Tax: Lilly Outline 2
Tax I
Professor Lilly
Casebook Outline
Part Two: Identification of Income Subject to Taxation
Chapter 2: Gross Income: The Scope of Section 61
i.
Is money found
in a piano taxable income?
ii.
Yes, it is.
i.
Did the payment by the employer of the income taxes
assessable against the employee constitute additional taxable income to such
employee?
ii.
Yes.
i.
Whether money received as exemplary damages for fraud or
as the punitive two-thirds portion of a treble-damage antitrust recovery must be
reported by a taxpayer as gross income under s. 22(a) of the Internal Revenue
Code of 1939.
ii.
Punitive damages are considered gross income.
iii.
Undeniable accessions to wealth, clearly realized, and
over which the taxpayers have complete dominion are includable in gross income.
i.
The Charleys challenged the tax court’s determination
that travel credits accumulated by Philip Charley in the course of his
employment with Truesdail laboratories constituted gross income subject to
taxation.
ii.
Travel credits accumulated and retained by an employee n
the course of his employment constitute gross income subject to taxation.
iii.
Travel credits converted to cash are considered taxable
income.
i.
Must a taxpayer include in gross income the rental value
of a building owned and occupied by the taxpayer?
ii.
No. The
rental value of the building used by the owner does not constitute income within
the meaning of the Sixteenth Amendment.
i.
If services are paid for other than in money, the fair
market value of the property or services taken in payment must be included in
income.
i.
Dean and his wife were the sole shareholders of a
corporation that held title to their family residence, which they occupied
without paying any rent to the corporation.
ii.
The court held that the fair rental value of the
premises occupied by a taxpayer without payment of rent constitutes income which
must be included in such taxpayer’s gross income.
Chapter 3: The
Exclusion of Gifts and Inheritances
i.
Not a mere return of capital, and
ii.
Not accompanied by a contemporaneously acknowledged
obligation to repay, and
iii.
Not excluded by any statutory provision.
i.
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.
ii.
The court construes §61 broadly and they construe
exclusions narrowly.
i.
Internal Revenue Code: Section 102(a)
ii.
Section 102 excludes from the gross income of the
recipient the value of cash or property received by gift or inheritance,
regardless of amount.
iii.
Commissioner v. Duberstein
1.
Duberstein received a Cadillac in return for providing a
business associate with some favorable business contacts.
2.
In order to be a gift under Section 102, amounts
received must have been given with a detached and disinterested generosity.
iv.
1.
2.
Same rule as in Duberstein
i.
Internal Revenue Code: Sections 102(c); 274(b).
See Sections 74(c); 132(e); 274(j)
ii.
Proposed Regulations: Section 1.102-1(f)
iii.
The exclusion of §102 does not extend to any transfer
made by an employer to an employee (§102(c)(1)).
These amounts are considered compensation, not gifts.
i.
Lyeth’s grandmother died leaving the bulk of her
inheritance to a church. Lyeth
contested the will and a compromise was made whereby Lyeth and other heirs would
split the inheritance between themselves and the church.
The IRS then taxed the money arguing that the money had befallen Lyeth
via a contract, and not by inheritance.
ii.
Money received from the compromise of a will contest is
received through inheritance and is exempt from income tax.
i.
Whether an attorney contracting to and performing
lifetime legal services for a client receives income when the client, pursuant
to the contract, bequeaths a substantial sum to the attorney in lieu of the
payment of fees during the client’s lifetime.
ii.
Where a bequest is made by contract to satisfy and
obligation, its receipt is income, taxable under §61 of the Internal Revenue
Code of 1954, and not excludable under §102.
Chapter 4: Employee Benefits
i.
Any property or service whose value is so small as to
make required accounting for it unreasonable or administratively impracticable
is excluded as a fringe benefit.
i.
Employees may exclude from gross income the value of the
use of any on-premises athletic facility.
i.
Hatt, president and majority stockholder of a funeral
home corporation, who lived in an apartment located in the building used for the
funeral home, used the
ii.
The value of lodging furnished to an employee may be
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.
Chapter 6: Gain From Dealings in Property
i.
The amount of money received and the fair market value
of property (other than money) received on disposition.
i.
Internal Revenue code: Sections 109; 1011(a); 1012;
1016(a)(1); 1019.
ii.
Regulations: Sections 1.61-2(d)(2)(i); 1.1012-1(a)
iii.
Philadelphia Park Amusement Co. v.
1.
Philadelphia Park Amusement Co deeded its interest in a
bridge to the city iin exchange for a ten-year extension of a franchise.
2.
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.
3.
§1016a
a.
Improvements to property result in an increase in the
basis of the property. See Reg.
§1.1016-2
i.
Internal Revenue Code: Section 1015(a).
See Sections 1015(d)(1)(A), (4) and (6).
ii.
Regulations: Section 1.1015-1(a)
iii.
Taft v. Bowers
1.
Taft was given shares of appreciated stock and contended
her basis was the appreciated value of the stock.
2.
The donee receives the basis of the donor in gift
property.
iv.
Farid-Es-Sultaneh v. Commissioner
1.
Farid-Es-Sultaneh received stock from a premarital
settlement agreement in exchange for the release of dower rights.
2.
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.
i.
Internal Revenue Code: Section 1041(a) and (b)
ii.
Regulations: Section 1.1041-1T(a) and (d)
i.
Internal Revenue Code: Sections 1014(a), (b)(1) and (6),
(e)
ii.
Regulations: Sections 1.1014-3(a); 20.2031-1(b)
i.
Mrs. Crane owned an apartment building that was subject
to a non-recourse mortgage. Over
the years, she claimed depreciation deductions.
She sold it to a buyer subject to the debt.
Mrs. Crane claimed that her only gain was her equity in the building.
She argued that her amount realized could not include the mortgage
assumed because she did not benefit from the buyer’s taking the property subject
to the debt. The Supreme Court held
that her amount realized included the amount of the non-recourse mortgage.
In that case the fair market value of the property exceeded the amount of
the non-recourse debt, and the Supreme Court observed that it did not rule on
the result that would obtain if the property’s fair market value were less than
the debt encumbering the property.
ii.
When the amount of the mortgage is less than the fair
market value of the property, the seller’s amount realized included the debt
assumed, regardless of the nature of the mortgage as recourse or non-recourse.
i.
Tufts contended that the assumption of a mortgage which
exceeded the fair market value of the property by the purchaser was not a
taxable event.
ii.
The assumption of a non-recourse mortgage constitutes a
taxable gain to the mortgager even if the mortgage exceeds the fair market value
of the property.
Chapter 8: Discharge of Indebtedness
i.
Kirby Lumber issued bonds at par value and then later
repurchased some of them in the open market below par.
The IRS contended that the difference between the issuing price and the
repurchase price was a taxable gain to Kirby Lumber.
ii.
The retirement of debt by a corporation for less than
face value represents a realized increase in net worth to the corporation and is
therefore taxable gain.
Chapter 7:
Life Insurance Proceeds and Annuities
Chapter 9:
Damages and Related Receipts
i.
Taxpayer settled a lawsuit under the federal anti-trust
laws against R.C.A. The issue was
whether the settlement was required to be included in the taxpayer’s gross
income. Raytheon is arguing that
the settlement is excludable from its gross income.
ii.
Damages for violation of the anti-trust acts are treated
as income where they represent compensation for lost profits.
i.
Section 104(a)(2)
ii.
Section 106(a)
iii.
Section 104(a)(1)
iv.
Section 104(a)(3)
v.
Sections 104(a)(4) and 104(a)(5)
vi.
Section 105(a)
vii.
Section 105(b)
viii.
Section 105(c)
Chapter 10:
Separation and Divorce
i.
Internal Revenue Code: Section 71 (omit (c)(2) and (3),
(f))); 215(a) and (b); 7701(a)(17)
ii.
Regulations: Section 1.71-1T(a) and (b) (omit Q 6, 7,
11, and 12)
i.
Internal Revenue Code: Section 71(b)(1)(a)
ii.
Regulations: Section 1.71-1T(b)(Q6 and 7)
iii.
I.T. 4001
i.
Internal Revenue Code: Section 71(b)(1)(D), (c)
ii.
Regulations: See Section 1.71-1T(c)
i.
Internal Revenue Code: Sections 215; 682. See Sections
72; 1041.
Chapter 11:
Other Exclusions From Gross Income
IDENTIFICATION OF THE PROPER TAXPAYER
Chapter 12: Assignment of Income
i.
The Earls entered into a contract whereby they agreed
that whatever each acquired in any way during their marriage would be received
and owned by them as joint tenants.
Hence, Mr. Earl claimed that he should be taxed for only half of his income.
ii.
The court held that a statute can tax salaries to those
who earned them and can provide that a tax cannot be escaped by anticipatory
arrangements or contracts which prevent salary from vesting even for a second in
the person who earned it.
i.
Although Gianniini had refused to accept compensation
for his services to the Bancitaly Corporation which then, at Giannini’s
suggestion, donated the money as the corporation saw fit, nevertheless the
Commissioner argued that the donated funds had been “realized” as income to
Giannini.
ii.
The court held that when a taxpayer, by anticipatory
assignment, makes a gift of the interest or compensation which he is entitled to
receive at a future date in return for his present services, he nevertheless
thereby realizes taxable income just as surely as if he had first collected the
income and then himself paid it directly to the donee.
iii.
Ruling in favor of Giannini.
Giannini never received the money, he merely suggested it be used for
another purpose.
i.
Shortly before their due date, Horst detached negotiable
interest coupons from negotiable bonds and gave them to his son who in the same
year collected them at maturity.
ii.
The court held that for income tax purposes the power to
dispose of income is equivalent to ownership of it, and the exercise of that
power to transfer payment of the income to another is the equivalent of
realization of the income.
DEDUCTIONS IN COMPUTING TAXABLE INCOME
Chapter 14: Business Deductions
i.
A taxpayer has no constitutional right to a deduction.
ii.
A taxpayer must find a statutory provision that
specifically allows the deduction claimed.
i.
Internal Revenue Code: Section 162(a)
ii.
Regulations Section 1.162-1(a)
iii.
Welch v. Helvering
1.
A grain commission agent repaid the debts of the
bankrupt corporation he used to work for.
2.
The court held that in order to be deductible, an
expense must be “ordinary” in the business area practiced by the taxpayer.
Ordinary means that it would be accepted practice in a given segment of
the business world. The repayment
of the debts in the case at hand is not considered ordinary.
i.
Internal Revenue Code: Sections 162(a); 263(a)
ii.
Regulations: Sections 1.162-4; 1.263(a)-2 through
(c)(1), (d)(1), (e)(1)(i), (2), (3), (4)(i), -5(a), (b)(1).
iii.
Midland Empire Packing Co, v. Commissioner
iv.
INDOPCO, INC. v. Commissioner
1.
INDOPCo sought to deduct, as a business expense, costs
and fees associated with its friendly takeover by another corporation.
2.
The court held that costs and fees associated with a
corporate acquisition are not deductible as “ordinary and necessary” business
expenses under §162(a).
3.
The burden of proving deductibility of an item rests
with the taxpayer.
i.
Internal Revenue Code:
Sections 161(a); 195; 262
ii.
Regulations: Section 1.195-1(a)
iii.
Morton Frank v. Commissioner
1.
Frank and his wife incurred traveling, telephone, and
legal expenses in investigating opportunities throughout the country in order to
purchase a newspaper. Frank sought
to deduct the expenses from his gross income as ordinary and necessary business
expenses.
2.
The court held that the expenses of investigating and
looking for a new business and trips preparatory to entering a business are not
deductible as ordinary and necessary business expenses incurred in carrying on a
business.
3.
Distinguish Frank from: situations where the
taxpayer has proceeded beyond an initial investigation stage and has entered a
transactional stage, or situations where if Frank had been in a trade or
business and he was seeking to expand that business or some branch of it.
i.
Internal Revenue Code: Section 162(a)(1).
See Sections 162(m); 280G.
ii.
Regulations: Section 1.162-7, -8, -9
iii.
Exacto Spring Corporation v. Commissioner
1.
Exacto paid its president a high salary and deducted the
salary from their income.
iv.
Harolds Club v. Commissioner
1.
Pursuant to an employment agreement, the owners of a
casino paid a large percentage of their profits to their father as salary for
his services as manager.
2.
An unreasonably large salary expense that has not been
determined by a free bargain between the employer and employee may not be
deducted by the employer.
i.
Internal Revenue Code: Section 162(a)(2), 162(a) second
to last sentence; 274(n)(1). See
Sections 162(h); 274(c), (h) and (m)(1) and (3)
ii.
Regulations: Section 1.162-2 (omit-2(c))
iii.
Generally
1.
§162(a) allows a deduction for all the ordinary ad
necessary expenses paid or incurred during the taxable year in carrying on any
trade or business.
2.
§262 however
provides that no deduction is allowed for personal, living, or family expenses.
iv.
Rosenspan v.
1.
Rosenspan was a traveling salesman with no permanent
home. Rosenspan attempted to deduct
as traveling expenses the costs of his meals and lodging.
2.
The court held that §162 permits a deduction for
traveling expenses if and only if such expenses are: (1) “reasonable and
necessary” (2) incurred in connection with business pursuits, and (3) incurred
“while away from home.”
3.
Rosenspan had no home to be away from, therefore he does
not meet the criteria for §162.
v.
Andrews v. Commissioner
1.
Andrews maintained a home in
2.
A person owning a second home in which to reside while
on business may deduct costs associated therewith.
i.
Internal Revenue Code: Sections 162(a); 274(a), (d),
(e), (k), (l) and (n).
ii.
Regulations: See Sections 1.162-20(a)(2); 1.274-2(a)(1),
(c), (d).
iii.
Business Meals and Entertainment
iv.
Uniforms
1.
Deductions for uniforms are allowed only if:
a.
The uniforms are specifically required as a condition of
employment; and
b.
The uniforms are not of a type adaptable to general or
continued usage to the extent that they take the place of ordinary clothing.
v.
Advertising
1.
Generally advertising expenses of a business are
deductible in the year in which they are incurred or paid even though the
benefits may extend over several years.
vi.
Dues
1.
Dues paid to organizatons directly related to one’s
business are deductible under §162.
vii.
Lobbying Expenses
1.
Such expenses are now non-deductible.
i.
Internal Revenue Code: Sections 165(c)(1); 280B
i.
Internal Revenue Code: Sections 167(a), (c); 168(a),
(b), (c), (e)(1) and (2), (f)(1) and (5), (g)(1), (2), and (7), (i)(1);
1016(a)(2). See Section 62(a)(1)
and (4); 168(d); 263(a); 263A
ii.
Regulations: Sections 1.162-4; 1.167(a)-1(a), -10;
1.167(b)-0(a), -1(a), -2(a)
iii.
Prerequisites for Deduction
1.
Depreciation is restricted to:
a.
Property used in a trade or business; or
b.
Property held for the production of income
iv.
The Useful Life Concept
1.
Only property which has an identifiable useful life to
the taxpayer can qualify for deduction.
2.
Salvage value:
Acquisition value minus the cost recovered
v.
Depreciation Methods
1.
Straight-line method
a.
The cost or other basis of the property, less its
estimated salvage value, is deducted in equal annual installments over the
period of its estimated useful life.
2.
Declining balance method
a.
A uniform rate is applied to the unrecovered basis of
the asset.
vi.
The Relationship of Depreciation to Basis
1.
When a taxpayer claims depreciation on property, the
deduction is attended by a commensurate reduction in the basis for the property.
vii.
The Accelerated Cost Recovery System
1.
p. 425 reference reading
Chapter 17:
Restrictions on Deductions
i.
§469 disallows the deduction of passive activity losses
and the usage of passive activity credits.
i.
The passive activity rules apply to individuals, estates
and trusts, closely-held C corporations, and personal service corporations (for
definitions see p. 521).
i.
A passive activity is any business or profit seeking
activity in which the taxpayer-owner does not materially participate.
i.
A passive activity is any activity that involves the
conduct of a trade or business or a transaction entered into for profit in which
the taxpayer does not materially participate.
THE CHARACTERIZATION OF INCOME AND DEDUCTIONS
Chapter 21: Capital Gains and Losses
i.
Capital losses are deductible only to the extent of
capital gains plus, if such losses exceed such gains, an amount of ordinary
income not to exceed the lower of
$3,000 ($1,500 in the case of a married individual filing a separate return) or
the excess of such losses over gains.
i.
Capital losses not utilized in the year incurred are
carried over into subsequent taxable years and treated as long-term or
short-term losses, depending upon their original character.
i.
Losses from sales or exchanges of capital assets shall
be allowed only to the extent of gains from such sales or exchanges.
i.
The Statutory Definition
1.
Internal Revenue Code: Section 1221(a)(1)-(4).
See Sections 1221(a)(5)-(8), (b)
2.
Maudlin v. Commissioner
a.
Having bought certain land for use in a proposed cattle
business, Maudlin found such a venture unsuitable and proceeded to dispose of
the lots in bits and pieces at various times over a 28-year period.
b.
The court held that where the primary use or purpose of
an asset as changed, the primary purpose at the time of sale determines the
nature of the asset for tax purposes.
c.