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FREE Law School Outlines List by Subject Taxation Federal Income Tax Spring 2003 | Federal Income Tax Spring 2003 |
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Federal Tax (A) Outline Fundamentals of Federal Income Taxation
Chapter 2 – Identification of Income:
Page 41 -- Income tax is imposed annually – Taxable income is “gross income” less certain authorized deductions
§61 Defines gross income as – all income from whatever source derive. §61 lists 15 potential sources of income, but is not limited to these sources.
Gross income can potentially be referred to as “gross take” because the definition is so broad.
The term income in the Code and incomes in the 16th amendment may vary in meaning accorded. Example – treasure trove may not be income to an economist because not recurring, but maybe for tax purposes.
Cesarini v. US – page 42 –
Cesarini purchased a piano in ’57. In ’64 they found $4,300 in cash in the piano, which they included as ordinary income on their ’64 tax return, in ’65 they filed for a refund claiming the money was not ordinary income under §61, and that if the income was ordinary income under §61 it should have been filed in ’57 and therefore the claim by the US is barred by the 3 year statute of limitations, and that if a tax were to be assessed then it should be a capital gains tax. IRS denied the refund, and Cesarini appealed to district court. Issue: is the found money includable as ordinary income?
Holding: Yes, §61 states, all income shall be included unless specifically excepted, no exceptions are listed for found money. No, statute of limitations bar because the money was not reduced to undisputed possession until ’64 – further found money does not qualify as a gift or capital gains treatment, found money treated as ordinary income within the year it was reduced to undisputed possession. Concise rule: Found money is treated as ordinary income in the year in which the taxpayer attains uncontested possession of it.
Old Colony Trust Co. v. Commissioner – page 47 –
Company resolved to pay the income taxes of certain officers, including president Wood’s taxes. Wood’s taxes for 1918 and 1919 totaled a little more than $1,000,000. The Commissioner argued that the payment amounted to additional income, and was also taxable as ordinary income. Issue – Does the payment by an employer of the income taxes assessed against an employee constitute additional taxable income?
Holding: Yes, the payment is considered inconsideration of services rendered, the form of payment is irrelevant. The payment is not considered a gift, even though the payment was entirely voluntary it is nevertheless compensation. Concise rule – The payment by a employer of income taxes assessed against his employee’s constitutes additional taxable income to the employee.
Commissioner v. Glenshaw Glass Co. (1955) – page 51 –
Two cases representing identical issues were consolidated for review. Glenshaw sued a supplier for fraud and antitrust violations seeking compensatory damages and exemplary damages for the fraud and treble damages for the antitrust violations. A settlement was reached and Glenshaw received $800,000 of which $325,000 represented punitive damages. Goldman theaters sued corporation for antitrust violations and was awarded $375,000 representing treble damages of sustained loss of $125,000, $250,000 was punitive. Neither company reported the punitive damages they won. The IRS assessed tax deficiencies against both. Issue: Does the general definition gross income include all amount recovered as the result of a lawsuit that represents an increase in wealth to recipient rather than compensation for non-contractual losses?
Holding – Yes, the general definitions of gross income concludes by including as gross income, gains and profits and income derived from any source whatsoever, this broad language has consistently been given broad application. Concise rule – The general definition of gross income includes all amounts recovered as the result of a lawsuit that represents an increase in wealth to recipient and not merely compensation for non-contractual damages.
Charley v. Commissioner (1996) – page 54 –
Note on Page 56 – Glenshaw attempts to define gross income, when it refers to undeniable accessions in wealth, clearly realized, and over which the taxpayers have complete dominion. This obviously does not include loans, loans are based on concurrently acknowledged obligation to repay which, offsetting the receipt, negate an accession of wealth. A security deposit maybe likened to a loan, in Commissioner v. Indianapolis Power and Light, the Supreme court concluded that a contractual arrangement between customers and the power company cast a deposit as a loan to the company, but if the company has no intention to give this back, “repay the loan” it becomes an illegal appropriation of the would-be creditor and is considered income under §61.
The Court in James v. US – deciding that illegal gain is income despite a legal obligation to make restitution. The court said that both lawful and unlawful are comprehended in the terms of gross income, extortion, kidnapping bribes, graft, black market gains, most all illegal gains are taxable since the revision of the code specifically excluded the word lawful from the gross income definition where previous versions included the word “lawful gains.”
In more recent cases, the Commissioner has been successful at attempts at taxing illegal gains from narcotics sales.
Page 59 – Income without Receipt of Cash or Property –
Code §61 Regulations sections 1.61-2(a)(1), - 2(d)(i)
Helvering v. Independent Lifer Insurance Co. – Page 60 –
Independent owned an office building. Independent occupied a portion of the building for its own use. The IRS alleged that fair market value of the rental space should be included as income by independent. Independent brought suit alleging that article 1, §9, Cl. 4 of the Constitution mandated against such construction of the tax law, since it merely saved money by occupying a portion of its own building an no income was ever realized. Issue: May the IRS tax the owner and occupier of a building for its fair rental value?
Holding – No, Article 9, §1 Cl.4 of the Constitution requires the apportionment of direct taxes. The tax assessment herein is on property, not income. The insurance company did not receive an income, it merely used already taxed funds to save money on its own building. The 16th amendment required direct taxes to be apportioned between the states. Taxing of space occupied by the owner of the building is a direct unapportioned tax, which is unconstitutional. Judgment for Independent. Concise rule – The rental value of buildings used by their owners is not taxable income.
Page 60 – Revenue Ruling 70-24: Situation 1 – a painter and lawyer barter for the exchange of services.
Situation 2 – Landlord takes a painting in exchange for six months rent.
Law: Applicable sections are §61(a) and 1.61-2 relating to compensation of services Sections 1.61-2(d)(1) – provide that if services are paid for in means other than money, the fair market value of services at time must be included as income. If 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 to the contrary.
Holdings: Situation 1 – the fair market value of exchanged services is to be included as income under §61. Situation 2 – The fair market value of both the painting and six months rent for both parties are includable as income under §61.
Dean v. Commissioner (1951) – page 61 –
Dean and his wife were the sole shareholders of the Nemours Corporation. They occupied a residence which was owned by Mrs. Dean prior to their marriage. The residence was transferred to Nemours to secure a bank loan for the corporation. The Dean continued to live in the house but paid no rent to Nemours. The commissioner sought to include the fair market rental value of the house and the tax court agreed. Dean Appealed. Issue: Does fair rental value of premises occupied by a taxpayer without payment of rent constitute income, which must be included in such taxpayer’s gross income?
Holding: Yes, Taxpayer provided a family home, the property was held by the corporation, and the fair rental value therefore became income to him. The fair rental of a premises occupied by a taxpayer without payment of rent constitutes income which must be included in such taxpayer’s gross income. Affirmed. Concise rule – The fair rental value of premises occupied by taxpayer without payment of rent constitutes income, which must be included in such taxpayer’s gross income.
Chapter 3 – The Exclusions of Gifts and Inheritances – Page 63
Applicable Code § 102(a) and (b) first sentence Regulations: 1.102-1(a) and (b)
Congress has been unwilling to rely on unexplained gross income, two series sections set out certain specific items that are either includable or partially includable as gross income: §71 – 90 and §101 – 137 but these sections are not exhaustive
General definitions of gross income §61 – list 15 items still not a exhaustive list
Important note – When an explicit statutory rule applicable it takes precedence over the general definition. Example, interest is an illustration of an item of gross income specified in §61(a)(4), but there are explicit statutory exclusions for this, §103(a) gross income does not include interest on some state or local bonds.
There is no single definition of gross income that will answer all the questions that may arise; but there is a kind of checklist that may help:
Gross income includes receipts of any financial benefit, which is –
A simple long-standing exclusionary rule is found in §102 – the exclusion from income tax for inheritance – this can be read literally.
Securities received that produce dividends must be treated as income - §102(b)(1)
Page 64 - Irwin v. Gavit, the Supreme Court held that language such as it now appears in §102(a), excluding from gross income property by bequest, did not exclude a gift of the income from property – this is codified in §102(b)(2).
Page 64 – B. The Income Tax Meaning of Gift – §102(a)
Commissioner v. Duberstein - Duberstein (P) through his company had conducted business dealings with Berman, the president of another corporation, P gave Berman many good business leads and Berman decided he wanted to reward P with a Cadillac as a gift. P initially refused the gift but finally gave in. Berman’s company later deducted the car off their corporate taxes as a business expense. Second consolidated case, Stanton, Comptroller of church resigned, the board of the church decided to give him a $20,000 departing bonus in appreciation of services rendered. Issue: Were the car received by Duberstein and the money received by Stanton given with a detached and disinterested generosity and thus gifts under §102.
Holding – No, the car received was taxable income- but the court reversed the decision in Stanton because the factual findings did not show the legal standards. In reaching its decision the court first rejected the government’s definition of a gift (all transfers of property made for personal and not business reasons) on the grounds that such a definition was too concise and not suitable for all factual situations that may arise. As such, a gift is not shown by the mere absence of legal or moral duty to make a payment, or from lack of economic incentive; where payments are made for compensation. As a general rule a gift will be found where “it proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses, and it is the donor’s intention which is controlling as to those factors. Concise rule: In order to be a gift under §102, amounts received must have been given with a detached and disinterested generosity. Page 75 – C. Employee Gifts - § 102(c), 274(b). See §74(c); 132(e) and 274(j) Regulations § 1.102 –1 (f)
§102(c)(1) is fairly straight forward – An employee “shall not exclude from gross income any amount transferred by or for an employer to, or for the benefit of an employee – the 1986 reform act makes no specific exception, except in passing as follows:
Except to the extent that new section 74(c) exclusion or section 132(e) applies, the fair market value of an employee award (whether or not satisfying the definition of an employee achievement award) is includable in the employee’s gross income under §61, and is not excludable under §74 or §102 (gifts).
Legislative history is lacking, but the statute seems to indicate a broad congressional intent to deny “gift” classification to all transfers by employers to employees.
The regulations recognized to tax all transfer would be unfair so its carves out certain exceptions, “extraordinary transfers to the natural objects of an employer’s bounty *** if the employee can show the transfer was not made in recognition of an employee’s employment.
To additional exceptions - §102(c) inclusion rule. Under §132(e) certain traditional retirement gifts are treated as de minimis fringe benefits; second under §74(c) certain employee achievement awards are freed from tax, these are both examples of specific statutory rules of exclusions to gross income.
§274(b)(1) generally limits the deductible amount of business gifts to $25 per donee per year. As employee “gifts” now are includable in gross income under §102(c), they are not subject to §274(b)(1) ceiling. That ceiling is applicable only to non-employee business gifts.
Page 77 – D. The Income Tax Meaning of inheritance – §102(a), (b) and the first sentence of (c) Regulations §1.102-1(a), (b)
Lyeth v. Hoey Lyeth’s grandmother left the bulk of her estate to a chuch, the heirs contested this further saying she was under undue influence, a compromise was finally reached whereby by the heirs and the church each got half. The IRS charged a tax where it claimed the money was received by contract and not inheritance. Issue: Are funds received through the compromise of rights under a will contest income under the tax laws?
Holding: No, Lyeth was one of the heirs, an heir has a right to take under a will or contest it, the money received was for the release of his rights as an heir. Congress did not intend for state law to mandate a different result between states. We hold for tax purposes state law on the nature of a taking is not controlling, where an heir compromises his claim, funds received are not income, they are excluded under §102 as received through inheritance. Concise rule: Money received from the compromise of a will contest is received through inheritance and is exempt from income tax.
Wolder v Commissioner – page 82: Wolder (D), an attorney, contracted with a client, Mrs. Boyce, to provide her with free legal services for the rest of her life in exchange for her to leave him her securities. Wolder received about $16,000 from convertible preferred shares. Wolder argued that the bequest was specifically excluded from gross income under §102(a), which provides that gross income does not include the value of property acquired by gift, bequest, devise or inheritance, Wolder appealed an adverse judgment. Issue: Where a bequest is made to satisfy an obligation under a contract, is it receipt income taxable under §61.
Holding: Yes, where the bequest is made to satisfy an obligation, its receipt is income taxable under §61 and not excludable under §102, Wolder was contracted for services, while limited in nature the services were rendered. Concise rule – Where a bequest is made by contract to satisfy and obligation, its receipt is income, taxable under §61, and not excludable under §102.
Chapter 4 --- Limitations in Employment Relationships
A. Fringe Benefits §132 omit (j)(2) and (5). See §61(a)(1); 79; 83; 112; 120; 125 Regulations - §1.61-1(a), -21(a)(1) and (2), (b)(1) and (2). Also see 1.132-1 through 8.
Section 61(a)(1) specifically includes in gross income “compensation for services”, such compensation may take the form of property paid as well as cash, and it can be directly paid as well as indirectly. The Supreme Court has stated that §61(a)(1) is broad enough to include in taxable income any economic or financial benefit conferred on the employee as compensation.
This section now under takes the concept of fringe benefits, for example coffee provided at work, technically each cup is income, these items are impossible to account for and are considered de minimis anyway. The issue is when the fringe benefits become more substantial, such as travel passes or store discounts.
The 1984 Congress passed a series of enactments that allow for certain fringe benefit exclusion; for example, a retail store that sells clothes will offer discounts to employees to buy and wear their clothes when selling them, this serves as a type of advertising for the stores products, things such as this the committee believes, that employers may provide a broad group of employees, either free or at a discount, the products and services which the employer sells or provides to the public do not serve merely to replace cash compensation.
But this area is still very unsettled, employee in similar situations may have very different outcomes, there is still much unsettled in this area.
An important point is that under this bill most fringe benefits, which may be made available tax-free to officers, owners, or highly compensated employees only if the fringe benefits are also provided on substantially, equal terms to other employees.
The tax law on fringe benefits still completely statutory now, though still subject to judicial and administrative interpretation, if an employee benefit is not specifically excluded from gross income, then it must be included within the meaning of section 61.
Most of the exclusionary rules of the 1984 appear within §132.
§132 excludes fringe benefits for employees and the definition for employees is expanded to include not only persons currently employed but also retired and disabled ex-employees and surviving spouses of employees or retired or disabled ex-employees as well as spouses and dependant children of employees.
§132 excludes the first two classifications of fringes and employee-eating facilities provided to highly compensated employees only if those fringe benefits are offered to all employees on a non-discriminatory basis.
§132(a)(1) – No additional cost services – The first type of fringe benefit excluded from an employee’s gross income under §132 is services provided to an employee by an employer. Their value escapes gross income if the services are offered for sale to customers in the same line of business as that in which the employee is performing services, the employer incurs no additional substantial charge in providing the service to the employee, and to highly compensated employees as long as it is provided on a non-discriminatory basis.
Examples of no additional cost services include – airline, railroad, or subway seats and hotel rooms furnished to employees, if they are working in their respective business and they do not displace non-employee customers – the exclusion is allowed whether the services are provided at no charge or at a partial charge or rebate program.
Services must be provided in the same line of business as that in which the employee is employed. For example, an employee is an steward for an airline owned by a company that also owns a cruise ship, free standby flights are excludable for employee, spouse and his dependants are excludable but the cruise is not. This is to preclude an unfair advantage for employees of conglomerates.
But is one company has a reciprocal agreement to provide no additional cost services to each other’s employees then they can be excludable.
Page 92 -- Section 132(a)(2): Qualified Employee Discounts – employees may exclude from gross income courtesy discounts within limits.
The code imposes a ceiling on the amount of the exclusions; in the case of services the exclusion may not exceed 20% of the price at which the employer offers the services to the customers. The maximum discount for property is essentially the employer’s gross profit percentage on the goods in the employer’s line of business -- Formula: Aggregate sales price reduced by cost / aggregate sales price
Example – Employee works for a home appliance store and her employer has total sales for the entire year of $800,000 and paid $600,000 for the goods sold, the gross profit percentage is 25%: 800,000 – 600,00 / 800,000 = 200,000 / 800,000 = 25%
If the employer allows an employee to buy an item that generally sell for $1000 for $750, the full discount is excludable, anything beyond the discount ($250 in this case) must be reported as income.
132(a)(3): Working Condition Fringe – Congress allows exclusion for any property or services provided to an employee the cost of which, had the employee paid for it, would have been deductible by the employee as a business expense or by way of depreciation deductions. --- §162 business expenses, §167 depreciation deductions. Examples of this – use of a company car, or airplane for business purposes, an employers subscription to a periodical for an employee, bodyguard provided, and on-the-job training.
Under §132(j)(3) – a full time auto salesperson can exclude the use value of an employer provided demonstration car if the car is used primarily to facilitate the salesperson’s performance of services for the employer and there are substantial restrictions on the personal use of the car by the salesperson.
§132(a)(4): De Minimis Fringes – Any property or service whose value is so small as to make accounting for it unreasonable or administratively impracticable is excluded as a fringe benefit, in determining whether an item is within the de minimis concept, the frequency with which similar fringes are provided by an employer to employees must be taken into account. Examples of above that are excludable – typing of personal letters by a company secretary, occasional personal use of company copying machine, occasional cocktail parties or picnics for employees, occasional sporting of theater tickets, low value holiday gifts—and finally an exception added in the 1986 reform, “traditional” retirement gifts after a long period of service.
§132(a)(5): Qualified Transportation Fringe – An excludable transportation fringe was added by the 1992 Energy Bill. A qualified transportation provided to an employee by an employer may include: Transportation in a “commuter highway vehicle” between an employee’s residence and work, a transit pass, token, fare card, voucher, or similar item for mass transit facilities or for a commercial transportation service; and qualified parking provided on or near the business premises or on or near the location form which the employee is picked up by a commuter vehicle; except in cases of qualified parking, the transportation benefit must be provided in addition to and not in lieu of any compensation otherwise payable to the employee. The exclusion applies to cash reimbursements for qualifying items. The exclusion is limited to $60/month for all benefits in the form of commuter highway vehicle transportation and transits passes etc., and $155/month for qualified parking, any amounts paid for qualified transportation which, exceed the limits provided may not be excluded by any other subsection of §132.
§132(a)(6): Qualified Moving Expense Reimbursement – see also §132(g)
§132(j)(4): Athletic Facilities: Employee may exclude the use of any on-premises athletic facility, the exclusion applies to: gym, pool, golf course, tennis courts or other athletic facility, located on the premises operated by the employer, if substantially all the facility’s use is by employees, their spouses and their dependant children.
The Statutory Exclusions of Other Fringe Benefits: An important point - §132 indicates that if another code section provides an exclusion of a benefit, §132 is generally inapplicable to that type.
Other sections that exclude benefits from gross income: §79 – excludes group term life insurance premiums up to a maximum of $50,000 of coverage from an employee’s gross income, §120 which excludes the value of group legal services, §129 excludes amounts paid by an employer for “dependant care assistance” up to a maximum of $5,000/year. §137 excludes qualified adoption expenses, §112 compensation for military personal, §134 additional military benefits, §125 establishment of cafeteria plans.
Page 97 - B. Exclusions for Meals and Lodging - §107, 119(a) and see 119(d) Regulations: 1.119-1
Herbert G. Hatt (1972) – page 98 – Hatt married the president and majority stockholder of Johann, a funeral home and embalming business, by antenuptial agreement, Hatt became president, general manager and majority stockholder of Johann. He moved into an apartment located in the building used by Johann for its funeral home business, the building also housed and ambulance crew which picked up the bodies. The telephone which rang in the office also rang in the apartment and Hatt used the place to meet with clients after hours and he also supervised the ambulance crew. Hatt sought to deduct the apartment off of Johann corporate expenses or alternatively deduct it from his own personal expenses. Commissioner denied this because he was not required to live their as part of his employment; it also taxed Hatt on the fair market value of the apartment as a constructive dividend, Hatt contested this. Issue: Is the value of lodging furnished to an employee excluded from gross income if the lodging is on the business premises of the employer, the employee is required to accept such lodging as a condition of his employment, and the lodging is furnished for convenienc of the employer?
Holding: Yes, IRC §119 grants an exclusion from gross income the value of lodging furnished to an employee if three conditions are met: (1) the lodging is on the business premises of the employer (2) the employee is required to accept such lodging as a condition of his employment (3) the lodging is furnished for the convenience of the employer. Acceptance of lodging is considered a “condition of employment” if the employee must use the lodging in order to enable him to properly perform the duties of his employment, whether the lodging is furnished for the convenience of the employer is subject to the same test. Hatt being president determined himself what was for the convenience of the employer, he required himself to be available around the clock, plus the on-call nature of his work, Hatt Qualified for the exclusion. Concise rule: The value of lodging furnished to an employee maybe excluded from gross income if the lodging is on the business premises of the employer, the employee is required to accept such lodging as a condition of his employment, and the lodging is furnished for the convenience of the employer.
Note page 100 – Commissioner v. Anderson – a motel manager was always on-call at a residence owned by the motel owner two blocks away from the motel. The court concluded that ownership was not the test but that the employee performs a significant portion of his business. §119 was held inapplicable because the “on-call” status did not constitute a significant portion of the taxpayer employee’s duties. In Linderman held that a residence adjacent to the motel (across the street) was not geographically separated from the motel and was therefore “on the business premises.”
§119(d) allows an employee of an educational institution to exclude from gross income the value of lodging, not otherwise excluded under §119(a), if lodging is located on or in proximity of the campus of the educational institution. Lodging maybe used as a residence by the employee’s spouse and dependant’s, there is a ceiling amount.
Housing benefits provided to a “minister of a gospel” are excluded from the minister’s gross income by §107, but these have to be furnished to him as compensation, this not only applies to fair rental value of a home actually provided for the minister’s use, similar to §119, but also to a rental allowance.
Chapter 5 – Page 102: §74, see 102(c); 132(a)(4), (e); 274(j) Regulations: 1.74-1. Proposed Regulations: Section 1.74-1.
A. Prizes
Two major congressional goals in enacting the 1986 revenue-neutral tax legislation – first to broaden the tax base (increase the amount of taxable income subject to the income tax) a second, to lower the income tax rates.
Two principal ways to broaden the tax base: one is to increase the items included in gross income, and the other is to decrease items allowed as deductions
§74 income tax rules on prizes and awards relates to things such as: winning a company’s sales or other contest, Nobel Peace Prize, Pulitzer
§117 – Scholarships and fellowships
§74 now excludes prizes and awards from gross income only in two limited circumstances: first, under the current §74(b) prizes and awards that satisfy the requirements of old §74 (b) are excluded from gross income only if the taxpayer winner designates a governmental unit or §170(c)(1) or (2) charity to receive the award and if the award is transferred directly to the designee without use or enjoyment of it by the taxpayer. – Page 103
Second, §74(c) creates an exclusion for employee achievement awards. This exclusion needs to be considered in conjunction with several other code sections, §102(c) does not include gifts from an employer to an employee within the §102(a) gift exclusion rule. However a gift from an employer to an employee such as a retirement gift after a long period of service may escape gross income inclusion by qualifying as a §132(a)(4) de minimis fringe benefit. §74(c) adds an exclusion or partial exclusion from gross income for the value of certain employee achievement awards ---- An award may qualify if it relates to length of service or to safety, it must be in the form tangible personal property, be awarded as part of a meaningful ceremony, and not be mere disguised compensation. A length of service award does not qualify unless the employee has been in the employer’s service for five years or more and has not received a length of service award for the current or any of the prior four years.
A safety achievement award qualifies only if made to other than a manager, administrator, clerical or other professional employee, and only if 10% or less of the employers employees receive the same award during the same year, it cannot be part of the general pay scale, the amount of the employee exclusion is geared to the extent to which the employer qualifies for a deduction for the awards under §274(j).
Allen J. McDonell (1976) – Page 104: McDonell was an assistant sales manager for DECO, a bulk milk cooler sales company, at the time McDonell’s wife was interviewed and expected to go on DECO social trips with him. In 1959 a sales contest was held, there were 11 winners that year that got free trips to Hawaii for them and their wives, DECO also decided to randomly select 4 sales managers and send them with the employees, McDonell was selected with his wife and was told to consider the trip an assignment, and not a vacation. If manager were not with the employees the company was afraid the trip would turn into a big gripe session. McDonell did not report the approximately $1122 on this ’59 return, but did report $600 as additional income attributable to his wife’s presence on the trip. The commissioner petitioned the court for deficiency. Issue: Does all expenses paid business trip constitute taxable “disguised remuneration” when the recipient is required to go as an essential part of his employment and is expected to devote substantially all of his time on the trip to performance of duties on behalf of the employer?
Holding: No, An all-expenses paid trip does not constitute a taxable award under IRC §74 or additional compensation under §61 when the recipient is required to go as an essential part of his employment and is expected to devote substantially all of his time on the trip to performance of duties on behalf of the employer. Although the presence of an employer business purpose does not necessarily preclude a finding of compensation, but maybe taken it into account, this is not conclusive. The McDonell’s were required to take this trip, being selected at random does not make the trip taxable, the random selection was to obviate any discrimination, thus the McDonell’s are entitled to a $600 refund. Concise rule: An all-expenses paid business trip does not constitute taxable “disguised remuneration” when the recipient is required to go as an essential part of his employment and is expected to devote substantially all of his time on the trip to performance of duties on behalf of the employer. New developments – since 1986, currently under §74(b) prizes or awards given to recognize achievements in religious, charitable, scientific, educational, artistic, literally, or civic fields are excluded from gross income only if the winner designates a government unit or eligible charity for receipt and if the winner enjoys absolutely no use of the award. §74(c) length of service awards.
B. Scholarships and Fellowships – Page 108: §117; 127(a) and (b)(1) Proposed regulations: 1.117-6(b)-(d)
§117(a) excludes from gross income amounts received as a “qualified scholarship” by a degree candidate at an educational organization, the principal requirements here are found in the definition of a qualified scholarship, which is a grant that in accordance with the grant is used for “qualified tuition and related expenses.” Those expenses encompasses tuition and enrollment fees at the educational organization as well as fee, there is no exclusion for amounts which cover personal living expenses, such as meals and lodging, or for travel and research.
Under 117(c) a portion of an otherwise excluded scholarship or fellowship is required to be included in gross income to the extent that the portion represents a payment for teaching, research or other services by the student required as a condition for receiving the otherwise excludable amount.
Educational grants made by an employer, current or former, are generally taxable because they are considered compensation for past, present or future services. This result has been upheld even in cases in which the employee has not contractual obligation to render future services.
Exclusion is allowed for a university athletic scholarship if the university expects but does not require the student to participate in a particular sport, requires no particular activity in lieu of participation, and cannot terminate the scholarship if the student cannot participate. So to qualify for the exclusion there must be a gratuitous or non-contractual flavor to the grant, similar to the gift concept as ultimately developed out of the Duberstein Opinion.
Page 110 ---Two additional related exclusions of educational benefits: first, §117(d) allows a qualified tuition reduction below the graduate level or graduate level if the graduate student is engaged in teaching or research activities. The reduction is made available to the employees of the educational organization, employees is defined in §132(h). The section invokes the §132 concept of nondiscrimination, §117(d) is applicable to highly compensated employees.
§127 permits an employee to exclude up to $5250 from gross income for amounts paid by the employer for educational assistance. Educational assistance under §127 includes, tuition, books, supplies and employer provided educational course, but does not include assistance for courses involving sports, hobbies, or graduate level courses, such as law, business, medicine, or other advanced academic or professional degree.
Chapter 6 Gain form Dealings in Property
A. Factors in the Determination of Gain – page 112 §1001(a), (b) first sentence, (c); 1011(a); 1012 Regulations: §1.1001-1(a)
If T lends money to B there is no gain from mere repayment of the principal, repayment constitutes a mere return of capital, no element of gain in this transaction.
§1001(a), which identifies gain on the disposition of property as the excess of “amount realized” over the adjusted basis.”
§1001(b) defines amount realized, as the amount of money received and the fair market value of property (other than money) received on disposition
So if T sells his $10,000 property for $15,000 his unadjusted basis is 10,000 and his gain is 5,000, §1001(c) requires gain to be recognized unless otherwise provided by another code section.
B. Determination of Basis 1. Cost as Basis §109; 1012; 1016(a)(1); 1019 Regulations: §1.61-2(d)(2)(i); 1.1011-1; 1.1012-1(a)
Philadelphia Park Amusement Co. v. US (1954) – page 113: Philadelphia obtained a 50-year franchise to operate a railroad service to its park. A bridge was constructed for over $300,000 to operate the railroad. When the franchise was about to expire Philadelphia offered to transfer the bridge to the city in exchange for a ten-year franchise extension. No gain or loss was reported from the transaction. Philadelphia later abandoned the railroad in favor of a bus system. It the attempted to take a loss deduction from its income based on the abandonment of the franchise. The IRS denied the deduction on the grounds the transaction had no value, there had been no taxable exchange so no loss could be maintained. Philadelphia maintained that the value of the franchise was equal to the value of the bridge and it was entitled to take the undepreciated basis as a loss. Issue: Is the basis of property established as of the date of a taxable transfer?
Holding: Yes, a transfer of assets, except where exempted by statute, is a taxable event. The taxpayer’s basis in the new property is fair market value as of the date of the transfer plus any taxable gain to him associated with the transaction. Where the transfer is at arms length and the new asset cannot be valued, it is deemed to be equal to the value of the asset given up by the taxpayer. While the franchise extentsion cannot be valued the court felt the bridge had some value. The amount should be deemed the basis of the Amusement franchise. The undepreciated value of the franchise as of the date of abandonment was a proper deduction. The failure of the Co. to properly record the transaction originally does not prevent it from later establishing valuations for the purpose of deducting the loss. Concise rule: Where a taxable exchange of property occurs, gain or loss should be recognized in establishing the basis for the property on the date of the transfer. Additional notes – If the property is exchanged for other than cash the adjusted basis is the value of the property received, plus any gain which is taxed to the taxpayer as a result of the transaction. If a loss was taken, the adjusted basis is the value of the property received.
Property Acquired by Gift §1015(a). See §1015(d)(1)(A), (4) and (6) Regulations: §1.1001-1(e); 1.1015-1(a), -4
Taft v. Bowers (1929) – Page 117: Taft (P) received appreciated stock from her father as a gift. P later sold the stock for a profit. P paid taxes on the profit from the time she held the stock, no taxes were paid on the time when her father held the stock and it appreciated. The IRS assessed a deficiency on the grounds that the donee takes the donor’s basis, P argued her basis was fair market value at the date of transfer. Issue: Is the donee’s basis in a gift the same as the donor’s?
Holding: Yes, the donor is exempt from tax if he makes a gift of the property. §202 was a proper vehicle for deferring this tax until the property was ultimately disposed of by the donee by giving him the donor’s basis rather than the value of the asset at the date of transfer.
Farid-Es-Sultaneh v. Commissioner (1947) – Page 119: Farid (P) was given shares of stock to protect her if her fiancé died before marriage. The stock plus additional shares were given to her in exchange for her promise to marry and the release of marital rights. An antenuptial agreement to this effect was signed. P later married her fiancé and later sold her stock. The commissioner determined the stock had been a gift and that the donor’s basis in the stock should be used to compute the basis and gain.
Issue: Is property transferred pursuant to a release of marital rights and a promise to marry under an antenuptial agreement a gift?
Holding: No, Congress determined that such a transaction required the imposition of a gift tax on such transactions is not dispositive of the issue for income tax purposes. Where, as here, the transfer was not motivated by primarily donative intent and very real property rights were released, there was a bargained for arm’s-length transaction. No gift may be presumed. The construction placed on the transaction for gift tax purposes has no bearing with respect to the basis accorded the transferred property for income tax purposes. Since the court found that the transfer was not a gift, the basis of the property to P was its fair market value on the date of transfer. Concise Rule: No gift occurs for the purpose of computing the donee’s basis in property received in exchange for a promise to marry and the release of marital rights. Additional notes: Arm’s length transfers of any valuable inchoate right dispel a gift presumption. If a family member transfers to another family member in exchange for an assignment of heirship rights, if any, bargained for consideration exists unless the value of the transferred property so exceeds the value of the right given up that a donative intent can be inferred, the intent of the donor in such cases is normally controlling.
3. Property Acquired Between Spouses or Incident to Divorce – page 124 §1041 Regulations: 1.1041-1T(a) and (d)
Except for the purposes of determining loss on the sale of the property, the basis of property in the hands of a donee is the same basis the property had in the hands of the donor, §1015
§1041 accords almost complete tax neutrality to transfers of property between spouses and between former spouses and between former spouses if, in the latter instance, the transfer is incident to divorce. No gain or loss is recognized, this rule applies whether the transfer of property is for cash or other property, for the relinquiment of marital rights or for any other consideration or for the assumption of liabilities in excess of basis (unless the transfer is to a trust).
When is a sale-purchase not a sale-purchase? When §1041 applies.
Page 125- In the case of any transfer of property between spouses or former spouses, the transferee is treated as if the property were acquired by gift, and the basis of the property in the hand of the transferee is the same as the basis of the property in the hands of the transferor. Unlike the gift basis rule, the §1041 transferee spouse or former spouse always takes a transferred basis, even for computing loss.
Page 126 – Property Acquired from a Decedent: §1014(a), (b)(1) and 6 (e) Regulations §1.1014-1(a) – 3(a)
Under §1014(a) property acquired from a decedent generally receives a basis equal to its fair market value on the date on which it was valued for federal estate tax purposes.
The effect of this rule is that it gives the item a “stepped up” basis with no income tax cost to anyone, and of course a stepped down basis occurs without deductible loss if the property declined in value during the decedent’s ownership
§1014 applies not only to property held by the decedent at death, but also to some property that a decedent transferred during life if the value of the property is nevertheless required to be included in decedent’s gross estate for federal estate tax purposes
If appreciated property is acquired by a decedent within the one year period ending on decedent’s death, and if the property passes from the decedent back to the donor or the donor’s spouse the adjusted basis of the property is the same as in the hands of the decedent immediately prior to her death. Example, if a some buys a piece of property for $20,000 worth $100,000, transfers to mom, then upon death mom transfers back the basis is the $100,000; see §1014(e).
C. The Amount Realized: §1001(b) Regulations: 1.1001-1(a) – 2(b)
International Freighting Corporation v. Commissioner (1943) – Page 128
Dupont owned all the shares of IFC (P) from 1933-1935 and two-thirds of the shares in 1936. During those years, IFC informally adopted Dupont’s bonus plan for its employees. Class B bonuses were awarded to employees who contributed the most to IFC’s success in a general way. The bonuses were funded by profits set aside by IFC. There was no requirement that the entire bonus fund be used, and the program could be discontinued at any time. In 1936, IFC paid to the class B award winners certificates representing 150 shares of Dupont stock, consisting of $16,153.36, and having a market value of $24,858.75. Each recipient paid income tax on the market value of the stock received. IFC took a deduction of $24,858. In a notice of deficiency, the Commissioner reduced the deduction of 16,153, and recalculated IFC’s tax finding a deficiency of $2,156. IFC petitioned the Tax court for a redetermination of deficiency. The Tax court upheld the deduction of $24,858 but also held that IFC realized a taxable profit of $8,705, the difference between the market value and the cost of stock. The deficiency resulting from the decision was the same, $2,156, the decision was appealed. Issue: Does an employer who pays bonuses in stock realize a taxable gain if the market value of the stock at the time the bonus is paid is greater than the cost of the stock to the employer?
Holding: Yes, an employer who pays bonuses in stock realizes a taxable gain if the market value of the stock at the time the bonus was given is greater than the cost of the stock to the employer. The Tax Court was correct in allowing the deduction for the full market value of the shares as the payment depleted IFC’s assets in an amount equal to that market value. The delivery of shares was not a gift, but compensation for services rendered. The basis of the shares is their cost, and the gain realized is the excess of the amount realized from the disposition over the basis. Concise rule: An employer who pays bonuses in stock realizes a taxable gain if the market value of the stock at the time the bonus is paid is greater than the cost of the stock to the employer. Additional note: gain must also be realized under §1002
Crane v. Commissioner (1947) – Page 131: Crane (P) inherited an apartment building. The building has a mortgage on it which when combined with unpaid interest exactly equaled the estate tax appraisers valuation of the building and property. P did not assume the mortgage, she agreed to remit the net rental proceeds after taxes to the mortgagor, some six years later faced with foreclosure P sold the property and received $2,500 net in cash for it. P included $1250 in her income for the year on the theory that the property was a capital asset; her original basis was zero; and therefore, one-half the profits had to be included as income from the sale of a capital asset. The commissioner levied a deficiency tax, claiming that basis is fair market value at the time of acquisition less allowable depreciation. Therefore, P realized a gain of $2,500 in cash plus six years of depreciation deductions totaling $23,767. P argued that only her equity in the property could be considered as her basis, since it was zero to begin with, no depreciation was allowed, since she only realized $2,500 in cash, this was all that could be taxed. Issue: Is basis based on the fair market value at date of acquisition rather than equity?
Holding: Yes, §113(a)(5) states that the basis for property received by inheritance is the fair market value of the property on the date of acquisition. Value is nowhere defined or treated synonymous with equity, therefore petitioner’s basis was $262,045 i.e. the fair market value at date of acquisition. The building is subject to wear and tear; see §113(b)(1)(B) requires that proper adjustments to basis shall be made in such cases. Adjusted basis is defined under §113(b)(1)(B) as the basis less allowance for depreciation of he asset whether or not actual deductions were taken. The difference between the selling price and P’s adjusted basis is $23,767; P actually took most of the deductions allowed her by law. P used these deductions to reduce her income; P cannot be allowed to benefit from such a deduction with no corresponding gain as of the date of sale. P actually realized $2,500 in cash plus all her allowable deductions over six years. Concise rule: In computing basis, it is the fair market value of the property rather than the purchaser’s equity, which determines the basis.
Commissioner v. Tufts (1983) – Page 140: Tufts (P) and others entered into a partnership with Pelt, a builder who previously entered into an agreement with Farm and Home Savings to transfer a note and deed of trust to the bank in return for a loan to construct an apartment complex in the amount of $1,851,500. The loan was made on a non-recourse basis in that neither the partnership nor the partners assumed personal responsibility for repayment. A year after construction was completed, the partnership could not make the mortgage payments, and each partner sold his interest in Bayles. The fair market value of the property at the time did not exceed $1.4 million. As consideration, Bayles paid each partner’s sales expenses and assumed the mortgage. The IRS assessed a deficiency against each partner, contending the assumption of the mortgage constituted the creation of taxable gain to each of them, which they failed to report. P and the others sued for a redetermination, contending that no gain was realized because the mortgage exceeded the fair market value of the property. The Tax Court upheld the deficiencies and the court of appeals reversed, Cert was granted Issue: Does the assumption of a non-recourse mortgage constitute a taxable gain to the mortgagor even if the mortgage exceeds the fair market value of the property?
Holding: Yes, The assumption of a non-recourse mortgage constitutes a taxable gain to the mortgagor even if the mortgage exceeds the fair market value of the property. When a mortgage executed the amount is included, tax free, in the mortgagor’s basis of the property. The amount is tax free because of the mortgagor’s obligation to repay. Unless the outstanding amount of an assumed mortgage is calculated in the seller’s amount realized, the money originally received in the mortgage transaction will forever escape taxation. When the obligation to repay is canceled the mortgagor is relived of his responsibility repay the amount he originally received. Therefore he realizes value to the extent of he relief from the debt. When the obligation is assumed it is as if the mortgagor was paid the amount in cash and then paid the mortgage off. As such it is clearly income and taxable. Reversed Concise rule: The assumption of a non-recourse mortgage constitutes a taxable gain to the mortgagor even if the mortgage exceeds the fair market value of the property. Additional notes: This case illustrates cost basis of property under §1012 is the cost of the property includeing any amount paid with borrowed funds.
Diedrich v. Commissioner (1982) – Page 147: Both Mrs. Grant (P) and the Diedrichs (P) had made certain gifts conditioned upon the donee of each gift paying the resulting gift taxes. The cases were consolidated before the Supreme Court to resolve a conflict among the circuits as to whether the commissioner (D) was correct in his position that a donor who makes a gift of property on condition that the donee pay the resulting gift tax received taxable income to the extent that the gift tax paid by the donee exceeds the donor’s adjusted basis in the property transferred. Issue: Does the donor realize taxable income to the extent that the gift taxes paid by the donee as a condition of the gift exceed the donor’s adjusted basis in property transferred?
Holding: Yes, to the extent the gift taxes paid by a donee as a condition of the gift exceed the donor’s adjusted basis in the property transferred, the donor realizes taxable income. It has been recognized that income may be realized by a variety of indirect means. In Old Colony, payment of an employee’s income taxes by an employer was held to constitute income. In Crane, relief from the obligation of a non-recourse mortgage (in that case the value of the property exceeded the value of the mortgage) was held to constitute income to the taxpayer. The principles of these cases control and dictate that when, as in the cases at bar, the donor realizes an immediate economic benefit by the donee’s assumption of the donor’s legal obligation to pay the gift tax, it can be considered as income. Concise rule: A donor who makes a gift of property on condition that the donee pay the resulting gift taxes realizes taxable income to the extent that the gift taxes paid by the donee exceed the donor’s adjusted basis in the property transferred. Additional notes: In essence, the Commissioner treats such conditional gifts as part gift and part sale, it is viewed as sold the property to the donee for the amount of gift taxes paid by the donee (which is generally less than fair market value, the balance of the property is seen as a gift.
#18 - DAMAGES
A. Introduction Code: Sections: 104(a)(2),(3), Reg: Sections: 1.104-1(c), (d) Amounts received as damages or reimbursements, for damages are governed in part by statute. Code Sections 104-106 contain most of the tax rules on compensation for injuries and sickness.
Raytheon Production Corporation v. Commissioner Facts: Taxpayer settled a lawsuit under the Federal Anti-Trust Laws against R.C.A.
Issue: Was the settlement required to be included in gross income?
Reasoning: Damages in an antitrust action are not necessarily nontaxable as a return of capital. Recoveries which represent a reimbursement for lost profits are income. (Since profits would be taxable income, the proceeds of litigation which are their substitute, are taxable in like manner.) The question is "In lieu of what were the damages awarded?" Compensation for the loss of Raytheon's good will in excess of its cost is gross income.
Problems (p. 185) 1(c). P's suit was based on a breach of a business contract and P recovered $8,000 for lost profits and also recovered $16,000 of punitive damages. $8,000 taxable (Raytheon) $16,000 taxable (Glenshaw)
1(d). P's suit was based on a claim of injury to the goodwill of P's business arising from a breach of a business contract. P had a $4,000 basis for the goodwill. The goodwill was worth $10,000 at the time of the breach on contract.
(1).What result to P if the suit is settled for $10,000 in a situation where the goodwill was totally destroyed? $6,000 gain (Raytheon - compensation in excess of its cost is gross income)
(2). What result if P recovers $4,000 because the goodwill was partially destroyed and was worth $6,000 after the breach of contract? No Tax (Basis=$4,000, Damage=$4,000)
(3). What result if P recovers only $2,000 because the goodwill was worth $8,000 after the breach of contract? No tax, $2,000 reduced basis.
IRC: Sections 104(a); 105(a)-(c) and (e); 106(a) Reg: 1.104-1(a), (c), (d); 1-105-1(a),-2, -3; 1.106-1. The premise of §104 and §106 is the taxpayer has suffered enough already.
a. If an employer directly or indirectly reimburses an employee for expenses of medical care for the employee or the employee's spouse or dependents, the amount received is excluded for gross income.
Revenue Ruling 79-313 Taxpayer sustained severe and permanent personal injuries as the result of being struck by an automobile. Taxpayer brought action against X, who had insurance through M. Suit settled with 50 annual payments, each annual payment to be increase by 5% over that amount of the preceding payment.
Are payments excludable for gross income?
Yes. Under §104(a)(2), all payments received by the taxpayer, pursuant to the settlement agreement, are excludable for gross income. Problems (P. 192)
#19 - MARRIAGE, DIVORCE AND SEPARATION
A. Classification of Taxpayers and Rates I.R.C.: Sections 1; 2; 68; 151(d)(3) and (4); 6013(a) and (d).
Note: For many years all individuals were taxed under a single set of tax rates. In 1930, the Supreme Court held that in community property state earnings and other income of either spouse were taxable 1/2 to each spouse.
Note: Use of the joint return by married persons is elective and is allowed only if the requirements of §6013 are satisfied. A consequence of doing so is joint and several liability, not only for tax reported, but also for deficiencies and interest and possibly civil penalties.
Note: "Sham Transactions" a term given by the Service to married couples who travel to a winter vacation resort at the end of the year, to obtain a divorce and desirable single tax status by New Year's Eve, and return home to remarry after the New Year. In the 1st judicial confrontation, the court concluded that as both parties were domiciled in their home state its courts would not recognize their divorces, because the foreign courts lack subject matter jurisdiction.
Note: §6012 is the requirement to file a return. Most, but no all, are required to file.
Problems (P. 956)
***** SEPARATION AND DIVORCE A. Alimony And Separate Maintenance Payments I.R.C.: Sections 71 (omit ©(2) and (3)); 215(a) and (b); 7701(a)(17).
A payment that is made in cash (or check or money order) qualifies as alimony or as separate maintenance, if five requirements are met:
Problems (p. 202)
I.R.C.: Section 71(b)(1)(A)
Note: If payments are made merely to maintain property owned by the payor spouse that is simply used by the payee spouse, they do not qualify as indirect alimony payments. These include premium payments on life insurance or mortgage payments on real property where the underlying property is owned by the payor spouse. However, if payments are made in satisfaction of a legal obligation exclusively that of the payee spouse and are applicable with respect to property in which the payor spouse has no legal interest, such indirect payments qualify as deductible alimony.
I.T. 4001 Advice is requested whether premiums paid by a husband on (1) a life insurance policy assigned to his former wife and with respect to which she is the irrevocable beneficiary, and (2) a life insurance policy not assigned to the wife and with respect to which she is only the contingent beneficiary are includible in the gross income of the wife under §71(a) and deductible under §215. In the instant case, the husband and his former wife entered into a property settlement agreement which provides, in addition to monthly support, husband pay premiums on two life insurance policies covering the husband's life. The 1st is assigned absolutely to the wife, as the irrevocable beneficiary. |