Gross Income Flashcards

Question

Loans | (as gross income)

Answer 1

_Item not income_ ## Footnote Did the taxpayer borrow the amount received under a consensual arrangement under which the taxpayer has an obligation to repay the lender? If yes, the transaction is a loan and the taxpayer does not have gross income from the transaction. A borrower does not have an “accession to wealth” from the receipt of loan proceeds because there is an offsetting liability to repay the amount borrowed.

Answer 2

_Item not income_ ## Footnote Is the taxpayer under an obligation to repay the amount received upon the occurrence of a contingency that is outside the taxpayer’s control? If yes, the taxpayer has received a deposit and there is no inclusion in gross income until such time as the contingency lapses and the taxpayer is entitled to keep the amount received. *Commissioner v. Indianapolis Power & Light Company,* 493 U.S. 203 (1990). Thus, for example, a damage deposit received by a landlord from a new tenant is not gross income to the landlord at the time of receipt because the tenant retains the power to reclaim the deposit upon surrendering an undamaged and clean premises to the landlord upon termination of the lease. If the premises is damaged to the point that the lease agreement permits the landlord to retain the damage deposit, the landlord then has gross income.

Answer 3

Does the income represent compensation for services, or is the income item attributable to services performed by a person? If yes, then the income is generally taxed to the person who performed the services, not necessarily the person who receives the income. *Lucas v. Earl*, 281 U.S. 111 (1929). * **_Earner Has No Rights to Income_** — If the person performing the services has no right to receive the income, the income cannot be taxed to that person even though he or she performed the services that generated the income. For example, in *Teschner v. Commissioner*, 38 T.C. 1003 (1962), a father entered a contest that would award an education annuity to an individual who was under a stipulated age. The father named his daughter as the beneficiary on the contest entry form. The taxpayer’s entry form was selected as the winner, and the prize was awarded to the daughter. The Tax Court held that the daughter should be taxed on the value of the prize and not the father, for although he performed the services necessary to generate the income, he was never entitled to have the income and had no claim to it under the contest rules. * **_Direction and Control_** — If the service provider has the final say as to who receives the income, the service provider will be the one who is taxed. If the service provider disclaims all rights to the income and such income passes to person related to the service provider, the service provider likely would not be taxed on the income because the service provider had no control over the recipient of the income. See *Commissioner v. Giannini*, 129 F.2d 638 (9th Cir. 1942). If, however, the service provider knows that a disclaimer will cause the income to be paid to the related person, the Internal Revenue Service might succeed in claiming that the service provider indirectly controlled the payment of the income and therefore should still be taxed on it.

Answer 4

Is the income attributable to property? Examples include rents from an apartment complex, royalties on a copyright, interest on a promissory note, damages on a cause of action, and dividends on stock. If yes, the income will generally be taxed to the person who owns the property. *Helvering v. Horst*, 311 U.S. 112 (1940). The income is said to be the “fruit” of the property “tree,” and the fruit must be taxed to the person who owns the tree when the fruit is realized. * **_Transfer the Property to Assign the Income_**— Accordingly, if a taxpayer wants to assign income from property to another person, the taxpayer must generally assign the entire property to the desired person. In Horst, a father attempted to assign interest income from a coupon bond to his son by giving the interest coupons to the son. Because the father retained the bond, however, the Court held that the father was the person to be taxed on the interest income and not the son. A different result may have occurred if the father had transferred the entire bond to the son. * **_Exception for Transfers of Property with Vested Income_** — If the taxpayer assigns property that already has vested income associated with it (a tree with ripe fruit?), the taxpayer may still be the person taxed on such vested income. In *Salvatore v. Commissioner,* T.C. Memo. 1970–30, for example, the taxpayer conveyed a one-half interest in a gas station to her children after accepting an offer from Texaco to sell the entire property. The court held that the entire gain from the sale to Texaco should be taxed to the taxpayer because her conveyance to the children was merely a single step in an overall plan to sell the entire property to Texaco. It was no different, said the court, than if the taxpayer sold the entire property to Texaco herself and then gave half of the cash to her children. * **_Exception to Exception_** — Even if property has vested income associated with it, a taxpayer can effectively shift such income by selling the property to the transferee instead of gifting it. In *Estate of Stranahan v. Commissioner,* 472 F.2d 867 (6th Cir. 1973), for instance, the taxpayer wanted to recognize some income to offset a substantial interest expense deduction for the year at issue. So the taxpayer sold his rights to $123,000 in future dividends on stock to his son for $115,000 (the present value of the $123,000 that would be paid over time). The Tax Court held that the dividends ultimately paid to the son should be taxed to the son because the prior sale of the property interest (the right to dividends) was not a gratuitous transfer to any extent.

Answer 5

_Item Not Income_ ## Footnote IRC § 101(a)(1) excludes amounts received under a life insurance contract if such amounts are paid because of the death of the insured. There are two general exceptions to this exclusion. The first is the “transfer-for value rule” set forth in IRC § 101(a)(2). If the owner-beneficiary of a policy acquired it for “valuable consideration,” the exclusion is limited to the sum of the consideration paid and any amounts (including premiums) paid after the transfer by the owner-beneficiary. The other exception applies to installment payments of death benefits. Under IRC § 101(d), to the extent any such installment payment represents interest, such portion must be included in gross income.

Answer 6

Item Not Income ## Footnote The exclusion in IRC § 102(a) for gifts and bequests is one of the centerpieces of the Internal Revenue Code. The exclusion has been justified on the grounds of administrative convenience, that it softens the burden imposed on transferors by federal estate and gift taxes, and that it encourages generosity and wealth transfers. None of these justifications has been universally embraced, however. In any case, IRC § 102(a) ensures that donees do not have to include the value of gifted or inherited property in gross income. Gifts of income, however, are not eligible for the exclusion, as IRC § 102(b) makes clear. In addition, IRC § 102(c) declares that an employee can never receive a “gift” from an employer. As a result, any property transferred to an employee will likely be treated as compensation income unless a different exclusion provision applies.

Answer 7

_Item Not Income_ ## Footnote The exclusion in IRC § 103 for interest received on state and local bonds effectively represents a federal subsidy to state and local governments. Because the interest is tax-free, state and local governments can sell their bonds at a lower interest rate, making the bonds less expensive for the governmental units to issue. There are several limitations to the exclusion, most attributable to perceived abuses by local governments. For example, a city might issue bonds to finance the development of private businesses, an activity that may be of marginal public benefit. The interest on these “private activity bonds” generally is ineligible for the exclusion.

Answer 8

_Item Not Income_ ## Footnote IRC § 104(a)(2) excludes from gross income most damages received “on account of personal physical injuries or physical sickness.” Punitive damages are not excludable under this rule. The exclusion used to apply to damages received for “personal injury or sickness,” but Congress added the word “physical” (twice, no less) in 1996 after courts interpreted the term “personal injury” to authorize exclusion for any tort recovery. Now it is clear that the taxpayer must receive damages on account of a physical injury or physical sickness to qualify for the exclusion. Congress also added language to IRC § 104(a) to make it clear that emotional distress, by itself, was not a physical injury or physical sickness. Accordingly, taxpayers suing only for emotional distress will recover taxable damages, while taxpayers suing for physical injuries will recover tax-free damages, even if some of those damages compensate for emotional distress.

Answer 9

_Item Not Income_ ## Footnote The Supreme Court held that when a corporation was able to repurchase its own bonds for an amount less than it borrowed from investors, the corporation had gross income equal to the difference. Congress codified that result in IRC § 61(a)(12), which provides that gross income includes income from the discharge of indebtedness. The premise is simple: if a taxpayer borrows money from a lender, there is no gross income because the taxpayer’s additional wealth is offset by the contemporaneous obligation to repay that amount to the lender in the future. If the lender cancels, forgives, or discharges the repayment obligation, then, the rationale for excluding the amount received by the taxpayer has likewise disappeared. Consequently, the amount of the discharged debt is included in gross income. Where the taxpayer is insolvent or bankrupt, however, there is little sense in requiring the taxpayer to include the amount of canceled debt in gross income because there is hardly an accession to the taxpayer’s wealth in these instances. IRC § 108(a) lists five events (bankruptcy, insolvency, and three others) where the canceled debt is excluded from gross income. This exclusion comes at a cost, however; generally, the amount excluded must be applied to reduce the taxpayer’s “tax attributes,” features like loss and credit carryovers and the basis in property that would normally be of benefit to the taxpayer in later years. Thus, one should view IRC § 108(a) not as a permanent exclusion of income but instead as a deferral of income until a later date.

Answer 10

Item Not Income ## Footnote IRC § 109 was expressly enacted to overrule the Supreme Court’s holding that a landlord had gross income upon reclaiming possession of real property from a tenant where the tenant had made permanent improvements to the property. IRC § 109 provides that the value of the improvements is excluded from gross income, but IRC § 1019 then provides that the taxpayer’s basis in the property cannot be adjusted to reflect the value of such improvements. This means that while the landlord will not have gross income upon repossession of the property, the landlord very likely will have gross income in the form of additional gain when the taxpayer later sells the property.

Answer 11

_Item Not Income_ ## Footnote IRC § 117 contains a limited exclusion for certain scholarship and fellowship grants. Recall that prizes and awards are generally included in gross income under IRC § 74(a) (see Chapter 2), so this exclusion provision ensures that two types of scholarships are not subject to tax. The first is a “qualified scholarship,” generally defined as a payment used for tuition and related expenses (but not room and board) by a degree candidate at a nonprofit educational institution. The second is a “qualified tuition reduction” extended to employees of certain education organizations generally for the undergraduate education of the employee, the employee’s spouse, or the employee’s children.

Answer 12

_Item Not Income_ ## Footnote Compensation can come in many forms, and free meals and lodging provided by an employer to an employee (or the employee’s spouse or dependents) would normally qualify as compensation to the employee. But IRC § 119 generally provides that if the meals and lodging are furnished for the convenience of the employer and on the employer’s business premises, the employee can exclude the value of these benefits from gross income. The thinking here is that the primary benefit of the meal or lodging inures to the employer and not the employee.

Answer 13

_Item Not Income_ ## Footnote There are other forms of compensation that arguably benefit the employer more than the employee or which come at little or no cost to the employer. Congress has identified a number of other “fringe benefits” that can be excluded from an employee’s gross income and crammed all of them into IRC § 132. IRC § 132 is a veritable cornucopia of exclusions, including no-additional-cost services, qualified employee discounts, working condition fringes, de minimis fringes, qualified moving expense reimbursements, and much more. It is important to note that all of these excludable benefits apply only to employees and not to self-employed individuals or independent contractors.

Answer 14

**Adjusted basis =** unadjusted basis + additions – reductions \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ **Gain =** amount realized – adjusted basis \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ **Loss =** adjusted basis – amount realized

Answer 15

* Adjusted basis = unadjusted basis + additions – reductions * Gain = amount realized – adjusted basis * Loss = adjusted basis – amount realized **Unadjusted Basis** This is usually cost. However, there are special rules for gifts, inheritances, and tax-free exchanges. * **(1) Cost Basis** — Generally, the basis of property is the cost thereof. It includes cash, mortgages, or other property paid to obtain the asset. Income charged to the taxpayer in acquiring the property also is added to the basis. * **(2) Inter Vivos Gifts** —**** For the purpose of computing gain, the donee takes the donor’s basis; But for loss purposes, the donee’s basis is the fair market value at the time of the gift or the donor’s basis, whichever is less. * **(a) Increase by Gift Tax Paid** — The basis is increased by the gift tax the donor paid, which is attributable to an appreciation in property, but not in excess of the fair market value at the time of the gift. * **(3) Tax-Free Exchanges** — The basis of property in a tax-free exchange is that of the property transferred—adjusted upward for gain recognized and downward for money received on the exchange. * **(4) Inherited Property** — The basis of inherited property in the hands of decedent’s estate or the person inheriting it is the property’s value at the date of death of decedent (or six months later if the alternate valuation date is elected). * **(a) Form in Which Property is Held** * _1) Community Property_ — If decedent and her surviving spouse owned the property as community property, both halves receive a new basis. * _2) Tenants in Common_ — On the death of one tenant in common, the person inheriting the decedent’s interest receives a new basis, but the surviving tenants in common do not. * _3) Joint Tenancy_ — Property owned as joint tenants receives a new basis if includible in the estate for estate tax purposes, and maintains its former basis if excluded from the estate. * **(b) Term Interests** — “Term interests” include life estates, term for years, or an income interest in a trust. Special rules apply to determining the recipient’s basis in the term interest. * **(c) Income in Respect of a Decedent** — This refers to situations wherein income is not taxed to the decedent even though events leading to its realization occurred prior to his death. In these cases income is taxed to the recipient, but a deduction is available if the item was subject to estate tax.

Answer 16

* Adjusted basis = unadjusted basis + additions – reductions * Gain = amount realized – adjusted basis * Loss = adjusted basis – amount realized **Adjusted Basis** is determined by adding to the unadjusted basis all subsequent expenditures chargeable to the asset that were not deductible as current expenses. From the sum is subtracted (i) receipts, losses, or other items properly chargeable to a capital account; and (ii) depreciation, depletion, amortization, or obsolescence allowed.