Tax Outline

OVERVIEW Approach 1) 2) 3) 4) 5) Is it income? When is it income? Whose income is it? How much income? What kind of income is it? Steps to Determining Income Tax Gross Income (§ 61) - Above-The-Line Deductions (§ 62) ------------------------- Adjusted Gross Income (§ 62) - Below-the-Line Deductions: Itemized Deductions OR Standard Deduction (§§ 63, 67) ------------------------- Taxable Income (Apply the tax rate schedules (§ 1(j)) ------------------------- Tax liability - Credits ------------------------- Final tax liability What is Income? No universally accepted definition - Most widely accepted is Haig-Simons: income = consumption + ∆ savings This is an economic ideal for income tax - Gross income is defined in § 61 as "all income from whatever source derived" (includes non-exhaustive list of what is income) o Includes compensation for services § 61(a): barring exceptions, income includes… (1) Compensation for services, including fees, commissioners, fringe benefits, and similar items; (2) Gross income derived from business; (3) Gains derived from dealings in property; (4) Interest; (5) Rents; 1 (6) Royalties (7) Dividends (8) Annuities (9) Income from life insurance and endowment contracts (10) Pensions (11) Income from discharge of indebtedness (12) Distributive share of partnership gross income; (13) Income in respect of decedent; and (14) Income from an interest in estate or trust What is Deductible? Steps for determining what is deductible: 1) If in § 62, take above the line deduction 2) If in § 67, take below the line deduction 3) If not in § 67, then MID and thus not deductible § 62(a)(1): business deductions which are attributable to a trade or business carried on by the taxpayer, so long as that does not consist of the performance of services by the taxpayer as an employee § 62: following are above-the-line deductions… (1) Trade and business deductions (§ 162) (2) Certain trade and business deductions of employers (A) Reimbursed expenses of employees (B) Certain expenses of performing artists (C) Certain expenses of officials (D) Certain expenses of elementary and secondary school teachers a. Not in excess of $250 b. Must be in connection with materials needed in the classroom (E) Certain expenses of members of reserve components (3) Losses from sale or exchange of property (4) Deductions attributable to rents and royalties (under §§ 161 and 212) (17) Interest on education loans (§ 221) (18) Higher education expenses (§ 222) (20) Costs involving discrimination suits (21) Attorneys' fees relating to awards to whistleblowers § 67(b): following are below the line deductions… (1) Interest payments under § 163 (2) State and local taxes under § 164 (3) Under § 165(a) for casualty or theft loss described in § 165(c)(2)-(3) or losses described in § 165(d) (4) Charitable contributions and gifts under § 170 (5) Medical expenses under § 213 2 (6) Impairment-related work expenses (7) [] (8) [] (9) [] (10) When annuity payments cease before investment recovered under § 72(b)(3) (11) [] (12) [] Standing 4 courts that tax issues can potentially be brought in: tax court, bankruptcy court (if consequence of bankruptcy), district court, and court of federal claims - In district and federal claims court, you must pay the taxes then sue for refund, whereas in tax court and bankruptcy you don't have to pay first Arizona Christian (2011) - No standing when taxpayer challenged Arizona's tuition tax credit, which allowed Arizona income taxpayers who voluntarily contributed money to a "student tuition organization" (STO) to receive a dollar-for-dollar tax credit - Because respondents challenged a tax credit as opposed to a governmental expenditure, they lack Article III standing under Flast COMPENSATION Payment of Tax by Third-Party Old Colony (1929) - When an employer pays a tax for an employee, that's still income for the employee [If the only thing that counts as taxable income is actual wages, companies would shift towards more of a barter system] o [Grossing up: when your employer pays the full gross amount in taxes so the employee is left with a given after-tax amount] - Income is anything that's compensatory in nature The discharge by a third person of an obligation of his is equivalent to receipt by the person taxed Fringe Benefits § 61(a)(1): fringe benefits are included in gross income 3 § 132: - 132(c): can exclude employee discounts, but anything past the profit margin is taxable income - 132(d): working condition fringes—if employee (not employer) could deduct this under 162, then he can exclude it under 132 - 132(f): qualified transportation fringe is $265 (not $175 as stated in the code, because must account for inflation) - 132(j): nondiscrimination provision Can't just give executives/managers employee discounts and no additional cost Doesn't apply to de minimis, transportation, lodging, and working condition fringes § 119(a): can exclude meals or lodging furnished by employer to taxpayer, spouse, or dependents for the convenience of the employer, BUT ONLY IF - 1) In the case of meals, the meals are furnished on the business premises of the employer; or - 2) In the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment Townsend Industries (8th Cir. 2003) - Company fishing trip was working condition fringe benefit - Reasonable and necessary business expense that was directly related to/associated with the business Gotcher (5th Cir. 1968) - Gotcher's trip to Germany to tour the Volkswagen facilities was untaxed fringe benefit (but his wife's trip was taxable) - Consider taxpayer control over the money (here, VW did all the planning) - Court looks to dominant business purpose in assessing trips Consider the primary purpose of the expense and intention of the payor - "Dominant business purpose" = assessed by determining whether you're doing business for more than 50% of the trip (not counting weekends) Kowalski (1977) - NJ state police trooper cash meal allowances were taxable income Accessions to wealth, clearly realized, and over which employees had complete control - Employee control should be considered Benalia (1937) [NOTE: this was before § 119 was passed] - Manager of Hawaiian resorts and a golf club and his wife occupied a suite of rooms and took meals free of charge at the hotel "entirely for the convenience" of the employer This was necessary because a hotel manager may be summoned at a moment's notice 4 Adams - House was excludable because significant business was done there - [Suggests that entertaining can be business-related and thus a residence can constitute lodging under 119 if employee entertains customers, other employees, etc. there] Hargrove - Homes were not business premises of employer because no taxpayer performed any work at the homes - Significant that it was 22 miles away from the defense facility (although this was closest place of residence to the facility) Turner - Unusual case in which in-kind gift (trip to South America) value was deemed to be value to petitioner rather than fair market value because it was a luxury beyond their means - [Most cases do not follow Turner, and instead use fair market value] Health insurance - § 104(a): gross income doesn't include… o § 104(a)(2): damages received by lawsuit resulting from physical injury or sickness (BUT punitive damages are taxable) § Emotional distress is not considered physical injury or sickness, UNLESS it's actually for medical care for emotional distress (104(a)(6)(B)) o § 104(a)(3): proceeds from health insurance in event of sickness or disability are not taxed - § 105(b): amounts received from employer health plan to pay medical care (or be reimbursed for medical care payment) are excludable BUT sick pay is taxable Can be covered by parents' health insurance until age 27 - § 106: exclusions for premiums paid by employer - § 36B: refundable credit for lower income individuals to help pay for health insurance Discharge of Indebtedness § 108(a): exception for discharge of indebtedness constituting income - § 108 (a)(1)(A): bankruptcy case [e.g. if discharge was taxed, that would likely push that party back into bankruptcy] - § 108 (a)(1)(B): insolvency § 108(a)(3): taxpayer can exclude debt cancellation from income to the extent of his insolvency (i.e. amount excluded is limited to extent to which his liabilities exceed his assets) - § 108 (a)(1)(C): qualified farm indebtedness 5 -- § 108 (a)(1)(D): indebtedness discharged is qualified real property business indebtedness (except if the taxpayer is a C corporation) § 108 (a)(1)(E): indebtedness discharged is qualified principal residence indebtedness which is discharged before Jan. 1, 2018 OR subject to an arrangement that is entered into and evidence in writing before Jan. 1, 2018 § 108(h)(1): amount excluded from gross income by (a)(1)(E) shall be applied to reduce (but not below zero) the basis of the principal residence of the taxpayer § 108(e)(2): excludes from income the discharge of a debt if its payment would've given rise to a deduction § 108(e)(5): allows reduction of debt to be treated as purchase price adjustment (and thus not taxable income) IF… o 1) The debt is that of a purchaser of property to the seller which arose out of the purchase of such property; o 2) The taxpayer is solvent and not in bankruptcy when the debt reduction occurs; AND o 3) debt reduction would otherwise have resulted in discharge of indebtedness § 108(f): gross income does not include any amount from the forgiveness of certain student loans (generally made by a government agency), provided the forgiveness is contingent on the student working for a certain period of time in a certain profession for any of a broad class of employers (e.g. providing health care services to a nonprofit organization, public service, etc.) In a commercial setting, a discharge of indebtedness is not a gift, but in a noncommercial setting (e.g. loan between family members), a discharge may be treated as a gift excludable under § 102. Court has held that it does not matter whether the cancelled debt constitutes principal or interest; either is taxable unless an exception applies (Payne) Hort (1941) - Amount received for cancelation of lease was gross income Zarin v. Commissioner (T.C. 1989) [OVERTURNED IN 3D CIRCUIT, BUT OTHER CIRCUITS HAVE FOUND THIS TO BE GOOD LAW]Settlement of gambling debt with casino was not the type of "property" referenced in 108(e)(5) and therefore the debt reduction was taxable income [Third Circuit: loan was unenforceable under NJ law (and chips were not property to which a debt related) so cannot have cancellation of indebtedness] Bullock (T.C. 2017) - Mother (who was effectively cosigner on loan) didn't receive COD income when son stopped making payments after truck got stolen and insurance only paid portion of outstanding balance Need a bona fide debt for COD to exist 6 Illegal Income § 165(c): taxpayer may deduct payments made in restitution § 6321: government's claim for taxes takes priority over victim's claim for the stolen property Collins (2d. Cir. 1993) - Off-Track Betting employee must pay taxes on the $80k he stole (by placing bets without putting up capital), but he can deduct any restitution he makes - All unlawful gains are taxable (James) Sullivan (1927) - Income of a bootlegger was subject to tax notwithstanding its illegal origin GIFTS, PRIZES, AWARDS, AND SCHOLARSHIPS Gifts § 102: gifts are excluded from income - Donor doesn't deduct and donee doesn't include in income - Section 102(c): gift exclusion does not apply to a transfer from an employer to an employee - Bequests are not included in income Wolder: attorney worked into clients will that his payment for lifetime of attorney fees will be paid by client's estate when client dies because "bequest" was considered income because this was essentially deferred/disguised compensation § 274(b): disallows deduction under § 162 and § 212 for the cost of gifts, UNLESS… - Such costs for all such gifts to that person in the taxable year are less than $25; OR - Gift is a branded item that costs less than $4; OR - Item is "a sign, display rack, or other promotional material to be used on the business premises of the recipient" Duberstein (1960) - Car given to Duberstein (given because he was helpful in suggesting customers to the giver) was income - A gift proceeds from a "detached and disinterested generosity" on the part of the donor Most important consideration is transferor's intent (Bogardus) Yang 7

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