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Washington & Lee University School of Law
Hellwig, Brant J.

Federal Income Taxation Outline


Fall 2012

Introduction to Federal Taxation

Functions of a Tax System:

1) Raise revenue

2) Means by which govt. can pursue fiscal policy

– Stimulate economy by reducing tax rates in depressions

– Increase tax rates in inflationary periods

3) Accomplish a distribution of wealth and set up burden sharing among taxpayers

– Graduated/progressive system disproportionately burdens highest wage earners with greatest taxes

4) Accomplish social policy by providing incentives for people to do certain things

– Done by exempting certain receipts, deductions, and tax credits

– Negative implications:

o Tremendous amount of complexity

o Sometimes doesn’t operate fairly – the higher your tax bracket the more valuable tax deductions are

16th A.: The 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.

– Today, Internal Revenue Code of 1986

Overall fed. tax level and individual tax have remained relatively constant, but:

– Revenues for Social Security and Medicare have risen dramatically

– Revenues from corp. tax decreased dramatically

Income (items of inflow)

Definitions of Income:

§ Haig-Simons = increases in wealth + consumption

– Problem: isn’t workable admin., as everyone would have to appraise their property each year

– All income is either saved or spent, and thus def. usually produces a higher income figure than govt. def.

§ Govt. def. GI (§61) = “all income from whatever source derived”

– Glenshaw Glass: “an undeniable accession to wealth, clearly realized, over which individual had complete control”

– Problem: tautological


§ Salary and other compensation for services rendered (regardless of form)

– Old Colony Trust: co. paying EEs fed. taxes

o Fed. tax = tax-inclusive (amt. paid not deductible)

o Sales tax = tax-exclusive (amt. paid is deductible)

– If paid other than in cash = fringe benefits taxed at their FMV

§ Punitive damages from lawsuit (Glenshaw Glass)

§ Prizes and awards under §74

– However, excluded if they aren’t retained and meet several other criteria

§ Gains derives from dealings in property (§61(a)(3))

§ Treasure troves under Reg. §1.61-14: found $/FMV of found property in US currency

– Cesarini: cash found in piano bought for $15 includable as income, as would a ring

Not Income (Exclusions):

§ Certain fringe benefits:

– Deviation of HS def., as govt. values consumption at 0

o Thus, better to get fringe benefits below than an increase in salary of that amt.

1) Tax expenditure fringe benefits:

– Contributions to health insurance, workers’ comp., disability, and medical expenses (§104-106)

– Retirement plan contributions – taxes deferred until benefits received, except Roth IRAs

– Dependent care – limited to $5,000/year under §129 (closely parallel dependent care credit)

– Education – limited to $5,250/year under §127

– Cafeteria plans – allow EEs to pick their fringe benefits

2) Work related fringe benefits:

– Justified for admin. simplicity = policy reason

– §132 stat. exclusion for people in ER/EE rel. (1984):

b) No-additional cost services – free airline tickets

c) Qualified EE discount – must be a good/service of the same type ordinarily sold to public in the

line of bus. EE works in

– For goods, excluded to extent it doesn’t exceed ER’s gross profit

– For services, excluded to extent it doesn’t exceed 20% of selling price

d) Working condition fringe – deductible to the extent that if EE had paid for it himself, he would

have been able to deduct

– Normal office furnishings (painting on EEs wall)

e) De minimis fringe – accounting unreasonable and admin. impracticable to tax

f) Qualified transportation fringe

– Gotcher rule: looks to dominant purpose of payer in providing benefit (for all, not just for his EE)

Trips intended to benefit the payer’s bus. are NOT includable in income

– Mr. Gotcher (EE of Economy, not VW): didn’t really have a choice in going if he wanted to exercise sound bus. judgment (forced consumption) and VW set itinerary

Trips intended to benefit the payee personally are includable in income as consumption

– Mrs. Gotcher

§ Meals and lodging under §119 (to EE and his immediate family):

– Justified as forced consumption = policy reason

– Following criteria must be met:

1) Must be furnished

– Kowalski: cash meal allowances to state troopers is NOT furnishing food, implying that the meal must be furnished “in kind” (bought by ER and handed to EE)

2) On the bus. premises – functional, not spatial test

– Adams v. US: US corp. house owned in Tokyo a bus. premise because co. bus. was done there

– Dole v. Commissioner: houses 1 mile from mile not on bus. premise because no bus. done there

3) For the convenience of the ER – requires a substantial non-compensatory purpose

– Prong satisfied by:

o Being required to be on call after bus. hours

o Policy that precludes EEs from eating away from bus. premise

4) Must be accepted as a condition of employment (for lodging only)

– Benaglia: wife and manger of 2 HI resorts allowed to exclude cost of hotel suite and dining room expenses

§ Imputed income (deviation from HS def.) – benefits derived from labor on one’s own behalf or ownership of property

– Violates horizontal equity – similarly situated taxpayers pay diff. tax

§ Gifts (donor is alive) and bequests/inheritances (donor is dead) under §102

– Justified because donor has already included amt. in income, and it shouldn’t be counted again in donee’s income = policy reason

– While HS would tax the donee and not the donor, the IRS taxes the donor and not the donee

o Admin. easier to trace $ and donor is more likely to be in a higher tax bracket

– Duberstein: whether

I since basis for right to lease property can’t be carved out of other bundle of rights owner has in property

Sometimes Income and Sometimes Not Income:

§ Realization requirement (deviation from HS def.; AR from §1001 above):

– Realization – the sale or disposition of property that is not identical in the absence of a non-recognition provision (hair trigger requirement)

– Realization requirement necessary because:

1) Admin. difficulty in reporting

2) Valuing assets every year to see how much appreciation or depreciation has occurred

3) In order to pay the tax without a realization event, taxpayers would have liquidate

4) With a contracted def. of realization, gain would be realized only when property is sold and cash is kept (many triggers)

– Would reduce HS def. of income to just consumption

– Makes tax deferral a major tool of tax planning

– Requirement often results in violations of horizontal equity

– Ex. realized/taxable transactions and inclusion in GI:

o Getting a dividend (cash), or getting a stock dividend and selling the extra shares

o Cesarini: year when $ in piano was reduced to undisputed possession (when it is found)

o Haverly: principal claimed a charitable deduction for unsolicited sample textbooks

– Otherwise, he would receive a double benefit by deducting from income an excluded item

– Problematic rationale since it also applies to D who decided to keep book/give it to a friend

o Prof. recommends using Gotcher instead – books were given not as a gift or compensation, but to further publisher’s bus.

o Cottage Savings Ass’n: exchanges of interest in one group of res. mortgage loans for another lender’s interest in another group are materially diff. to result in realization of losses here since they were made to diff. obligors and secured by diff. homes/properties (diff. legally distinct entitlements)

– Ex. of no realization and exclusion from GI:

o Eisner v. Macomber: stock dividends since shareholder simply has what he had before (% of co.)

– Installment accounting method:

o Most preferred open transaction: allows basis/cost recovery 1st with anything left being taxable gain

– Strict requirements:

a) FMV of property received and given up most not be readily ascertainable

– IRS often disagrees

b) Gain must be contingent on future events

– Burnet v. Logan: taxpayer sold stock for cash and a right to receive $.60 for each ton of ore removed from a mine