Chapter 1-4 Flashcards
Chapter 1
Constitutional Authority
Article I, section 8 of the Constitution vests Congress with the power “to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States”; it further empowers Congress “to make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers.”
Chapter 1
Direct Tax
Subject to “direct tax” clause (Article I, section 9): No direct tax allowed unless it is in proportion to population as determined by a census.
Chapter 1
History of Federal Income Tax
- Pre-1861: tariffs, excise and property taxes
- First income tax enacted to pay for Civil War in 1861, expired in 1871
- First permanent income tax passed in 1894, but struck down by Supreme Court as unconstitutional
- Sixteenth Amendment ratified in 1913 made the income tax constitutional
Chapter 1
Sixteenth Amendment
1913: 16th Amendment ratifiedThe Congress shall have the power to lay and collect taxes on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration.
This was the beginning of our current income tax system
Chapter 1
Internal Revenue Code
Title 26 of the U.S. Code (26 U.S. Code §….)
- Internal Revenue Code was enacted in 1939 and subsequently revised in 1954 and 1986
- The current Code is the Internal Revenue Code of 1986, as amended
Chapter 2
Gross Income
What is income?
Income taxed is, by definition, a tax on income. However, the Code does not define “income.” There is no answer to the question.
Economic Approach: As you will see, the Code seems to adopt an economic approach to income. That is, a taxpayer is generally viewed as having some income when he or she receives an economic benefit (whether in cash or property).
Chapter 2
Gross Income
Describe Gross Income - Code section 61?
Section 61(a) defines “gross income” as follows:
Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;
(2) Gross income derived from business;
(3) Gains derived from dealings in property;
(4) Interest;
(5) Rents;
(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;
(13) Distributive share of partnership gross income;
(14) Income in respect of a decedent; and
(15) Income from an interest in an estate or trust.
Chapter 2
Gross Income
Describe Treas. Reg. Section 1.61-1(a)
Treas. Reg. §1.61-1(a): Gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services. Income may be realized, therefore, in the form of services, meals, accommodations, stock, or other property, as well as in cash. Section 61 lists the more common items of gross income for purposes of illustration.
For purposes of further illustration, §1.61-14 mentions several miscellaneous items of gross income not listed specifically in section 61. Gross income, however, is not limited to the items so enumerated.
Taxability of income follows the realization principle from accounting
Realization principle: Revenue is recorded when earned and costs are expensed when incurred.
Income is GENERALLY recognized (taxed) when realized
This is not always the case. Understand the difference between realization and recognition.
Mere appreciation in wealth (economic income) is not considered realized income
It might be more correct to say that an appreciation in wealth (e.g., growth in the value of stock) is realized, but not recognized.
Income is recognized whether it is in the form of cash, or “in-kind” cash equivalents (i.e., property or services)
The amount of income from “in-kind” receipts is equal to the FMV of the property or services
Income does not include recovery of the taxpayer’s capital investment
Chapter 2
Gross Income
Describe code and compensation for service, including fees, commissions and similar items.
Treas. Reg. section 1.61-2(a)(1): Wages, salaries, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury fees, marriage fees and other contributions received by a clergyman for services, pay of persons in the military or naval forces of the United States, retired pay of employees, pensions, and retirement allowances are income to the recipients unless excluded by law. Several special rules apply to members of the Armed Forces, National Oceanic and Atmospheric Administration, and Public Health Service of the United States; see paragraph (b) of this section.
Chapter 2
Gross Income
Describe Miscellaneous Items of Gross Income
Treas. Reg. §1.61-14(a) In general. –In addition to the items enumerated in section 61(a), there are many other kinds of gross income. For example, punitive damages such as treble damages under the antitrust laws and exemplary damages for fraud are gross income. Another person’s payment of the taxpayer’s income taxes constitutes gross income to the taxpayer unless excluded by law. Illegal gains constitute gross income. Treasure trove, to the extent of its value in United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession.
Chapter 2
Gross Income
Review Chapter 2 Cases
Chapter 2 cases / rulings interpreting Code section 61:
Cesarini v. U.S.: Found money is taxable as ordinary income in the year in which the taxpayer attains uncontested possession of it.
Old Colony Trust Co. v. Commissioner: The payment by an employer of the income taxes assessed against his employee constitutes additional taxable income to the employee.
Commissioner v. Glenshaw Glass: The general definition of gross income includes all amounts recovered as the result of a lawsuit that represent an increase in wealth to the recipient and not merely compensation for non-contractual losses.
Charley v. Commissioner: Travel credits accumulated and retained by an employee in the course of his employment constitute gross income subject to taxation.
Chapter 2
Gross Income
Review Chapter 2 Cases cont..
Chapter 2 cases, cont’d:
Helvering v. Independent Life Ins. Co: The rental value of buildings used by their owners is not taxable income.
Rev. Rul. 79-24: Certain members of barter clubs must include in income the fair market value of services received in exchange for services rendered. Likewise, the owner of an apartment building who receives a work of art created by a professional artist in return for the rent-free use of an apartment must include in income the fair market value of the work of art, and the artist must include the fair rental value of the apartment.
Dean v. Commissioner: The fair rental value of premises occupied by taxpayer (who is not the owner) without payment of rent constitutes income which must be included in such taxpayer’s gross income.
Chapter 2
Gross Income
Review Cesarini Case
Facts: The Cesarinis (taxpayer) purchased a used piano in 1957. In 1964 they found $4,467 in cash hidden in the piano. This was included as ordinary income in their 1964 tax return. In 1965, the taxpayer filed for a refund on the grounds that the $4,467 was not ordinary income under Code §61; that the income, if so deemed, should have been filed in 1957 and therefore a claim by the U.S. was barred by the three-year statute of limitations; and that if any tax were assessed it should be a capital gains tax. The IRS denied the refund and the taxpayers appealed to the district court.
Issue: Is found money includable as ordinary income?
Holding and Decision: Yes. Found money is taxable ordinary income in the year in which the taxpayer obtains undisputed control over it.
Chapter 2
Gross Income
Case Cesarini Rationale:
Rationale: Section 61 (a) states that all income shall be included in gross income unless specifically excepted. No exceptions exempt found funds from gross income. Therefore, the $4,467 must be included as gross income under §61(a). Revenue Ruling 61 (1953) states that treasure trove must be included as income in the year in which it is reduced to undisputed possession. Here, the money was not reduced to undisputed possession until 1964, when it was found and it was determined that no other claimant existed. The taxpayers cannot prevail on the theory that it was a gift, since found money does not fit within the definition of “gift.” Finally, the finding of money does not entitle the taxpayers to capital gains treatment. Denied.
Chapter 2
Gross Income
Exclusion
An exclusion from gross income means that the item is simply not included in gross income, so that it never enters the computation of taxable income.
Compare to a deduction: A deduction is a subtraction from income in computing taxable income. Both a deduction and exclusion will reduce taxable income. However, the process by which each works is very different. Excluding an item from gross income means that the item will forever escape the income tax. A deduction, by contrast, will offset (or shelter) an equal amount of income so that the amount of income will not be taxed.
Interpret narrowly: Exclusions are matters of legislative grace, and in order for an item to be excluded from gross income, it must meet the specific requirements of a statute allowing an exclusion.
Exclusions are generally found in Sections 101 through 150
Chapter 3
Exclusion of Gifts and Inheritances
What’s the general rule?
102(a) GENERAL RULE. –Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.
102(b) INCOME. --Subsection (a) shall not exclude from gross income -- 102(b)(1) the income from any property referred to in subsection (a); or 102(b)(2) where the gift, bequest, devise, or inheritance is of income from property, the amount of such income. Where, under the terms of the gift, bequest, devise, or inheritance, the payment, crediting, or distribution thereof is to be made at intervals, then, to the extent that it is paid or credited or to be distributed out of income from property, it shall be treated for purposes of paragraph (2) as a gift, bequest, devise, or inheritance of income from property. Any amount included in the gross income of a beneficiary under subchapter J shall be treated for purposes of paragraph (2) as a gift, bequest, devise, or inheritance of income from property.
Chapter 3
Exclusion of Gifts and Inheritances
what is the Employee gifts rule 102(c)?
102(c) EMPLOYEE GIFTS
102(c)(1) IN GENERAL. –Subsection (a) shall not exclude from gross income any amount transferred by or for an employer to, or for the benefit of, an employee.
102(c)(2) CROSS REFERENCES. –For provisions excluding certain employee achievement awards from gross income, see section 74(c).
For provisions excluding certain de minimis fringes from gross income, see section 132(e).
Chapter 3
Exclusion of Gifts and Inheritances
What is the general rule 1.102-1(a)?
Treas. Reg. section 1.102-1 (a) General rule. –Property received as a gift, or received under a will or under statutes of descent and distribution, is not includible in gross income, although the income from such property is includible in gross income. An amount of principal paid under a marriage settlement is a gift. However, see section 71 and the regulations thereunder for rules relating to alimony or allowances paid upon divorce or separation. Section 102 does not apply to prizes and awards (see section 74 and §1.74-1) nor to scholarships and fellowship grants (see section 117 and the regulations thereunder).
Chapter 3
Exclusion of Gifts and Inheritances
What is the general rule 1.102-1(b)?
Treas. Reg. section 1.102-1(b) Income from gifts and inheritances. –The income from any property received as a gift, or under a will or statute of descent and distribution shall not be excluded from gross income under paragraph (a) of this section.
Chapter 3
Exclusion of Gifts and Inheritances
Why is gifts or inheritance excluded from gross income?
Clearly, a gift or inheritance is an accession to wealth. Is it any different than a treasure trove? So…why are these excluded from gross income? Some potential rationales:
Support: Most gifts occur within families and look like support. How do we distinguish support from a gift?
Estate and Gift Tax: The decedent / donor may be subject to estate or gift tax on a bequest/gift. Causing the donee to recognize income on receipt of the gift would subject the amount to two tax regimes.
Chapter 3
Exclusion of Gifts and Inheritances
Examples of why gifts and inheritance are non taxable
Gifts are nontaxable to donee if:
Transfer is voluntary without adequate consideration, and
Made out of affection, respect, admiration, charity, or donative intent
Inheritances are nontaxable to beneficiary
Devise: Real property
Bequest: Personal property / cash
Income earned on gifts or inheritances is taxable under normal rules
Example: Father gifts corporate bond to daughter. Gift is excluded from daughter’s gross income, but interest income earned after gift date is taxable to her.
Chapter 3
Exclusion of Gifts and Inheritances
Exceptions
Transfers by employers to employees do not qualify as excludible gifts
Exceptions:
May be excludible under other provisions, e.g., employee achievement awards
Victims of a qualified disaster who are reimbursed by their employers for living expenses, funeral expenses, and property damage can exclude the payments from gross income
Chapter 3
Exclusion of Gifts and Inheritances
Case review:
Commissioner v. Duberstein
Lyeth v. Hoey
Wolder v. Commissioner
Commissioner v. Duberstein: In order to be a gift under §102, amounts received must have been given with a “detached and disinterested generosity.“
Lyeth v. Hoey: Money received from the compromise of a will contest is received through inheritance and is exempt from income tax.
Wolder v. Commissioner: Where a bequest is made by contract to satisfy an obligation, its receipt is income, taxable under §61 of the Internal Revenue Code of 1954, and not excludable under §102.
Chapter 4
Exclusions: Employee Benefits
What code section is Fringe Benefits?
What code section is Meals and Lodging?
Fringe Benefits: Code section 132 (omit (j)(2) and (5), (m), and (n)) Code sections 61(a)(1), 79, 93, 112, 125 Treas. Regs.: 1.61-1(a) 1.61-21(a)(1) and (2); (b)(1) and (2) Meals & Lodging: Code § §107, 119(a), 119(d) Treas. Reg. §1.119-1
