FEDERAL INCOME TAX
I. GROSS INCOME
a. § 61 – gross income is “all income from whatever source derived.”
i. Rule: Income includes that which is an undeniable accession to wealth, clearly realized, over which the taxpayer has complete dominion
a. Income realized in any form, whether in money, property, or services
b. Measures the full taxing power of government under 16th amendment
c. Creates a presumption that everything is income – you must prove that it is not
a. Realization – A sale or disposition of property
i. No tax consequences until realization occurs
ii. Has the advantage of definite value once realized
b. Complete Dominion
i. Taxpayer has complete dominion in the year the property is reduced to undisputed possession
1. Must examine state law to determine when something is reduced to undisputed possession
a. Treasure Trove (Cessarini)
i. Taxed in the year it is reduced to undisputed possession
b. § 61 – Inclusions
1. Specific inclusions – if it is not included then doesn’t mean it is not gross income
a. Compensation for services, including fees, commissions, fringe benefits, and similar items;
b. Gross income derived from business
c. Gains derived from dealings in property
h. Alimony and separate maintenance payments
j. Income from life insurance and endowment contracts
l. Income from discharge of indebtedness
m. Distributive share of partnership gross income
n. Income in respect of a decedent; and
o. Income from an interest in an estate or trust
p. § 61(a)(12) – Discharge of a legal obligation is income
i. A debt paid on one’s behalf is income
2. Other Inclusions (Case law)
a. Illegal income is gross income
i. Note: also can be deducted as business expenses
b. Punitive Damages (Glenshaw Glass)
c. Payments for Goods or Services
1. Was there a quid pro quo?
2. Was one given in exchange for another?
1. Was the taxpayer required to go?
2. Were there business meetings?
3. Were all employees required to go?
4. Was it a reward for services rendered?
iii. Fair Market Value – value of property for determining income is the fair market value. See Treas. Reg. § 1.61-2
d. Unemployment Compensation is income under § 85
1. Not mere returns of capital
2. Not accompanied by a contemporaneously acknowledged obligation to repay, and
3. Not excluded by statutory provisions
i. If the Cesarini’s discovered the piano was a Steinway worth $50,000 instead of finding money inside it would the results be different?
1. The piano would still be considered gross income because it falls in the “property” portion of the definition. See Reg. 1.61-6(a)
2. You can argue that you do not have a gain or loss until you realize the real worth of the piano
3. In the alternative you can argue that you realized the income when you purchased the piano and therefore the $500,000 is gross income if they actually sell it and make the money – goes to the basis of the piano – if you profit you pay tax on the profit – in order to have a taxable event you must sell it!
ii. Winner attends the opening of a new department store. All persons attending are given free raffle tickets for a digital watch worth $200. Disregarding any possible application of I.R.C. § 74, must Winner include anything within gross income when she wins the watch in the raffle?
1. Under the definition of gross income you would have to include the value of the watch as gross income.
iii. Employee has worked for Employer’s incorporated business for several years at a salary of $40,000 per year. Another company is attempting to hire Employee but Employer persuades Employee to agree to stay for at least two more years by giving Employee 2% of the company’s stock, which is worth $20,000, and by buying Employee’s spouse a new car worth $15,000. How much income does Employee realize from these transactions?
1. Employee realizes $130,000.
2. Employee realizes $100,000 from the stock
a. Does it matter that the car goes to the spouse?
3. Employee realizes $30,000 from the car
a. The company gave him the car to get him to stay with the company
iv. Insurance Adjuster refers clients to an auto repair firm that gives Adjuster a kickback of 10% of billings on all referrals.
1. Yes, 10% of the referrals
a. If the arrangement violates the law then it does not change because unlawful and lawful means fall into the gross income definition
1. The landlord realizes $4000 because she is receiving $1000 in rent and $3000 in property improvement as a gain from renting the property – Reg. 1.61-8(c)
a. Changing the facts – if landlord had done improvements herself she could deduct it
2. No – she still realized that amount in improvements
3. Tenant has $2500 worth of income because he did not pay that rent
vi. Frequent flyer
1. No – you aren’t getting any extra benefit because you bought the ticket
2. Yes – employee received them as part of business income
3. Yes – the credits are still valuable
4. Yes – credits are still valuable – when you use them it should not change result
5. HOWEVER, IRS has determined since that the frequent flyer miles are a perk and not taxable
vii. In class Hypo
1. Al is an extortionist – he makes $300,000 and he bought a gun for $900 to help him in his business.
i. $300,000 in income – doesn’t matter if its from illegal activities – it is still taxable
b. Business expense deductions
i. $900 for the gun
d. PROBLEMS (p. 66)
i. Vegy grows vegetables in her garden. Does Vegy have gross income when:
1. Vegy harvests her crop?
a. No (imputed income)
2. Vegy and her family consume $100 worth of vegetables?
a. No (imputed i
i. § 102 applies.
b. Father dies intestate and Daughter receives $20,000 worth of real estate as his heir.
i. § 102 applies.
c. Father leaves several family members out of his will and Daughter and others attack the will. As a result of a settlement of the controversy Daughter receives $20,000.
i. § 102 applies.
d. Father leaves Daughter $20,000 in his will stating that the amount is in appreciation of Daughter’s long and devoted service to him.
i. § 102 applies (flowery language in the will)
e. Father leaves Daughter $20,000 pursuant to a written agreement under which Daughter agreed to care for Father in his declining years.
i. § 102 does not apply because daughter was compensated for the service of caring for Father.
f. Same agreement as in (e), above, except that Father died intestate and Daughter successfully enforced her $20,000 claim under the agreement against the estate.
i. § 102 does not apply. The estate has a legal obligation to pay her because of the written agreement
g. Same as (f), above, except that Daughter settles her $20,000 claim for a $10,000 payment.
i. § 102 doesn’t apply for the same reasons in (f). But this time the $10,000 is taxable.
h. Father appointed Daughter executrix of his estate and Father’s will provided Daughter was to receive $20,000 for services as executrix.
i. § 102 does not apply because Daughter is being compensated for services as executrix.
i. Father appointed Daughter executrix of his estate and made a $20,000 bequest to her in lieu of all compensation or commissions to which she would otherwise be entitled as executrix.
i. § 102 does not apply because compensation is given for her services as executrix.
2. Boyfriend who has a “mental problem” with marriage agrees with Taxpayer that he will leave her “everything” at his death in return for her staying with him without marriage. She does, he doesn’t, she sues his estate on a theory of quantum meruit and settles her claim. Is her settlement excludable under § 102?
a. § 102 may not apply because based on the intent of Boyfriend. The only reason he would leave her everything is for compensation of Taxpayer staying with him. The settlement may be taxable.