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Taxation of Individual Income
WMU-Cooley Law School
Larson, JoniD.

TAX – Larson, J – Michaelmas 2010
Federal Taxation
·         Constitutional basis of tax?
o   Congress was granted the power under Article 1, §8, clause 1 –  “power to lay and collect taxes, duties, imposts, and excises…All duties, imposts, and excises shall be uniform throughout the United States.
o   MUST be uniform or same throughout the Nation.
·         Article 1, §2, Clause 3; §9 clause 4
o   “Direct” taxes must be apportioned among the several states in accordance with their respective populations.
§  This became a problem because if it is not based on population, it cannot be uniform.  To fix, congress passed the 16th amendment, which removed the population requirement.
·         16th amendment – congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.
o   The 16th amendment voids Article 1, §2 Cl. 3; §9 Cl. 4.
o   The source of congressional power to tax is now in the 16th amendment.
5 major topics:
1.       What is gross income?
a.       How much?
2.       What is deductible?
a.       How much?
3.       What is the applicable tax rate against one’s tax liability?
4.       Timing Issues
5.       Who is the right taxpayer to report the income?
Tax Maxims:
Substance of Transaction (Economically) Prevails over Form
Fair Market Value:  Objective Standard. 
·         What a willing buyer would pay a willing seller,
·         neither under compulsion to buy or sell,
·         and both parties having access to all relevant facts.
What is Gross Income? 
Always first define with either:
1.       §61(a) + “all income from whatever source derived” + Broadly Defined
2.       Glenshaw Glass + Broadly Defined + Applicable § of code or other Case Law
Section §61(a) of the code provides Gross Income is – all income from whatever source derived. Broadly Defined.  §61(a) specifically includes:
1.       Compensation for services, including fees, commissions, fringe benefits and similar items;
a.       Service Tips.  Olk
b.      Inheritances derived from client’s will.  Wolder
c.       Routine and organized donations to Pastor disguised as gifts. Goodwin
d.      Unemployment compensation. §85
2.       Gross income derived from business;
3.       Gains derived from dealings in property;
4.       Interest;
a.       Interest earned from Gifts.
b.      Interest earned from Life Insurance.
5.       Rent;
6.       Royalties;
7.       Dividends;
8.       Alimony and separate maintenance payments;
9.       Annuities;
10.   Income from life insurance and endowment contracts;
11.   Pensions;
12.   Income from discharge of indebtedness[1];
13.   Distributive share of partnership;
14.   Income in respect of a decedent; and
15.   Income from an interest in an estate or trust.
If something is not within §61(a), then look to the regulations and then the case law to clarify ambiguities.  If ambiguous define G.I. with Glenshaw Glass.
Commissioner v. Glenshaw Glass (1955)
·         Any accession to wealth, clearly realized, over which the taxpayer has dominion and control.
o   Accession to Wealth – better off with than without
o   Clearly Realized – Tax Payer actually has it
o   Dominion or Control – TP responsible for it/ has ownership
·         Holding:  Punitive damages are GI.
Don’t always have to include Glenshaw Glass in a definition of G.I.  Especially when §61(a) specifically lists something.
1.       Treasure trove[2] is includable GI.[3] a.       Must be able to provide authority/provision to exclude an accession of wealth from gross income.
b.      Taxpayer argument:  If §61 does not specifically include it as GI; it should not be required to report.
2.       Illegally obtained income is GI.[4] a.      What if taxpayer has to repay the illegal income at a later date? 
                                                   i.      Classified as a deduction.  Repayment of illegal income entitles the taxpayer to a deduction.  Rev. Rul. 65-254.  Under theory, that the illegally obtained income constitutes a loan – which has an obligation of repayment.
b.      What if the taxpayer commits a crime, gets caught, promises to repay, and executes a confession in favor of the victim all in the same year? 
                                                   i.      Considered gross income.  Rejected the argument of “consensual recognition” of indebtedness to transform the transaction into a loan. 
c.       Raises 5th amendment argument – federal privilege against self-incrimination.
3.       Payment of Obligation by 3rd party is an accession to wealth.[5] a.       Issue:  Did the payment by the employer[6] of the income tax liability against the employee constitute additional taxable income to such employee?
b.      Facts:  Company paying the tax liability of the employees.
4.       Employee- Employer Bonuses are Includable G.I.[7] a.      As amount of cash received or FMV of the property or services received
b.      Issue:  Is the bonus vacation trip gross income?
c.       Facts: Employer paid for McCann’s Vegas trip.  Sent to Vegas because wife met a sales goal. McCann did not report as gross income.  Commissioner issued a deficiency.  Trip resembled more leisure than work-related.
d.      Types of trips and their tax consequences:
                                                   i.      All Work – Non-taxable, because you work normal hours.
                                                 ii.      All Play – Taxable, an extra compensation for services.
                                                iii.      Half Work–Half Play:  (Weigh the Factors)
1.       Did you have to do something extra to win it?
2.       Was it mandatory?
3.       Was there work? How much?
4.       Was the trip apart of the job or was it a bonus?
5.       Barter Exchanges are includable GI[8] a.       If services are paid with something other than cash, the FMV of the property or services[9] rendered instead, must be included as GI.
b.      Example 1
                                                   i.      Facts – In return for personal legal services performed by a lawyer for a housepainter, the housepainter painted the lawyer’s personal residence.  Both individuals are apart of a barter club.
                                                 ii.      Holding – The fair market value of the services received by the lawyer and the housepainter are includible in their gross income under §61 of the Code.
c.       Example 2
                                                   i.      Facts – An individual who owned an apartment building received a work of art created by a professional artist in return for the rent-free use of an apartment for six months by the artist.
                                                 ii.      Holding – The fair market value of the work of art and the six months fair rental value of the apartment are includible in the gross incomes of the apartment-owner and the artist under §61 of the Code.
6.       Advance Payments are includable GI[10] a.       Test:  Who’s in Control? Look to the intent, obligations, conditions and contingencies of parties at the time of contracting to see how the payment is to be controlled.
                                                   i.      If the payor/tenant of the payment controls the conditions under which the money will be repaid or refunded, then the payment is not income to the recipient/landlord.
1.       Resembles a loan/security deposit – not taxable.
                                                 ii.      If the recipient/landlord of the payment controls the conditions under which the money will be repaid or refunded, then the recipient has some guaranty that it will be allowed to keep the money, the recipient enjoys complete dominion over the payment.
1.       Resembles advance payment – taxable.
7.       Assets Held Under Claim of Right Doctrine
a.       If a taxpayer received assets, without restriction as to their disposition, he has received income that he is required to report, even though it may still be claimed that he is not entitled to retain the money.
                                                   i.      Is there some legal condition hanging over the asset?
b.      Becomes income when asset first becomes entitled and actually receives.[11]                                         

rmine taxable portion of payment –
1.       Total yearly payment received from annuity company minus tax-free portion = amount of taxable interest.
b.      For each payment, prorate the ROI and Interest – reporting only the portion of the payment that represents interest.  Therefore, a portion will be taxable and a portion will be tax-free.
                                                   i.      The Return of Investment is not an accession to wealth.
                                                 ii.      Interest earned on investment is GI – taxed when payments are realized.
c.       If the annuitant elected to receive payments over his life and:
                                                   i.      Lives exactly to life expectancy – No problems
                                                 ii.      Lives beyond his life expectancy – means TP recovered entire investment, thus hence forth, entire payment is taxable.
                                                iii.      Dies before life expectancy – deduction is allowed for the unrecovered  original investment.  §72(b)(2);(3)(A)
10.   Income from Cancellation of Debt
a.       Generally §61(a)(12) includes discharge of indebtedness as GI (Cite §61(a) and Kirby Lumber)
                                                   i.      If a loan is discharged for less than the amount owed, the borrower must include in income the amount of the discount.
Cancellations of Debt are different from Discharge of Indebtedness.  COD is concerned with the relationship between a borrower and Lender[18] – particularly when a creditor himself releases or diminishes a debt.  In contrast, DOI is concerned with a debt existing and a 3rd party (friend, family [may or may not be a gift] or employer [may or may not be compensation for services]) paying a portion or sum
[1] If 3rd party pays your credit card bills or debts. If a loan is discharged for less than the amount owed, the borrower must include in income the amount of the discount.
[2] Treasure Trove is defined as cash, jewelry, gold.  Something that the true owner will not return for, most likely because dead, and a substantial period of time has passed.
[3] Cesarini v. U.S. (1969)
[4] James v. US (1961).  Also, The rent and wage expenses incurred in operating an illegal bookmaking establishment are deductible – Commissioner v. Sullivan
[5] Old Colony Trust co. v. Commissioner (1929) and specifically codified in §61(a)(12)
[6] Court broadened issue to say any third-party that discharges another’s debt.
[7] McCann v. U.S. 1983
[8] Revenue Ruling 79-24
[9] If the services were rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence of the contrary.
[10] Always contrast with security deposits.
[11] North American Oil v. Burnet (1932)
[12] McCoy v. Commissioner (1962)
[13] A corporation, trust, community chest, fund, or foundation.
[14] Limit is %50 of taxpayer’s GI
[15] Whichever is greater.
[16] Whichever is greater.
[17] An investment vehicle, A right, acquired under a life-insurance contract or endowment, to receive fixed payments periodically for a specified duration.  Payments terminate upon death of beneficiary. 
[18] Lender could be a bank, employer (address compensation), or family member (address gift and whether note was specific enough)