Federal Income Tax
Spring 2007
Professor Hussey
Taxation of Individual Income, 7th Edition
By Burke and Friel
I Chapter 2 Gross Income
A. Definition: Gross income: all income from whatever source derived. (Section 61)
1. Commissioner v. Glenshaw Glass Co.
a) “Undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”
2. Includes wages and salaries, rents, dividends and interest, fringe benefits, cancellation of indebtedness, and alimony and separate maintenance payments. 61 (a)
3. If services are paid for in property, then the fair market value of the property is the measure of compensation; if paid for I the form of services, the value of the services received is the amount of compensation. Regulation 1.61-2(d)(1)
4. Fair Market Value is generally defined as the price a willing buyer would pay a willing seller, with neither under a compulsion to buy or sell, and both having reasonable knowledge of relevant fact. Regulation 20.2031-1(b)
5. Bargain purchases are not income. A taxpayer who accumulates frequent flyer miles as a resulg of business travel paied by the employer is not required to report any gross income as a resulg of receving frequent flyer miles used for personal travel.
B. Terms:
1. Taxable income: the amount upon which you pay tax- gross income less any deductions. Section 63
2. Rates: (not all income is taxed at the same rate)
a) Marginal rates-the rate in which the last dollar of taxable income is taxed the marginal rate is the rate the last dollar is taxed.
b) Effective rates- the overall percentage, the amount of tax you pay divided by taxable income.
3. Exclusions: things that really are gross income, but by statement of congress, it is not included.
4. Deductions: reduce adjusted income to bring down taxable income (it is reducing dollars off the top). The higher the tax bracket you are in, the more a deduction is worth to you.
5. Credits: credits are an automatic savings on your tax (better than a deduction). Credit reduces your tax dollar for dollar whereas a deduction is dependant upon the marginal rate. Some are refundable, but most are not. Earned income tax credit is refundable.
6. Imputed income: the value of the services I have received for working for myself. It is not taxable, it is a benefit that is derived from either
a) self help or
b) the value of owning something rather than renting/ leasing from someone else.
7. Realization: an exchange of property gives rise to a realization event so long as the exchanged properties are materially different, that is, so long as they embody legally distinct entitlement.
a) We have a “realization” concept regarding gross income from Glenshaw Glass Co. case, which means that you do not pay taxes on the increased value of your stock, until you sell it (which is when you have realized the profit).
1. Realization
a. Code B’1001
b. Regulations B”1.61-6, 1.1001-1(a)
c. Gains or losses in investment are not taxed until they have been severed from the capital that created them
d. Severance occurs on a sale, exchange, or other disposition of the property
e. The annual appreciation in the value of an asset is not included in gross income until the year in which that appreciation is realized through a taxable disposition
f. At the time of disposition, the total appreciation in value (not just the appreciation that occurred during the year of sale) is included in gross income.
8. Effective Tax Rate: the amount of tax you pay divided by the amount that was included in the income to determine the tax.
a) Example: Tax due on $20k
– 1st $10k tax is 10% = $1000
– Next $10k, the tax is 15% = $1500
– Total tax is $2500
– Effective Rate is 2500/20,000 = 12.5%
Cesarini v. United States
Facts: 1957- buy piano; 1964- discover money in the piano; 1964 tax return (filed April, 1965). Issue: whether the money found was gross income. Rule: Section 1.61-14 of the Treasury Regulation states that treasure trove constitutes gross income. Analysis: If they found it in 1957 and statute of limitations is 3 years, then they could not be taxed on it. Under Ohio law, they started possession upon finding the money in 1964; therefore, the money tax payers found is still includable as gross income.
Old Colony Trust Company v. Commissioner
A company tried to pay an employee his taxes for him as a benefit. The IRS states that the payment of taxes for the employee is itself income.
II Chapter 3 Effect of an Obligation to Repay
A. Loans:
1. A loan is not gross income.
a) A loan is not an “accession of wealth” since you also have an obligation to pay back that money.
2. Repayment of a loan is not a deductible expense.
3. But, if you are forgiven the debt, you receive gross income because you have an accession of wealth.
4. A lender has no income when the loan is repaid and no deduction when the loan is made.
5. Failure to repay a loan can generate tax consequences:
a) The reason a loan is not taxable is because of the obligation to repay.
B. Claim of right: what is the proper tax treatment of money received subject to a contingent repayment obligation?
1. If a taxpayer received earnings under a claim of right and without restriction to its disposition, he has received income which he is required to report on his tax return.
a) Under 1341, if the taxpayer is subsequently required to refund the money, the taxpayer is then entitled to a deduction (assuming it was properly reported in the first place).
b) ISSUE: what degree of restriction negates the application of this rule?
(i) Even if the taxpayer exercises restraint and elects not to spend the money received, it is still income;
(ii) However, where the taxpayer was required, under court order, to deposit excess commissions with a clerk of the court, the amounts deposited were not income.
(iii)Funds over which the taxpayer acts only as a conduit are not received under a claim of right:
(a) A city employee received bribes, but promptly passed all funds on to another official, the employee was merely a condu
ount taxed when you inherit property is the fair market value of the property on the day you receive it.
2. Gain is the excess of the amount realized over the unrecovered cost or other basis for the property sold or exchanged. Regulation 1.61-6(a)
3. EX: Buy a stock for $80 and sell for $200. Amount realized is 200. “Unrecovered cost” is 80. “excess” means difference, so, 200 – 80 = 120. $120 of gain is gross income under 61(a)(3)
4. Terms:
a) amount realized: the sum of any money received + Fair Market Value of any other property received. Section 1001(b)
b) Basis is equal to cost, except as adjusted according to 1016. (1012)
c) Tax cost basis means that you do not have to count income twice if not received in money and then re-sold. Regulation 1.61-2(d)(2)(i).
(i) Ex: I get a car from my employer worth $20,000, then sell it for $22,000. I report $20,000 in tax for the car, then $2,000 in gain for selling. I don’t have to report the $20,000 for getting it, then $22,000 total on selling it. That way, it works out the same as if I got cash from the employer, bought the car and sold it for profit.
d) Carry over basis- section 1015- the basis of property acquired by gifts and transfers in trusts. If property is acquired by gift, the basis shall be the same as the property’s worth just before it was given.
e) Adjusted Basis- section 1011- (“Unrecovered cost”) is equal to the basis as determined under section 1012 adjusted as provided in 1016.
(i) A taxpayer must adjust basis to reflect any recovery of her investment or any additional investment made in the property. (1016)
(ii) Dividends from a stock, rent paid to landlord, interest on loans- all are income that do not adjust basis. [61 (a)(4) and 61 (a)(5)]
(iii)EX: you buy a home for $150,000 and add a room costing $25,000. Your adjusted basis is $175,000. If a storm destroys your greenhouse after the room is built, causing you to lose $10,000 in value, then you can reduce AB by $10,000 to $165,000.
Then, if you sell for $200,000:
$200,000 (Amount realized)
– $165,000 (Adjusted Basis)
$35,000 (taxable gain)
Don’t be thrown off if you borrow some of what you use to buy the house and someone else is borrowing to buy it from you. Money you borrow is still a cost for your basis and a debt that someone takes from you is still a gain. So, if the $150,000 home was bought
