Tax Outline – Schenk – Fall 2011 – Final
· Four main topics of the second half:
1. Whose income is it?
2. The character of the income (capital or ordinary)
4. Timing rules- when is income reportable? When are expenses deductible?
IV. Whose Income Is It?
· We have this problem because we have a progressive tax system.
o The more income you have, the higher the tax rate.
o These questions are basically application of § 1.
· Three categories of whose income:
1. Income from services
· Lucas v. Earle- income is taxed on the person who earns it. One may not contract for compensation to shift to someone else.
2. Income from income producing property
· Horst- income from income producing property is taxed on the owner of the property.
3. Gain or loss from the disposition of income producing property.
· Only the owner of the property may report the gain or loss.
· Salvatore- the owner is determined at the time of the sale.
A. The Taxable Unit
1. Taxation of the Family
· Druker v. Commissioner, 1983 page 465
o Facts: Druker, an assistant U.S. Attorney, challenged the constitutionality of the tax burden on a married couple (the marriage penalty). Because we have a progressive tax system, a person filing individually who earns $25,000 pays a lower tax rate than if that same person files jointly and combined with his/her spouse has $50,000 in income.
o Holding: the burden on marriage is not unconstitutional under any standard of scrutiny.
§ The disparity between filing individually and filing jointly used to be worse, but Congress has changed some of the laws to reduce this disparity.
o While the right to marry is fundamental, reasonable regulations that do not significantly interfere with the decision to marry may be imposed.
o For tax rates, see the rate tables on p. 1899 of the Code book.
· The Kiddie Tax (§ 1(g)) page 474
o Children under 18 (sometimes under 25) will be taxed at their parents’ top marginal rate.
o The purpose of this section is to prevent parents from avoiding tax consequences by transferring income to their children thereby reducing their own income and putting them in a lower tax bracket.
§ Children with some income were taxed at a very low rate. They also got the standard deduction, personal exemptions, etc. thereby sheltering thousands of dollars in taxes.
2. Dissolution of the Family- separation and divorce
· One cannot, by any private arrangement, shift tax consequences from one individual to another. The only exception to this rule is upon separation or divorce. Separated or divorced couples may negotiate tax consequences.
· Rev. Rul. 76-255, page 476
o Facts: What if a married couple gets a divorce on December 28th and remarries on January 2nd so that on December 31st, the day that the taxpayer’s status is recognized, the two are unmarried?
§ § 143(a)(1) the determination of whether one is married is determined on Dec. 31st.
o Holding: for tax purposes, such a sham divorce/marriage is not recognized.
o Reg. § 1.143-1(a) and Reg. § 1.6013-4(a) An individual shall be considered married even if living apart from the spouse unless they are legally separated under a decree of divorce or separate maintenance.
· Estate of Borax v. Commissioner, 1965 page 479
o Facts: Husband and Wife, married in New York separated and entered a separation agreement. H and W2 went to Mexico where they got an ex parte divorce. H then married W2 in Mexico, then came back and had another ceremony in Connecticut. W1 filed a lawsuit for an injunction declaring that she and H were still legally married.
o Holding: the Second Circuit ruled that the payments were deductible even though the court said that the divorce was invalid.
o Superseded by Rev. Rul. 67-442: When the court recognizes a marriage, the IRS will respect that declaration.
§ For tax purposes, since they didn’t have a valid divorce, H could not deduct the alimony payments under § 215.
a. Alimony or Support Payments
· The payment of alimony (federally defined) constitutes a deduction to the payor and is includable in the gross income of the recipient.
o § 71(a) gross income includes amounts received as alimony or separate maintenance payments.
§ (b)(1)(A) This refers to payments made under a divorce or separation instrument.
§ (b)(1)(B) The instrument must not state that the payment is not income to the recipient for tax purposes, and it must not be allowable as a deduction under § 215.
o § 215 There shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual’s taxable year.
§ Historically, the paying spouse only got this deduction if he/she itemized. Now, § 62(a)(10) allows the § 215 deduction to be deducted in arriving at AGI.
o If the two live under the same roof, § 71 and § 215 don’t apply.
· The payment of child support generates no deduction to the payor and no income to the recipient.
o The parent receiving those funds has an obligation to use that money to support the child.
o § 71(c) states that subsection (a) does not apply to funds that are designated child support.
o Lester- § 71(c) calls for a “fixed” payment for child support. If the payment is not explicitly “fixed,” then it will not be considered child support.
b. Property Settlements
· United States v. Davis, 1962 page 482
o Facts: H and W had land with AB of $100,000 and FMV of $250,000. They divorce- they have $500,000 in assets ($250,000 this land, $250,000 cash).
o Issue: is transfer of the property pursuant to a divorce decree a realization transaction?
o Holding: any time property is transferred to discharge an obligation, it is a realization transaction.
§ The H is discharging his legal obligation under the divorce decree, so it is a realization transaction. He has $150,000 in gain.
· § 1041 Transfers of Property Between Spouses or Incident to Divorce
o Congress didn’t like the Davis result, so they enacted this section in response.
o (a) No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)
§ (1) a spouse or
§ (2) a former spouse, but only if the transfer is incident to a divorce.
o (b) The transfer of property described in (a) shall be treated
§ (1) as acquired by the transferee by gift and
§ (2) the basis of the transferee in the property shall be the AB of the transferor.
c. Antenuptial Agreements
· Farid-Es-Sultaneh v. Commissioner, 1947 page 484
o Facts: Kresge gave W2 (Farid) some Kresge stock, and then divorced W1. After the divorce from W1, but before he married W2 Kresge gave W2 more stock as part of an antenuptial agreement. In exchange, W2 released her dower and other marital rights (in case they got divorced). Kresge’s basis in the stock was 15¢ per share, and W2’s basis would be $10 per share. She sells some of the stock.
o Issue: What is her gain from sale of stock? What is W2’s basis in the stock that she received?
§ This depends on whether the
e: whether the taxpayer must report the $35,000 in income.
o Holding: yes he must report it because he is entitled to receive that money for his/her services.
§ Analysis greatly depends on how much control the taxpayer has over disposition of the income. Here, he voluntarily gives it to the order, he is not under any obligation to do so. Because he is completely in control of this decision, he must report the income.
2. Income from Property
· Is what is being transferred a right to income or a right to income producing property?
o Only a transfer of the latter will effectively transfer the tax consequences.
o For example, Schenk can transfer his stock to his grandson, and the grandson will pay taxes on the dividends from that stock (as well as on any gain/loss if he sells). Schenk cannot, however, keep the stock and transfer the right to receive the dividends to his grandson and have his grandson pay taxes on those dividends. The dividends will be Schenk’s income.
· Helvering v. Horst, 1940 page 499
o Income from property is taxed to the owner of the property.
o Facts: Taxpayer detached interest coupons from bonds and gave them to his son as a gift.
o Holding: the father must include the income from the coupons in his own income- the gift did not effectively transfer the income.
§ Because of the progressive tax structure, there is strict adherence to principles preventing shifting of income from income producing property.
o The Horst decision is no longer effective with respect to bonds.
§ § 1286 allows taxpayers to split the interest on bonds from the principal.
· Blair v. Commissioner, 1937 page 497
o Facts: TP is a life income beneficiary of a trust. He transferred part of his rights as life income beneficiary to his children.
o Issue: whether or not that transfer was effective so that the kids would be taxable on the income that is distributed from the trust.
o Holding: transfer of INCOME PRODUCING PROPERTY will shift the tax burden of income from property.
§ First, figure out if what was owned was more than just the right to receive income.
· If he has something more than the right to receive income, then his interest is in income producing property and his transfer is effective.
§ A beneficiary of a trust has a right to enforce fiduciary duties, therefore he has more than just a right to receive income. The beneficiary giving away part of his rights is like Schenk giving away the actual stock, not just the dividends.
· Braunstein v. Commissioner, 1962 page 504
o Facts: After the taxpayer’s sweepstakes ticket was selected as the winner, but before he received the money, he assigned 2/3 of the ticket to members of his family.
o Holding: the taxpayer was liable for the taxes on the entire sweepstakes.
§ At the time he made the assignment, all he had was a right to receive income.