending classes at such school, college, or university…
Issue: How far do those special exceptions extend? How broadly does the term “student” apply?
Treasury regulations
Full-time employee: the services of a full-time employee are not incident to and for the purpose of pursuing a course of study.
Mayo must argue that the regulation is invalid.
The regulation must be a reasonable interpretation of the statute. Then courts are obligated to follow the regulation, up to and including the Supreme Court.
Bright line rule: full time employee can’t be a student.
Mayo argued that this should be approached case by case (IRS)
Chapter 2: Gross Income
Overview
Gross Income
All income from whatever source derived
May be realized in any form (see inclusions below) — money, property, services
The Realization Requirement
Increases in value of property are not taken into account for tax purposes when they accrue each year, but only when they are realized by a potentially taxable event (when taxpayer actually sells the property)
Determines proper timing of taxation by telling us when income or gain is recorded
Generally, realization does not occur, and income or gain is not recorded, until a provider of services or a seller of property has fulfilled all the material steps on her side of a bargain
Non-cash compensation (Old Colony Trust)
Treasure Trove (Cesarini)
Punitive/Exemplary Damages (Glenshaw Glass)
Prizes and Awards (Section 74)
Proceeds from Illegal Activity (James)
Services Received as Payment (Section 61)
Realized Gains (Section 61) – Topic 3
Cancellation of Indebtedness Income (unless insolvent) (Section 61) – Topic 4
Borrowed Proceeds (James)
Security Deposits (Indianapolis Power & Light)
Imputed Income (IRS Administrative Practice)
Bargain Purchases (IRS Administrative Practice)
It would be nearly impossible to go figure this out for the IRS
Gratuitous Services (Implied IRS Administrative Practice; Madison’s Article)
Rental of Principal Residence for de minimus Length of Time (Section 280A(g))
Unrealized Appreciation in Value (Eisner) – Topic 3
Gifts (Section 102(a)) – Topic 4
Cancellation of Indebtedness While Insolvent (Section 108) – Topic 5
Fringe Benefits (Only if it falls within Sections 132) – Topic 6
Employee Benefits (Only if it falls within Section 274(j), pursuant to Section 74(c))
General Welfare Exception (IRS Administrative Practice)
Frequent Flyer Trips (IRS Administrative Practice, unless benefits are converted to cash)
Cases
Commissioner v. Glenshaw Glass Co. (1955)
Issue: whether money received as exemplary damages for fraud or as the punitive 2/3 portion of a treble-damage antitrust recovery must be reported by a taxpayer as gross income.
In a settlement paid to Glenshaw, $324,529.94 represented payment of punitive damages. Does the IRC include punitive damages as gross income?
Congress applied no limitations as to the source of taxable receipts, nor restrictive labels to their nature. Here, there was undeniable accession to wealth, clearly realized, over which the taxpayers had complete dominion.
Punitive damages cannot reasonably be classified as gifts, nor do they come under any other exemption provision in the Code.
Cesarini v. United States (1969)
Treasure trove is taxable:
Found money is not listed among the exclusions from gross income in the Code.
IRS revenue ruling: The finder of treasure trove is in receipt of taxable income, for federal income tax purposes, to the extent of its value in US currency, for the taxable year in which it is reduced to undisputed possession.
Treasury regulation: treasure trove is included among the many other kinds of gross income.
Old Colony Trust Co. v. Commissioner (1929)
Issue: Did payment by an employer of income taxes assessable against the employee constitute additional taxable income to such employee?
The payment of the tax by employers was in consideration of the services rendered by the employee, and was a gain derived by the employee from his labor.
The payment for services, even though entirely voluntary, was nevertheless compensation within the statute.
Chapter 3: Gains and Losses from Dealings in Property
Overview
Section 61(a)(3)
Gross income includes gains derived from dealings in property
Section 1001(a)
Amount Realized à the sum of any money received plus the fair market val
that the fair market value of the property received in a taxable exchange is the cost basis, the basis of the property received will equal the adjusted basis of the property given plus any gain recognized, or that should have been recognized, or minus any loss recognized, or that should have been recognized.
Crane v. Commissioner (1947)
Issue: How a taxpayer who acquires depreciable property subject to an unassumed mortgage, holds it for a period, and finally sells it still so encumbered, must compute her taxable gain.
Gain: the excess of the amount realized from the sale or other disposition of property over the adjusted basis.
Amount realized: the sum of any money received plus the fair market value of the property (other than money) received.
Adjusted basis: the adjusted basis for determining the gain or loss from the sale or other disposition of property is declared to be the basis determined under subsection (a), adjusted … for exhaustion, wear and tear, obsolescence, amortization … to the extent allowed (but not less than the amount allowable)…
Definition of property:
“Equity” is appropriate when constructing what property is.
The applicable provisions of the Act expressly preclude an equity basis, and the use of it is contrary to certain implicit principles of income tax depreciation, and entails very great administrative difficulties.
Amount realized: the sum of any money received plus the fair market value of the property (other than money) received.
Gain on the sale of property is the excess of the amount realized over the basis.
“We think that a mortgagor, not personally liable on the debt, who sells the property subject to the mortgage and for additional consideration, realizes a benefit in the amount of the mortgage as well as the boot.
“If he transfers subject to the mortgage, the benefit to him is as real and substantial as if the mortgage were discharged, or as if a personal debt in an equal amount had been assumed by another.
Chapter 4: Gifts and Inheritances
Overview
Section 102(a)
Exclusionary Rule for Gifts and Inheritances
Exclusion for Inter Vivos Gifts
Section 102(a) specifically excludes the value of property “acquired by gift” from gross income
Exclusion for Bequests, Devises, and Inheritances
Section 102(a) also provides that the value of property acquired by “bequest, devise, or inheritance” is excludable
Policy Reasons Behind Section 102(a)
Administratively burdensome for taxpayers and the IRS
Avoid excessive taxation
