FEDERAL TAXATION
I. History of Federal Income Tax
A. The federal income tax system serves a number of functions apart from rasining revenues:
1. (1) It allocates the cost of public goods and services among Americans on an ability-to-pay basis
i. Accomplishes through a higher rate structure – taxes rich a larger % of there income and the poor a lower %
2. (2) Congress uses it as a tool of social policy
i. Ex: § 163 allows taxpayers to deduct home mortgage interest – this is meant to encourage home ownership
3. (3) Congress uses it to implement economic policy
i. Ex: § 168 stimulates the economy by allowing businesses to depreciate certain tangible property rapidly, therby encouraging businesses to invest in new equipment
II. Tax Law Authority
A. The Internal Revenue Code of 1986: the primary source of the federal tax law
1. Note: most cases cited under the 1939 Code and the 1954 Code may still be relied on as authority
B. Legislative History: With the advent of each new tax act, the major tax services publish compilations of legislative histories as well as helpful explanations of the new provisions
C. Regulations: issued by Dept of Treasury (of which IRS is apart) and have the force of law
1. Each regulation is identified by a prefix number and the particular code section which it interprets.
i. The prefix for income tax regulations is “1”
2. There are two types:
i. Legislative
ii. Interpretative (§7805(a))
D. Revenue Rulings and Procedures: the IRS issues official rulings which are interpretative pronouncements designed to indicated the their position regarding the application of the tax law to a certain set of facts.
1. Rulings are of two types:
i. (1) Revenue rulings à rulings which the IRS determines are of general interest; are usually a result of a taxpayers request for advice
a. Unless superseded, modified, or revoked, they can be relied upon by any taxpayer whose circumstances are similar to the set of facts; may be cited as precedent
1. IRS has been none to take back
2. You have to pay for them
b. Where are they found? à in the weekly Internal Revenue Bulletin; are consolidated semiannually in the Cumulative Bulletin
ii. (2) Letter rulings à responses to a particular taxpayer’s request for advice on the tax consequences of a specific transaction.
a. IRS does not consider itself bound by them
E. Case Law:
1. Courts that decide tax cases:
i. Tax court: where a tax payer commences an action for redetermination of a deficiency without first paying the asserted deficiency (since the debt does not have to be paid first, this is the favored forum for a taxpayer to choose)
a. Will apply the law of the circuit in which it falls
b. There are two types of tax court decisions:
1. (1) Regular decisions à officially reported in the Tax Court Reports (T.C.) and generally involve important issues in tax which may not have previously been resovled
2. (2) Memorandum decisions à not officially published and generally involve the application of settled points of the tax law to particular facts
i. this doesn’t mean they can’t have precedential value
c. When the Tax Court rules against the Commissioner of IRS, he will commonly issue a notice of acquiescence or of nonacquiescence
1. If nonacquiescence, the Service does not accept the conclusion and intends to continue challenging taxpayers with respect to the issue
2. These are published in the Internal Revenue Bulletin and appear bound in the Cumulative Bulletins
ii. US Court of Federal Claims: Where a taxpayer sues IRS for a refund (the tax deficiency has already been paid)
a. Jury trial not available
iii. Federal District Courts: Has jurisdiction in any tax case against the US seeking a refund
a. Jury trial IS available
iv. Federal Appellate Courts: Where appeals go from Tax Court
III. Resolution of Tax Issues through the Judicial Process
A. The Commissioner of the IRS asserts a deficiency in income tax, the taxpayer may:
1. (1) refuse to pay the tax and petition the Tax Court for a redetermination of the deficiency
2. (2) pay the deficiency, file an administrative claim for refund, and upon denial of the claim, sue for refund in federal district court or the United States Court of Federal Claims
B. *Just because IRS looses in Tax Court, doesn’t mean it can’t go after taxpayer in another court
Gross Income
I. What constitutes Income?
A. DEF: §61(a)à “all income from whatever source derived.”
1. This Section specifically includes in gross income:
i. (1) Compensation for services, including fees, commissions, fringe benefits, and similar items
ii. (2) Gross income derived from business;
iii. (3) Gains derived from dealings in property;
iv. (4) Interest;
v. (5) Rents;
vi. (6) Royalties;
vii. (7) Dividends;
viii. (8) Alimony and separate maintenance payments;
ix. (9) Annuities;
x. (10) Income from life insurance and endowment contracts;
xi. (11) Pensions;
xii. (12) Income from discharge of indebtedness;
xiii. (13) Distributive share of partnership gross income;
xiv. (14) Income in respect of a decedent; and
xv. (15) Income from an interest in an estate or trus
B. Income also constitutes:
1. (1) Punitive and treble damages
i. Commissioner v. Glenshaw Glass Co, 348 US 426:
a. Issue: whether money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble-damage antitrust recovery must be reported by a taxpayer as gross income
b. Held: Reversed. Yes, the damages constitute income
c. Reasoning:
1. Here there was an undeniable accession of wealth, clearly realized, and over which the taxpayer had complete dominion
2. It would be an anomaly to say that a recovery for actual damages in taxable but not the amount extracted as punishment
2. (2) Discovered money (treasure trove)
i. Cesarani v. United States, 296 F. Supp. 3: couple purchased used piano in 1957 and seven years later found money in it. They reported it as income but now are suing for a refund. They argued (1) that it wasn’t income and (2) if tax was due it was due in 1957 when the piano was purchased and that now the Gov was blocked from collecting to the statute of limitations (3 years).
a. Issue: Whether discovered money constitutes income?
b. Held:
1. (1) The $4,467 was properly included in gross income for the calendar year of 1964
2. (2) The old currency was not “reduced to undisputed possession” until its discovery in 1964, and thus the US was not barred by the statute of limitations from collecting
c. Reasoning:
3. (3) Payment by employer of income taxes
i. Old Colony Trust Co v. Commissioner, 279 US 716: Petitioners are the executers of the will of Mr. Wood, who was the president of American Woolen Company during the years of 1918, 1919, and 1920. In 1916, American Woolen had adopted a resolution that said, “this company pay an and all income taxes, state and federal, that may hereafter become due and payable upon the salaries of all the officers of the company. The officers shall receive their salaries or other compensation in full without deduction on account of income taxes, State of Federal, which taxes are to be paid out of the treasure of this corporation. American Woolen then paied the IRS, Mr. Wood’s federal income and surtaxes.
a. Issue: Did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee?
b. Held: The payment of the tax by the employers was in consideration of the services rendered by the employee and was a gain derived by the employee from his labor.
c. Reasoning:
1. the discharge by a third person of an obligation to him is equivalent t
porate income tax return but Duberstein did not include the value of the car as income for 1951. He deemed it as a gift.
a. Held: Tax court was warranted in concluding that despite the characterization of the transfer, it was at bottom a recompense for his services, or an inducement for him to be of further service
b. RULE: A gift proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity or like impulses.
1. The most critical consideration is the transferor’s intent
c. Courts should look at all the factors – not just merely whether it was between an employer and an employee or whether the employer deducted it as a business expense
1. In trying to determine whether car is income, Berman’s treatment is just evidence – it is not the touchstone as to whether or not this is a gift
4. Cases
i. Olk v. United States:
a. Issue: whether monies, called tokies in the relevant rade, received by the taxpayer, a craps dealer employed by casinos, constitute taxable income or gifts within the meaning of section 102
b. Held: Tokes are taxable income
ii. Goodwin v. United States: Reverend Goodwin received “special occasion gifts” from his congregation, totaling over $15,000 for the year. His salary and parsonage was the same amount. They did not declare them as income on tax returns.
a. Held: No reasonable jury could conclude that these payments were excludable from the Goodwins taxable income and summary judgment was appropriate.
b. Facts that show it was a gift:
1. Made by the congregation as a whole, rather than individuals
2. The cash payments were gathered by congregation leaders in a routined, highly structured program
3. Members contributed anonymously and the payments were made on behalf of the congregation
4. The gifts were substantial compared to the Goodwins salary
c. RULE: Sizable payments made by persons to whom the taxpayer provides services are customarily regarded as a form of compensation and may therefore be treated as taxable income
B. The Nature of a Bequest of Inheritance
1. Wolder v. Commssioner: Attorney entered into a written agreement with client that he would perform free legal services for her in exchange for 500 shares of class B common stock of White Laboratories and other securities she may obtain from a merger.
i. Issue: whether an attorney contracting to and performing lifetime legal services for a client receives income when the client, pursuant to the contract, bequeaths a substantial sum to the attorney in lie of the payment of fees during the client’s lifetime.
ii. Held: money was simply a method for paying compensation for legal services, and was not a true bequest
iii. Reasoning: the contract in effect was one for the postponed payment of legal services, ie by a legacy under the will for services rendered during the decedent’s life.
a. Per Duberstein, the true test is whether in actuality the gift is a bona fide gift or simply a method for paying compensation.
II. Statutory Limitations on the Exclusion – § 102(b)
A. §102(b) provides two limitations on the exclusion:
