Tax I Outline
v Prior to 1939 there was no tax code.
v The tax code was substantially revised in 1954 and again in 1986.
v The purpose of the revisions was to simplify tax law.
What makes up tax law?
v Tax Code 1986, as amended.
v The constitution.
v Regulations – interpretations by the Treasurer of what the law means; to dispute it you must show that the interpretation is unreasonable (note: some of the regs in the book have been repealed; thus, need to know when the Reg. was promulgated to determine if it is still in effect.)
v IRS rulings – the Treasury’s answer to specific questions raised by a Tax Payer (TP) concerning the TP’s liability. These are published in a cumulative bulletin. These are useful in planning and in understanding IRS policy.
v IRS acquiescence or non-acquiescence on Tax Ct. decisions (published by the IRS) – a statement of whether the IRS will continue to contest a decision.
v Case law.
v Treaties cut across code and modify its provisions.
v Internal Rev. Code Regs. Admin. Tax Chief Counsel’s office Rulings
v Justice Department – both civil and criminal – in district court of appeals.
v Tax Ct. and District Ct. decisions are appealed to the Ct. of Appeals – Ct. of Federal Claims decisions are appealed to the Federal Circuit – the U.S. Supreme Ct. determines disputes among circuits.
Unofficial Tax Materials:
v Commerce Clearing House (middle floor of library)
v Federal Tax Code. (textual w/ footnotes)
v Tax Law Review (in Library)
CHAPTER 2 – GROSS INCOME : THE SCOPE OF §61 (PP. 48-68)
A. Introduction to Income:
IRC §61(a): “flush”: defines gross income as “all income from whatever source derived…”, unless otherwise specifically excluded. For tax law purposes, the concept of income encompasses:
v Realization requirement, and
v Receipt of an economic benefit
o Compensation for services; including fees, commissions, fringe benefits, and similar items (this includes ANY economic or financial benefit conferred on an employee as compensation for services);
o Gross income derived from a business;
o Gains derived from dealings in property;
o Alimony and separate maintenance payments;
o Income from discharge of indebtedness;
o Distributive share of partnership gross income;
o Income in respect of a decedent; and
o Income from an interest in an estate or trust.
Reg. §1.61-1(a): Gross income includes income realized in any form, whether in money, property, or services. Thus, income may be realized in the form of services, meals, accommodations, stock, or other property, as well as in cash.
v Note: loans are NOT income – b/c obligation exists to repay the loan, there is no accession of wealth; therefore no income.
Reg. §1.61-14(a): In addition to the items listed in §61(a), there are many other types of gross income:
v Punitive damages such as treble damages under the antitrust laws, and exemplary damages for fraud. (see Glenshaw Glass)
v Another person’s payment of the taxpayer’s income taxes is gross income to the taxpayer, unless excluded by law. (see Old Colony)
v Illegal gains (per James v. U.S., still income despite a legal obligation to make restitution – unlike true loans, which are not income.)
v Treasure trove, to the extent of its monetary value, is gross income for the taxable year in which it is reduced to undisputed possession. (see Cesarini).
Reg. §1.61-2-(a)(1): regarding compensation for services (gives some examples); and
Reg. §1.61-2(d)(1): regarding compensation paid other than in cash (FMV of services taken in payment for other services are included as compensation.)
B. Equivocal Receipt of Financial Benefit:
[§61, §1.61-1, -2(a)(1), -14(a)]
Cesarini v. U.S.:
Piano buyers (P) v. Federal Government (D)
Nature of Case: Action by taxpayer for a tax refund.
Fact Summary: The Cesarinis (P) found $4,467 in cash in a used piano purchased by them.
Concise Rule of Law: Found money is taxable as ordinary income in the year in which the taxpayer attains uncontested possession of it.
Facts: The (P) purchased a used piano in 1957. In 1964 they found $4,467 in cash hidden in the piano. This was included as ordinary income in their 1964 tax return. In 1965, the Cesarinis (P) filed for a refund on the grounds that the $4,467 was not ordinary income under §61 of the Code; that the income, if so deemed, should have been filed in 1957 and therefore a claim by the U.S. (D) was barred by the three-year statute of limitations; and that if any tax were assessed it should be a capital gains tax. The IRS (D) denied the refund and the Cesarinis (P) appealed to the district court.
Issue: Is found money includable as ordinary income?
Holding and Decision: (Young, J.) Yes.
v Found money is taxable ordinary income in the year in which the taxpayer obtains undisputed control over it §61(a) states that all income shall be included in gross income unless specifically excepted.
v No exceptions exempt found funds from gross income. Therefore, the $4,467 must be included as gross income under §61(a).
v Revenue Ruling 61 (1953) states that treasure trove must be included as income in the year in which it is reduced to undisputed possession.
v Here, the money was not reduced to undisputed possession until 1964, when it was found and it was determined that no other claimant existed.
v The Cesarinis (P) cannot prevail on the theory that it was a gift, since found money does not fit within the definition of “gift.”
v Finally, the finding of money does not entitle the Cesarinis (P) to capital gains treatment. Denied.
Editor’s Analysis: In many cases, the tax on treasure trove must be delayed for many years due to court battles over the ultimate possession of the trove. It is not necessary that the treasure be reduced to cash. Its appraisal value is deemed to be taxable income, as where a Picasso is found in an attic and is retained. Gifts are not included as ordinary income since they are taxed, if at all, to the giver by application of the gift tax rules, different tax tables.
Class Notes: August 21, 2002
v Paid money filed for refund and commissioner rejected it.
v $836 is amount of tax paid on found money.
v What are they fighting here?
o Õ says that it doesn’t fall under §61 as income; and
o should have been taxed in 1957 (check date, theory correct) when piano bought and statute of limitation ran; and
o if taxable should have been at Capital Gains. Lower tax rate. L. may be making argument because the “sale or exchange” was the exchange of money at bank.
§ General rule is 3 years from date you file or if filed early from date due April 15th.
§ If omit more than 25% of GI then SOL is 6 yrs.
· If that faulty it is so erroneous it doesn’t give service proper notice.
§ If you don’t file a return at all the SOL never runs.
§ If you file a fraudulent return the SOL never runs.
v What about notion that money found should not be income at all under §61
o Court says that §61(a) flush picks up by broad statement of “all income from whatever source derived” and if you don’t find a specific exemption then you are in trouble.
o If no common law exception or statutory exceptions probably income.
v What about when found money becomes income?
o Taxable year when in your hands with no restrictions.
o TP tries to use examples of prizes and awards being excluded and that they are specifically stated as being included so Congress must not have wanted to include found money. Court does not buy this argument.
v Problem with this is that service has taken consistent bases in this and Reg. Rule supports.
v Court Holds: This stuff is income.
v Glen Shaw Glass even talks about this that treasure trove is income. When something is reduced to “undisputed possession.”
o What law do you look at to see if something is “undisputed possession.” State law. Common law: “finder is owner to all the world except true owner.”
v 1964 is the year reduced to undisputed income and the SOL is not an issue.
Gross Income – The total income earned by an individual or business.
Gift – A transfer of property to another person that is voluntary and which lacks consideration.
Capital Gain and Loss – Gain and loss from the “Sale or Exchange” of a “Capital Asset” as defined in §1221.
The Court held that the money was Gross Income (GI):
v Fit in §61 – gross income means all income from whatever source derived.
v Not excludable in §101 et seq.
v §6501 limitations
o tax will be assessed due w/in 3 years after filed or w/in 3 years after 4/15 if filed early; for amended return – SOL is 3 years after filed.
o (c)(1): SOL never runs if fraud/intent to evade income taxes.
o (e)(1)(A): if TP omits more than 25% from GI, then the SOL is 6 years.
v IRS Rev-Rule 61, 1953 is on point – finder of treasure trove is in receipt of taxable income…for taxable year in which it is reduced to undisputed possession. Dougherty does not provide an answer b/c it was decided 2 years b/4 IRS Ruling.
v §1.61-14(a) treasure trove, to the extent of its value in US currency, constitutes GI for the
Supreme Court granted review.
ISSUE: Does the general definition of gross income include all amounts recovered as the result of a lawsuit that represent an increase in wealth to the recipient rather than compensation for non-contractual losses?
HOLDING AND DECISION: (Warren, C.J.) Yes.
v Section 22(a), the general definition of gross income, concludes by including in gross income “gains or profits and income derived from any source whatever…”
v This broad language has consistently been given broad application by this Court.
v Both companies (P) concede that the amounts recovered that represent lost profits are taxable as income.
v But the amounts recovered as punitive damages clearly represent an increase in wealth.
v If contract damage awards are taxable, it would make no sense to exclude from taxation those amounts recovered which do not represent compensation for losses but are accessions to wealth. As such they are subject to tax. Reversed.
EDITOR’S ANALYSIS: Personal injury lawsuit recoveries are not subject to tax on the theory that they are roughly analogous to a return of capital and do not represent an increase in wealth to the recipient but rather a compensation or restoration of a loss. Contractual damage recoveries are taxable since they represent reimbursement for amounts that would have been taxable had they been received as provided for by the contract.
Class Notes: August 21, 2002
v §22 complements §61 code.
v Dealing with same language of “from whatever source derived.”
v Court says that if you have to include compensatory damages that represent lost profits why would you not have to include punitive damages that represent a windfall.
v After Glen Shaw Glass says §61 language is real broad picks up everything unless exception.
GROSS INCOME: The total income earned by an individual or business.
DEFICIENCY JUDGMENT: A judgment against a mortgagor for the difference between the amount obtained at a foreclosure sale and the amount of the mortgage debt that is due.
PUNITIVE DAMAGE PURCHASE MONEY MORTGAGE: A mortgage or other security in property taken in order to ensure the performance of a duty undertaken pursuant to the purchase of such property.
v §61(a)(then §22(a)) – GI includes income form whatever source derived.
v These are instances of undeniable accessions of wealth, clearly realized, and over which the TP has complete dominion.
Charley v. Commissioner:
Frequent Flyer (P) v. Commissioner (D)
NATURE OF CASE: Appeal from tax court determination of a deficiency.
FACT SUMMARY: The Charleys (P) challenged the tax court’s determination that travel credits accumulated by Philip Charley (P) in the course of his employment with Truesdail Laboratories constituted gross income subject to taxation.
FACTS: Philip Charley (P) was President of Truesdail Laboratories, in which he and his wife, Katherine (P), owned 50.255% of the stock. Charley (P), in his capacity as employee, traveled to various accident sites in order to inspect allegedly defective machinery. Truesdail permitted its employees to retain any frequent flyer miles they accumulated in traveling on behalf of the company. Truesdail would bill the clients for first-class airfare, then Charley (P) would instruct the travel agent, Archer, to reserve a coach seat for himself. Charley (P) then utilized his personal frequent flyer miles in order to upgrade to first class, and directed Archer to transfer the credit balance into his personal account. In 1988, Charley (P) accumulated $3,149.93 of credit in his account. The tax court held this constituted taxable income to Charley (P), and charged him with a deficiency of $926.
ISSUE: Do travel credits accumulated and retained by an employee in the course of his employment constitute gross income subject to taxation?