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Income Taxation
University of Wyoming School of Law
Delaney, James M.

INCOME TAX OUTLINE
 
-History
Laws prior to 1939
1791 – taxes imposed on spirits and stills – Sin Taxes
Need money at country’s inception
Expanded to include tobacco, liquor and sales – like national sales tax.
Abolished in 1802 – Congress had enough money
War of 1812 –
Prompted imposition of tax in 1813, same type
Repealed in 1817
1862 – Income tax first collected (rather than previous sales type tax)
Related to Civil War
Income of producers taxed
Codified in Statute in 1873
Internal Revenue Code
IRS created
Constitutional
1913 – Constitutional Amendment (16th) to impose tax on income of individuals.
Internal Revenue Code as we know it came into being
1916-1939 – Code recodified and renumbered
1939 – Code simplified by renumbering and consolidating
Internal Revenue Code of 1954 – § 26 USC
Internal Revenue Code of 1986 – Tax Simplification Act – [today’s Code] Marginal Tax System – the more wealth annually, placed in higher tax bracket and attached to higher tax rate (Robin Hood Theory)
Internal Revenue Code of 1986 (as amended) – reference
Policy:
2 ways to look at tax
Exact renumeration
Policy – is this tax code fair
 
Income Tax and the US Constitution
Ø The Power to Tax –
o    article 1, § 8 – power to lay and collect taxes, duties, imposts and excises
o    article 1, § 2, clause 3 and §9, clause 4– require direct taxes to be apportioned amongst states in accordance with their respective populations.
o    Article 1, § 8, clause 1 – “all duties, imposts, and excises shall be uniform throughout the United States”
o    Direct Tax – flat tax on all persons
§ Ie tax everyone $1000
§ Must be apportioned
o    Indirect Tax
§ Sales tax – retailer sells a product, govt will exact tax from retailer
§ Indirect b/c can choose not to buy – not have to pay
Ø Apportionment Among the States –
o    If flat tax of $1000/person in every state – apportioned appropriately
o    If indirect tax – not perfectly apportioned
o    How to impose tax that is not perfectly apportioned
Ø The 16th Amendment –
o    “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.”
o    Apportionment no longer required
o    Broad power to tax – specifically salaried income.
Ø Uniformity Among the States –
o    Limitation on power to tax
 
o    If tax is not uniform, it is unconstitutional
§ Ie – 30% tax on income in CO and 15% in Wy
§ Must impose same tax on each state
Ø Due Process –
o    16th Amendment restricted by Due Process
o    Income measure in prior year, some due process issues have arisen with respect to the idea that when Congress changes the tax law, they can make it retrospective.
o    Arguments have not gone well.
Ø Self-Incrimination [5th Amendment] –
o    Ie – if you are drug dealer, do you report taxes?
o    It is income, which must be reported on tax return unless on face of tax return take the 5th Amendment,
§ Still must file
 
Tax Practitioner’s Tools
1)       Legislative Materials
a.       The Code – taxing power of federal govt is vested in Congress, which exercises its power by enacting legislation
 
 
 
 
IDENTIFICATION OF INCOME
SUBJECT TO TAXATION
 
Analysis
1) determine gross income
2) then adjustment
3) then deduction
4) then determine taxable income, apply rate.
5) then offset with credit
 
IDENTIFICATIONS OF INCOME SUBJECT TO TAXATION (overview of semester)
 
Chapter 2: Gross Income
Chapter 3: The Exclusion of Gifts and Inheritances
Chapter 6: Gains From Dealings in Property
Chapter 7: Life Insurance Proceeds and Annuities
Chapter 8: Discharge of Indebtedness
Chapter 9: Damages and Related Receipts
Chapter 10: Separation and Divorce
Chapter 11: Other Exclusions from Gross Income
 
-Chapter 2: Gross Income
Introduction
§ 61: Gross Income – means all income from whatever source derived, including but not limited to:
Non-Exclusive list
Compensation for services, fees, commissions, fringe benefits, and simlar items
Business income
Gains from dealings in property
Interest, rents, royalties, dividends, alimony, etc
Definition in tax code differs from GAP (generally accepted accounting practices for accountants.
Equivocal Receipt of Financial Benefit
Cases:
 
-Cessarini v. US
G/R: Found property is gross income at time reduced to undisputed income
Facts:
1957 taxpayers buy a used piano ($15.00)
1964 while cleaning piano in anticipation of selling it, TP finds $4,467 in currency.
TP reports $4,467 as income on 1964 tax return
1965, TP amends 64 return excluding the $4,467 as income and request a refund
1966 – Comm’r rejects refund claim
Issue – is treasure trove includable as gross income?
Holding: treasure trove is includable income
Reasoning:
§ 61: all inclusive section – broad language used by Congress to exert the full measure of its taxing power. Based on –
§1.61-1(a): gross income means all income from whatever source derived, unless excluded by law. Gross income included income realized in any form, whether in money, property, or services.
Rev. Ruling 61 – “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.
§ 1.61-14 – treasure trove to the extent of its value constitutes gross income for the taxable year in which it is reduced to undisputed possession
When reduced
Depends on state law
Ohio law – undisputed when found
Income from all sources is taxed unless can point to an express exemption.
­-Old Colony Trust
G/R: TP need not directly receive money to realize economic benefit; it is enough that the transaction has increased the wealth of the TP.
Think about 61(a)(12) – current codification including discharge of indebtedness.
Facts:
1916 – American Woolen Co, adopted a resolution which was in effect in 1919-20:
Company would pay any federal and state income taxes payable by, among others, Mr. Wood
Mr. Wood was president of American Woolen during 1918-20.
In 1918 and 1919 he received $978,725 and $548,132 as salary and commissions which he reported in those years respectively.
Pursuant to the resolution, the company paid Mr. Woods taxes.
However, Mr. Wood did not report as income the amount of taxes paid on his behalf in 1919 and 1918.
Issue – was the payment of the tax by a 3rd party income to Mr. Wood
Holding – the discharge by a 3rd party of an obligation owed by the taxpayer is an economic benefit to the TP, and is included as gross income.
Reasoning –
Not gift – court skeptical of gifts in EE/ER relationships
The payment of tax by ER was in consideration of the services rendered by the EE and was a gain derived from labor.
Form makes no difference – it is compensation
Tax Gross-up Formula:
Total Gross income = Wages
                                       1-(tax rate)
Thus, on $100,000 of wages at a 35% tax rate, if the employer agreed to pay the employee’s taxes, the employee would report $153,846 of gross income [1-.35 = .65], 100,000/.65 = 153,846
–          The employer would pay $153,846 to the employee who would pay $53,846 (153,846 X .35) of taxes.
–          This leaves the employee, of course with $100,000 after taxes.
–          Effective salary increase of 53.9% for the employer to cover a 35% tax on 100K.
–          If working overseas, EE negotiate for tax gross-up formula.
 
-Comm’r v. Glenshaw Glass
G/R: Punitive damage awards are taxable as gross income
Facts:
–          TP engages a third party in litigation and advances a claim for damages for fraud and treble damages for injury to its business in violation of antitrust.
–          Parties settle for approximately $800,000, allocating $324,530 of the 800K to fraud and antitrust violations
–          TP did not include the $324,530 in its gross income
–          Comm’r determined a deficiency in income of the same amount
Issue – Are punitive damages treated as gross income under § 61?
Holding – punitive damages should be included in gross income.
Reasoning – see 1.61-14
–          From any source- broad taxing power of Congress
–          Define Gross Income – an ascension to wealth, clearly realized, and over which the taxpayer has complete dominion.
–          All gains are taxable unless specifically excluded.
 
-Charley v. Comm’r
G/R – economic benefits (travel credits converted into cash) are gross income, regardless of source
Facts:
–          Phillip Charley was president of Truesdail Labs and with his wife, owned 50.255% of its shares
–          Truesdail’s policy was that frequent flyer miles earned during an employee’s business travel were the property of the employee.
–          At a client’s request, Philip would arrange the travel.
o    He would instruct the travel agent to arrange coach service but charge Truesdail for first class seats.
o    He would then use his business frequent flier miles to upgrade to 1st class.
o    He would then instruct the travel agent to transfer the difference between the 1st class and coach ticket amounts (collected from Truesdail) to his personal account.
–          Using this process, Philip received (but did not report) $3,149.93
Issue – whether travel credits constitute taxable income and whether conversion of miles to cash constitutes income
Holding – travel credits converted to cash constitute gross income
Reasoning –
–          Travel Credits – additional compensation, upon conversion of travel credits, can be seen as remittal of money thus compensation because rendering services to the company
–          Disposition of

rsuant to 1.61-4(a)
                                                             ii.      § 1.61-4(a): Farmer must include as gross income the amount of cash and value of merchandise or other property received during the taxable year from the sale of livestock and produce which he raised.
b.       Vegy and her family consume $100 worth of vegetables?
                                                               i.      No
                                                             ii.      Helvering – the consumption is imputed income and you can consume your own property.
c.        Vegy sells vegetables worth $100?
                                                               i.      Yes
                                                             ii.       1.61-4(a)(1): Sale of produce
                                                           iii.      Amount of gain = amount realized – adjusted cost basis
                                                           iv.      $100- basis (seed, water, negligible) = $100 gain realized
d.       Vegy exchanges $100 worth of vegetables with Charlie for $100 worth of tuna?
Yes – income to both because they did a sale or exchange
§ 1.61-2(d)(1) – Compensation paid other than in Cash
Provides in part:
 . . . if services are paid in property, the fair market value of the property taken in payment must be included in income as compensation.
–Arm’s length transaction between taxpayers
§ 1.61-2(d)(1) Cont.Determine fmv via valuation expert . if services are paid for in exchange for other services, the fair market
. value of such other services taken in payment must be included in income as compensation
 . . . if the services are rendered at the stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary
Ie – if I mow your lawn, and you pay me $15, that stipulated amount serves as the fair market value.
 
§ 1.61-14:Miscellaneous Items: in addition to those items enumerated in section 61(a) . . . gross income includes punitive damages, damages, such as treble damages under the antitrust laws and exemplary damages for fraud. Another person’s payment of the TPs income taxes constitutes gross income to TP unless excluded by law. Illegal gains constitute gross income. Treasure trove to the extent of its value in the US currency constitutes gross income for the taxable year in which it is reduced to undisputed income.
 
§ 61(a)general definition:
Except as otherwise provided in this subtitle, gross income means all income from whatever source derived.
Regs § 1.61-1: General Definition – income from whatever source derived.
Income may be realized in the form of services, meals, accommodations, stock or other property as well as cash.
§ 1.61-2: Compensation for Services –
(a) in general, wages, salaries, commission, compensation for service on the basis of the percentage of profits, insurance premiums, tips, bonuses, termination or severance pay
(c) When services are rendered directly to a charity, not considered income
§ 1.61-2(d)(1) – Compensation paid other than in Cash
Provides in part:
 . . . if services are paid in property, the fair market value of the property taken in payment must be included in income as compensation.
–Arm’s length transaction between taxpayers
§ 1.61-2(d)(1) Cont.Determine fmv via valuation expert . if services are paid for in exchange for other services, the fair market
. value of such other services taken in payment must be included in income as compensation
 . . . if the services are rendered at the stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary
Ie – if I mow your lawn, and you pay me $15, that stipulated amount serves as the fair market value.