Tax Final Outline- Schenk- Fall 2014
· 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?
Whose Income Is It?
· Who is the taxpayer?
· We have this problem because we have a progressive tax system (vs. flat tax)
– The more income you have, the higher the tax rate.
– These questions are basically application of § 1.
· Three categories of whose income: who should be taxed for…
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 (§1001) of income producing property
· Salvatore: TP inherited a gas station from deceased husband, operated it for a while; then one of the petroleum companies wanted to buy the station. They negotiated the sale, then transferred part of her interest in the property to the children (w/o consideration) for them to sell
– Held: Only the owner of the property may report the gain or loss.
§ The owner is determined at the time of the sale
· This issue is pretty straightforward (mostly we will deal with 1 and 2)
A. The Taxable Unit
1. Taxation of the Family
· Druker v. Commissioner, 1983
– 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.
– Holding: the marriage penalty 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.
– Rigorous scrutiny test- while the right to marry is fundamental, reasonable regulations that do not significantly interfere with the decision to marry may be imposed
§ Congress can do what they want to distinguish between married and unmarried and it won’t be unconstitutional
– Note: Difficult to design a tax system that makes a distinction between married and non-married, and give them equalivent treatment
· The Kiddie Tax: § 1(g)
– Children under 18 (sometimes under 25) – their unearned income will be taxed at their parents’ top marginal rate
§ So no benefit to parents from shifting income to the kids
– Purpose- 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.
Same Sex Couples
· United States v. Windsor, 2013
– Facts: Edith and Thea were a same-sex couple in New York, lawfully married in Canada. Windsor sought to claim estate tax exemption for surviving spouses after Thea died. IRS found exemption did not apply to same-sex marriages and denied the claim.
– Holding: Restricting the interpretation of “marriage” and “spouse” to apply only to heterosexual unions, by section 3 of DOMA, is unconstitutional under the Due Process Clause of the Fifth Amendment.
§ For tax purposes, if same sex marriage is recognized in state, it will also be recognized by IRS
– Rev. Rul. 2013-17 Even if domiciled in a state that does not recognize, if they were legally married in foreign or domestic jurisdiction that recognizes same-sex couples they will be treated as married for tax purposes
§ If they are married, they must file a joint return, or married filing individually. They no longer can file as unmarried
2. Dissolution of the Family- separation and divorce
· One cannot generally, by private arrangement, shift tax consequences from one individual to another (even if from husband to wife)
· Only exception to this rule is upon separation/divorce.
– Separated or divorced couples may negotiate tax consequences.
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. (above-the-line)
– § 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.
§ Point of (b) is to BE SPECIFIC
– § 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.
ü Ex. if the wife has to pay the husband alimony of $1000 a month, and she has income of $130,000 a year, she can deduct that $12,000 under §215 in arriving at AGI… therefore, she gets the deduction whether or not she itemizes. The husband has to report the $12,000 as part of his gross income
o So even if the wife’s income is all from personal services, she can now shift her income from her return, to her former husband’s return…through alimony. This is all done by private agreement
– Note: 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.
– The parent receiving those funds has an obligation to use that money to support the child.
– § 71(c)(1) – subsection (a) does not apply to funds that are designated child support
– 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.
§ Many people surprised by that result… Congress added:
ü (c)(2): if you provide in the instrument that, a certain amount shall be paid in alimony a month, deleg
esn’t have to be incident to divorce … a married couple can transfer property during marriage and §1041 applies
c. Antenuptial Agreements
· Farid-Es-Sultaneh v. Commissioner, 1947
– 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.
– Issue: What is her gain from sale of stock? What is W2’s basis in the stock she received?
§ This depends on whether the transfer of stock in exchange for her relinquishment of marital rights should be regarded as a taxable exchange.
– Holding: the transfer was not a gift for income tax purposes, but an exchange of valuable property interests- stock for marital property rights.
§ Therefore, her basis in the shares was $10- the FMV at the date transferred.
§ Kresge received something in return for the stock. He didn’t want to have to pay her if they got a divorce.
ü Therefore, since there was consideration, court characterizes the transaction as a purchase, rather than a gift …so there is an adjusted basis amount which is determined by §1012 (rather than § 1015).
– This decision is consistent with the holding in United States v. Davis.
– Rev. Rul. 67-221- there is no gain when marital rights are released (20 years after this case).
§ No analysis for why this is true
§ If you can’t prove basis of what you give up- presumption is that the basis is zero.
B. Assignments of Income in General
– Income from services is taxed to the person who earns it.
– Income from income producing property is taxed to the owner of the property.
– Proceeds from the disposition of income producing property are taxed to whoever is the owner at the time of the sale.
1. Income from Services
· Lucas v. Earle, 1930
– Facts: Husband and Wife entered a contract, which provided that income earned by either spouse would be treated as belonging equally to both. In 1920 and 1921 he paid half of his salary to his wife, then tried to only pay taxes on his part, arguing that the other half contractually belonged to his wife.
– Earned income is taxable to the person who earns it
§ The only time individuals can contract around tax consequences is in the case of alimony or child support payments.
§ Wages, salaries, or other professional fees (§ 911 (d)(2))