Taxation of Individual Income
I. Gross Income and Exclusions from Income
A. Three Elements to Gross Income
1. Accession to Wealth
2. Clearly Realized
3. Over which the taxpayers have complete dominion
B. Items that are gross income
1. §61 – All income derived from any source is gross income.
2. Treasure trove is gross income b/c it is an accession to wealth (Cesarini)
3. Employer paying your taxes in exchange for services is gross income. (Old Colony)
4. Business trip v. Reward (McCann)
a. If intention is to provide service for employer it is not gross income, if the intention is to reward the employee then it is gross income.
C. Items that are NOT gross income
1. Appreciation – if there is an appreciation in value of something you own that mere appreciation is not taxed until the appreciation is realized.
2. Imputed income – when we provide services for ourselves that is not included as gross income.
3. Bargain purchases. (Pellar)
D. Obligations to Repay
1. Loans
a. Borrowing money does not result in gross income
2. Illegal Income
a. All illegal income is gross income. When you repay it you get a deduction.
i. i.e.: you report the money the year you stole it, the year you pay it back you get the deduction
3. Claim of Right (North American Oil
a. Arises when you receive some income but there is some legal contingency that hangs over your right to that income.
b. You have to report it right away; you can’t wait until the legal contingency is removed.
c. Treasure trove is appropriate for claim of right b/c original owner could come and take away from finder.
E. Advanced Payment v. Deposits
1. Advanced payments for rent or services are generally gross income.
2. If taxpayer has complete dominion over the money and does not have an obligation to give the money back then it is an advance payment, otherwise it is a deposit. (IPL)
F. Rebates – not gross income; rather, they are a reduction in the purchase price. (Westpac)
G. Gains from Real Property
1. Amount Realized – selling price. FMV of property, amount of $, or FMV of services received.
2. Adjusted basis – cost, what you paid for the property you sold.
3. AR-AB = Gross Income
4. Philadelphia Park Amusement Co
a. Basis = FMV of property received
b. If you don’t know FMV of asset received, you assume it is equal to the FMV of the property given up
H. Tax Cost Basis – keeps you from being taxed twice
1. When someone receives property in exchange for services
2. Hypo: D performs services for employer and receives desk worth $4,000 for such services. One year later D sells the desk for $6,000.
a. Issue 1: GI = $4,000 as compensation for services
i. D includes FMV of desk in GI in year one
b. Issue 2: AR ($6,000) – AB ($4,000) = GI ($2,000)
i. In year 2 when D sells the desk D reports a gain of $2,000. A total of GI of $6,000 ($4,000 in yr 1 and $2,000 in yr 2)
3. Regulation § 1.61-2(d)(2)(i) – basis of property shall be the amt paid for the property increased by the amt included in gross income as a result of receiving such property.
a. Example: D performs services for employer and as a result the employer sells D a desk worth $4,000 for $100. One year later D sells the desk for $6,000.
i. Issue 1: This is compensation for services. Amt of compensation is $3,900 ($4,000 – $100). Therefore, in year one D must report the $3,900 as Gross Income.
§ Talk about substance over form rule and compensation for services rule on exam.
§ Substance over form – look to the substance to the transaction. Just b/c an employer calls something a gift doesn’t mean it is in fact a gift and not compensation for services.
ii. Issue 2: AR-AB. $6,000 – $4,000 = $2,000 GI for yr 2.
§ AB is the $100 D paid for desk plus the $3,900 GI from yr 1.
§ $100 should not be taxed b/c that’s what was paid, and the $3,900 should not be taxed b/c tax was paid on that amount in year 1.
I. Impact of Liabilities
1. Impact on Basis – amt borrowed is treated as adjusted basis
a. Put down $20,000 and borrow $80,000 for a house the adjusted basis is $100,000.
J. Life Insurance
1. § 101(a) – proceeds from life insurance upon the death of the insured are not gr
rd
iii. Award must be transferred to govt approved charity
b. § 74(c): employee achievement award
i. Cannot be cash, must be tangible property
ii. Value of $400 or less
N. Scholarships
1. § 117 – Qualified Scholarchip
a. Certificate of degree/completion
b. For education and necessary materials
c. Room and board is not included
2. If tuition is conditional on past, present, or future employment it is not a qualified scholarship, rather it is compensation for services which is gross income. (Bingler)
O. Discharge of Indebtedness
1. § 61(a)(12) – debt discharge is gross income
a. Example: assets = $170k; liabilities = $200k; debt discharge = $20k – leaving $180k liabilities. Still insolvent so no gross income.
b. Example: assets = $100k; liabilities = $110k; debt discharge = $95k. Gross income $15k.
2. § 108(e)(4) – if a related party pays off taxpayer’s obligation it is treated as if taxpayer paid off the obligation themselves.
a. Hypo: you borrow $10k to start business. You don’t pay anything back on the loan, and the lender asks for the money. If you pay $6k and lender discharges the debt, you have $4k of gross income (debt discharge – below) If your mother offers to pay the $6k for the debt it is treated as if you paid the $6k.
3. § 108(e)(5) – if we have a purchaser of property who owes seller money for the property, and the seller forgives some of that debt on the property it is not treated as debt forgiveness, rather it is treated as a reduction in purchase price.
4. If debt discharge is not being used as true debt discharge (such as gift, compensation of services, etc) we look to that set of rules rather than under debt discharge rules.
