Federal Income Tax Outline

Federal Income Tax

• Mechanics of Determining Individual Tax Liability:

  • 1. Gross income minus Section 62 (above the line) deductions equals adjusted gross income

  • 2. Adjusted gross income minus section 63 deductions to reach taxable income.

  • 3. Taxable income times applicable marginal rate equals tentative tax liability

  • 4. tentative tax liability minus credits equals tax liability

  • OR Alternative Minimum Tax

• Income:

  • Definition:

    • Eisner v. Macomber (p. 46) (1920)

      • Rule: “The gain derived from capital, from labor, or from both combined”

        • Later expanded by Glenshaw Glass

    • Commissioner v. Glenshaw Glass (p. 78) (1955) Current Law

      • Rule: “Gains or profits and income derived from any source whatever.”

      • Expands Eisner v. Macomber to include gains acquired from sources other than capital or labor.

        • Money found in street

        • Prize winnings

        • Gambling winnings

        • Gratuitous transfers

        • Punitive Damages

      • Congress has general taxation power; courts will not impose restrictions on Congress unless Congress has passed a statute restricting itself.

      • Compensatory damages: income because replaces income would have received (later overruled by §104, excluding damages for personal physical injury).

      • Punitive damages: is this from capital, labor? Should it be taxed? Court: yes

      • Reasoning: if it affects your ability to pay, it’s income

    • Old Colony Trust Co. v. Commissioner (p. 50) (1929)

      • Rule: “the discharge by a third person of an obligation to him is equivalent to receipt by the person taxed”

    • Haig-Simons definition (p. 46) (1938)

      • “Personal income may be defined as the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and the end of the period in question.”

      • Impractical - would need receipts of everything you do

    • For gifts as income see below

  • Inclusions (§61)

    • Fringe benefits included except as enumerated in §132

    • Includes but not limited to the following: (may be excepted in other statutes)

      • (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.

    • Constructive Receipt: when a benefit (either at that time or for the future) is treated as a taxable receipt at a certain time – see later on

    • Mutual Exchange of Services

      • In a commercial context: usually taxable

      • In a social context: usually not taxable

      • See also §83 (property transferred in connection with performance or services)

      • Rev. Ruling 79-24 (p. 76) (1979)

        • General Rule: if services are paid for other than in money, the FMV of the property or service taken in payment must be included as income. Assume stipulated price for services is FMV.

        • Facts 1: lawyer and house painter

        • Rule 1: FMV of value of services received by lawyer and the house painter are includible in their gross incomes

        • Facts 2: renter of apartment gave work of art instead of cash

        • Rule 2: FMV of the work of art and the six months fair rental value of the apartment are includible in gross income of the apartment-owner and the artist respectively

    • Damages §104 - (lawsuits)

      • Business:

        • Recovery for lost profits: income (Glenshaw Glass)

        • Recovery for damage to property: include amount recovered over the basis (Inaja Land Co., see below)

        • Punitive damages: include as income (Glenshaw Glass)

          • Even though this is a deterrent, it’s still taxable

      • Personal

        • 104(a)(2): the amount of ALL damages received, other than punitive damages, on account of personal (physical) injuries or sickness is excluded (note that this includes all damages other than punitive damages), see also the following for other exclusions:

          • (a)(1): workers compensation for injuries or sickness

          • (a)(2): all damages from personal physical injury or sickness other than punitive. Includes both lump sum and periodic payments, even if payments will over time exceed the amount of physical damage done.

            • Medical expenses (but check §213)

            • Pain and suffering

            • Lost wages

            • Other non-punitive damages

          • (a)(3): accident health insurance

          • (a)(5): disability income as a result of terrorist or military action

          • Note: there must be physical injury, emotional distress doesn’t count

        • Exclusion provisions of 104(a)(2) apply whether suit or settlement, and whether lump sum or periodic payments, and lump sum sale (JG Wentworth) follow same rules, but income therefrom taxable for JG Wentworth because not from personal injury

          • Once tortfeasor has paid the money, they may deduct it

            • Can deduct upfront if structured settlement, but need to wait for annuity payouts

          • Settlements are judged to see if unreasonable/excessive (Dennis Rodman photographer was seen as purchase of confidentiality, not settlement of purely things related to injury)

          • Interest accrued for structured settlements/periodic payments is also excludable

        • Note: Exclusions offset by previous deductions arising from the same issue. E.g. medical expenses deduction taken in year of accident:

          • 2015: $100k Salary, $18k Med Expenses

            • Deduct in excess of 10% of salary - $8k

          • 2016: $18k judgement (normally deductible)

            • Exclude $10k because you have already deducted $8k/$18k

          • Exclude to the extent that you haven’t deducted

          • See also: tax benefit rule

        • Compensatory damages other than relate to personal physical injury: treated as income (Glenshaw Glass)

          • Emotional distress

          • Dignitary torts (age discrimination, gender discrimination, etc.)

        • Punitive damages: treated as income (Glenshaw Glass)

        • If (d) is a business entity, would usually get deduction for payments to the person π(P)...

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