FEDERAL INCOME TAXATION
A. FEDERAL INCOME TAX AS IT APPLIES TO INDIVIDUALS:
1. Not corporations, partnerships, estates, trusts, etc.
2. Not state income tax.
3. Not other kind of taxes, such as
b. Estate & gifts,
c. Capital gains,
d. Social security,
e. Property, etc.
B. HISTORY OF FEDERAL INCOME TAX:
1. 16th Amendment in 1913 allowed for a federal income tax.
2. Revenue Act of 1913 provides the original tax act.
C. SOURCES OF TAX LAW:
1. Internal Revenue Code (Title 26 of the U.S. Code)
2. Interpretations of the Code (IRC) sections.
a. Regulations (Treasury Department’s interpretations of the Code)
(1) regulations can be overturned, not law
b. Committee Reports-legislative history
c. IRS pronouncements –enforcement arm of the IRS
a. when do we need a court decision
b. most tax issues resolved within the IRS
c. Otherwise, need to go to court; 3 types of trial courts:
(1) tax court-trial court, only tax matters, federal
i. appeals w/ US crt of appeals, then US Sup. court
(2) US district courts
i. appeal-US court of appeals, then US Sup. crt
(3) Court of federal claims-have tax jurisdiction
i. unique appeal to US court of appeals for the DC circuit
D. INCOME TAX ASSESSED ON AN INDIVIDUAL’S ANNUAL NET INCOME:
1. Gross Income: everything included in income without any deductions.
2. Deductions: subtracted from gross income, difference is the taxable income.
a. Common ones:
(1) dependency deductions
(2) business/entertainment expenses
(3) charitable contributions
I. GROSS INCOME: THE SCOPE OF § 61
A. INTRODUCTION TO INCOME:
What is included in gross income? Wages, interest, pretty much everything, unless the Code specifically excludes it. Deductions – none, unless the Code specifically grants it.
1. § 61 or the Regs:
a. Gross income means ALL income from WHATEVER SOURCE derived, unless excluded by law.
(1) Example: compensation for services (including fringe benefits), gains from dealings in property, interest, rents, royalties, dividends, alimony, etc.
2. § 1.61-1 – Gross Income: GI includes income realized in any form, whether money, property, or services.
B. EQUIVOCAL RECEIPT OF FINANCIAL BENEFIT:
1. Cesarini v. U.S. (1970), p. 49
Couple bought a piano for $15, decided to clean it out, finds a sack of money. Report as GI on their tax forms. Filed an amended return, didn’t declare it. Gov’t says they must pay taxes on it. Sued government for a refund. Argued (1) not included within § 61 as GI, and (2) should have been income in 1957, not 1964, and the 3-year statute had run.
Held: The only way it is not GI under § 61 is if one of the exceptions apply. Government says found money is not a listed exception, and GI is interpreted broadly.
a. § 1.61-14: Misc. Items of GI – Treasure trove, to the extent of its value in U.S. currency, constitutes GI for the taxable year in which it is reduced to undisputed possession.
b. They gained possession of it in 1964, so under the same section, proper year for the tax is 1964.
Problem 1 (page 63): Would the answer in Cesarini be different if piano was actually worth $500,000?
· No – There is no realization for the change in value. However, once the piano is sold, there is realized income. This triggering event must occur before the income is realized. Once the income is realized, then it is taxed as part of gross income. Must be realized to be income.
2. Old Colony Trust Co. (1929), p. 54
Mr. Wood is making $900,000 in salary in 1918. In 1919, he makes $550,000. His company, besides paying his salary, also pays his income tax, which was
to repair firm that gives him a kickback. GI?
· Yes. Even if it is illegal.
C. INCOME WITHOUT RECEIPT OF CASH OR PROPERTY:
1. There are some situations where you do NOT have to report income because it is imputed income.
a. Rental value of own home – Helvering v. Independent Life Ins. Co held that the rental value of the building used by owner as his principal residence does not constitute income w/in the meaning of the 16th Amendment. The exception to this rule is the separate entity theory (Dean case).
b. Value of services rendered to yourself – the value of services performed by yourself (i.e. lawyer makes a will for himself or prepares his own tax return) is NOT considered income for tax purposes
2. Separate Entity Theory
a. Dean v. Commissioner (1951), p.67
Wife owned property prior to marriage. Husband and Wife start a corporation, transfer their house to the corporation. They live in it and don’t pay rent to the corporation.
Held: The court said they should have paid rent to the corporation at the FMV of the house’s rent. These are separate entities and you have to respect the entities. Thus, the H & W have income for the FMVE of the rent on the house.
b. Hypo: A works at a law firm. $11,000/month salary. Law firm also pays for A’s apartment, where rent would have been $2,500/month. Is there any gross income?
· Yes, the $2,500 is income to A b/c separate entities.
Bartering – An Exchange of Services: Revenue Ruling 79-24