Federal Personal Income Tax

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4 essential questions

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What is income?
-not a lot of tax law deals with this qn
-Section 61 accession to wealth clearly realized
When is it income? (ALE: litigated more b/c time has $ value) (SJ: Most of what we look at will depend on when becuae most taxpayers want it to come later so they can invest now and make it grow. Time value of money-TP can save by delaying the tax bill)
3. To whom should the income be attribrutable? Divorce, Division
4. What adjustments are appropriate? Deduction-reduction is taxable income. Adjustment we make to income that would otherwise be taxable

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2 supplemental goals

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SJ: Role of pit in shaping public policy in the US-profound impact on shaping behavior.
SJ2: Statutes and regulations
ALE: Substantive greatly affects PP; 1)distro of tax, incentive to own, finance
ALE2: Methodoligical: statutes, regs, this is statutory law

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So, why are you choosing to challenge in tax court?

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Then you don't have to pay taxes first.

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Income tax, talk about it

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income can be distinguished from property, sales, transfer of wealth (like EGT), and various other excise taxes (cigarette or gasoline) taxes. Here, we focus on income. Gets tricky with income on money made on property and estate and gift tax

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Historical perspective from Serianna

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See outline

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History

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there didn't used to be any fed pers income tax, now it's the most significant source of fed income. And more

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Progressivity

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as your income increases, the marginal tax rate increases. Idea is that as income increases, percentage of income paid in tax also increases. Pg. 599 rate table as of 2004.

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What's an important note with progressivity?

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You have to go through the brackets--Bill Gates has to pay 10% on his first 7,150 bucks. Marginal rate is the tax on the last dollar (if it's 35%, that means you're in the bracket that taxes the last dollar 35%).

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When we talk about incentives...

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we focus on marginal rate becuase that is what is affected.

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What is the overall rate

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lesss than marginal because the lower part of income is subject to a lower tax rate.

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3 basic goals of any tax system, first goal

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1. Fairness
a.Horizontal equity: generally we want to treat similarly situated people the same, identical tax consequences for similarly situated people
b.Vertical equity: as we look up and down the income tax ladder, we want a distributional justice sense of fairness, we should treat people with less income better and have them feel less of a pinch

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2nd goal:

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Economic Efficiency-we want to distort economic decisions as little as possible. Getting people to do something (or not do something) b/c of tax consequences is bad and inefficient-we want to avoid this

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3rd goal:

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Administribility: whatever rules we come up with, they must be reasonably administrable. Ie, 50% of business dinners. Problem: sometimes this is just an arbitrary number, just to make more easily administrible.

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First characteristic of income

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Income is a FLOW. Wealth and assets can be frozen in time, not so with income. Income is always measured over a timeframe. Almost everyone is on the calendar year

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Give examples

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i. A paycheck: Salary in cash at the end of each month. The reason this is salary is that it is an increase in wealth from the beginning of the period to the end (aka an accession to wealth).
ii. A check in your hand: form of payment is different but it’s still income. Just a different form. As a matter of fairness and horizontal equity, we want to treat everyone the same.
iii. Random Discovery: Finding 5k on the floor: fairness implications- if someone worked for the money and you just found it, then you wouldn’t be treated fairly if you didn’t have to count it as income. It’s income- it’s still a change in wealth.

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So, what point are we trying to drive home

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Section 61: "an access to wealth clearly realized"
61a gross income defined: Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:

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Wha's the Basis?

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a. Basis: revisited many times this semester. Essential question to grapple with. Idea of keeping track of what someone has already paid to obtain something. Taxpayer’s investment in already taxed dollars. Gain or income in a circumstance like example 2 below is the amount realized (amount received) minus basis (what you’ve already paid to get it).

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Haig Simmons definition:

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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 b/w the beginning and the end to the period in question

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Employer paid rent: (pg. 40, example 1) Alice gets 5k per month for working. Wants the employer to send 1k to her landlord, then give her 4k in cash salary.
Is that 1k income?

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i. Is that 1k income? 61 says it is (from whatever source) Looking at horizontal equity- someone who makes the same amount of money but doesn’t get their employer to directly pay their landlord would be treated differently. Economic efficiency- if we do treat Alice this way as only earning 4k, we would create a whole group of people that would want to do this. Income need not be in the form of cash or cash equivalent.

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Old Colony (1929):

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ER Paid for EEs taxes. Holding: ERs payment of fed income tax on behalf of EE constituted income to the EE.

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Important note for the Old Colony case

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this case preceded thte adoption of the fed income tax witholding. Due to witholdig, it is now routine for ER to make fed income tax payments on EE's behalf and for these payments to be included in EE's gross income

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c. Employer purchased annuity: (pg. 41 example 2) Assume Unitek purchases an annuity policy, naming Alice the beneficiary. Purchase price in 2007 is 10k, and will pay Alice 50k in the future. Two questions-

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i. Year of purchase- any income tax changes for Alice in 2007 when the employer purchases the policy? When looking at this, ask whether Alice is any better off the day after Alice gets the policy in 2007. She’s in a different position the next day. If our definition is ‘a change in wealth’ then her wealth has increased. It shouldn’t matter that it’s not it her hand. The 10k is income in 2007.
ii. Year of payment- income tax changes in 2037 when she is supposed to get 50k? 40k.
iii. Note- if she bought this with her own cash, no tax because she’s already been taxed on the money she’s using to buy it. If it increases in value to 50k, then she would still pay taxes on the 40k.
ALE better: Liquidity problem: the EE doesn't really have the ability to pay. But otherwise, would be a slippery slope b/c you could make everything a deferred payment
i. Rule: the year of ER purchase: pay tax on the amount received in the form of payment for the annuity. Year of payment: pay tax on the remainder. Ie: ER pays 10k for 50k annuity. Alice pays tax on 10k in year of receipt, then upon the maturity of the annuity, she pay the 40k remainder on the policy.
ii. Why? Accession to wealth

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Section 61, Gross income defined

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add

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TR 1.61-1

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i.Gross income means all income from whatever source derived, unless excluded by law. cross-refs are to be found throughout the reg's under section 61. Purpose: to direct attention to more common items
1. 1.61-2: several special rules for: sickness, grants, scholarship, etc.
2. 2d: income paid other than in cash: if prop-than FMV of property
3. Services: FMV of services taken as payment
4. Property exception: to EE it a stock option

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Swag bags example:

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Academy awards, they don't pay presenters, but they do give ridiculous goody bags. This is income

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What is Benaglia showing us

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Employer provided food and lodging, application of Pre 119, income need not be in form of cash.

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What are the different ways we could resolve the problem in Benaglia?

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Tax them on income at fair market value (Benaglia will say too high), income at cost to the hotel (note that neither party would value at or above cost to hotel), income at the the subjective cost to the Benaglias, the cost of alternatives, or not tax them at all.

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Keep in mind that income is the degree to which

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someone has an increase in wealth.

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IRS position in Benaglia

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FMV of room and board is not EXCLUDABLE from income. It is subject to value to him.

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holding of Benaglia:

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Tax board chooses 0, Meals and lodging furnished by employer (or on his behalf) is excluded from income if it is provided for the convenience of the employer (Here it was b/c was required to take as condition of employment, maybe he doesn't want to eat there. Court says 0 value-this isn't true.

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J's critique

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maybe not 7600 value to him, but still some value, people who don't work at the hotel don't get this benefit. Doesn't really facilitate him getting his work done like a desk or computer.

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Dissent of Benaglia

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this was a K for employment and thus clearly compensation for his responsibilities. Q is not convenience to ER but whether it was income to employee

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What does CS do after Benaglia?

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Congress enacts 119 after Ben to clarify things. Sets specific rules for when employer meals and lodging can be excluded from income. Both confirms Benaglia by adopting "convenience of the employer" standard, and overrules it by stating that meals and lodging ARE income but can exclude if meet requirements.

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Suppose that the case of Benaglia v. Commissioner (pp. 42–46 of the casebook) arose today, and that Mr. Benaglia and his wife were provided meals and lodging by his employer, Hawaiian Hotels, Ltd. The facts are otherwise identical to those in the original case, except that §119 is now a part of the Code. Must the Benaglias include the value of their meals and lodging in income? If so, what amount should they include?

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1. What are the requirements for meals and lodging to be excluded from income? Under §119(a)(1), meals provided by an employer are excluded if: (1) they are furnished by or on behalf of the employer to the employee, his spouse, or his dependents; (2) they are provided for the convenience of the employer, and (3) they are provided on the business premises of the employer. Under §119(a)(2), lodging is excluded if all of the above requirements are met and the employee is required to accept such lodging as a condition of her employment.
Turning to Benaglia’s meals, were they furnished by his employer? Yes. For the convenience of his employer? Sure seems like it. Benaglia “was constantly on duty,” and thus it seems he would have met the “convenience of the employer” requirement. In the terms of Reg. §1.119–1, there was a “substantial noncompensatory reason” for the hotel to provide Benaglia the meals. Were the meals furnished on the business premises? Yes. Thus, the meals appear to meet the three requirements of §119.

Was Benaglia required to accept the lodging as a condition of his employment? The opinion is unclear on this point, but Benaglia can at least make a good argument that he was. Indeed, the lodging was part of his acceptance letter. Thus, Benaglia probably would be entitled to exclude from income the value of both the food and the lodging under §119.

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Edith is a San Jose police officer who is on duty from 10 a.m. to 6 p.m. each day. Her employment contract requires that she remain on duty, available for calls and to the public, during her lunch break, and that she remain within the city limits, the scope of her department’s jurisdiction. The San Jose police department reimburses Edith for her lunch expenses up to a maximum of $10 per day, so long as she eats at a restaurant that is located within the city limits. A city ordinance setting out the terms of employment for police officers states that the meals are provided as “a working condition and not part of an officer’s compensation.” Must Edith include in her gross income the amount of her reimbursements?

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Under the decision in Commissioner v. Kowalski, 434 U.S. 77 (1977), and Reg. §1.119–1(e), Edith must include the meal reimbursements in income. Stepping through the various parts of the §119 requirements:

Convenience of the employer? Edith is on call during lunch, so she meets this test. Under the regulations, “convenience of the employer" is a question of fact “to be determined by analysis of all the facts and circumstances of each case.” Reg. §1.119–1(a)(1). The inquiry is whether the meals are furnished “for a substantial noncompensatory business reason of the employer.” Reg. §1–119(a)(2). The regulations further provide that if a meal is furnished "to the employee during his working hours to have the employee available for emergency call during his meal period," it will be regarded as being provided for a "substantial noncompensatory business reason." Reg. §1.119–1(a)(1)(ii)(a). As a police officer on call during her meals, Edith meets this test.

On the employer’s premises? Perhaps. Under Reg. §1.119–1(c), the "'business premises of the employer’ generally means the place of employment of the employee.” Courts have stated that this is a largely factual question. It does not include places merely near business premises. Rather, it only comprises those premises on which the employee performs her duties. Because Edith is an employee of the police department, the entire city may well be considered her “business premises”—her “place of employment.” This is probably a close call, but Edith certainly has a defensible position.
Furnished by the employer? The reimbursements fail on this ground according to the Supreme Court’s decision in Kowalski, now codified in the applicable regulations. The regulations expressly provide that "[t]he exclusion provided by section 119 applies only to meals and lodging furnished in kind by an employer to his employee.” Reg. §1.119–1(e) (emphasis added). Kowalski held that the term "furnished" in §119(a) does not include reimbursements for meals purchased from a third party. Because Edith's meals have not been furnished to her in kind by her employer, they do not meet the requirements of §119, and she must include the reimbursements in income.

Relevance of city ordinance? Section 119(b)(1) states that the provisions of employment contract or state statute “shall not be determinative of whether the meals or lodging are intended as compensation.” This does not mean that the terms of the contract are necessarily irrelevant. Because the arrangement fails the “furnished” test, the reimbursements are not excludable regardless.

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Suppose that, instead of reimbursing Edith for her meals, the police department contracted in advance with a defined group of restaurants in the city to provide meals to its officers, and it paid those restaurants a set amount per month in advance. If Edith eats ten “free” lunches at these restaurants (“free” because she did not pay anything herself at the time she ate), must she include the value of these ten meals in her income?

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For the same reasons discussed above, this meets the convenience of the employer requirement. We still have the same question about whether the meals have been provided on the employer’s premises, an issue over which the courts of appeals split before the Supreme Court decided Kowalski. Have these meals been furnished by Edith’s employer? This is a tougher question. The employer has paid for the meals themselves in advance; by contracting with the restaurants, it effectively has hired them to provide the meals on its behalf. Does this qualify? Surely the food servers need not be employees of the employer for the meals to qualify under §119. (Think of the food service employees here on campus, who are employees of Bon Appetit rather than Santa Clara University.) But here, they are providing the meals in the restaurant, not, say, at the department’s headquarters. I have no idea what the answer should be, but it is an interesting question.

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Priscilla, a contestant on a quiz show, wins a new car. The producer of the show received the car free from the manufacturer because of the advertising value to the manufacturer. The ordinary dealer cost of the car was $30,000, and the “sticker” price was $36,000. Priscilla tried to sell the car, but the best offer she received was $28,000, and she decided to keep it. Was there was a valid business reason for the game show to use the car, rather than cash, as a prize (as there was in Benaglia for providing food and lodging)? If so, does this mean that Priscilla should not be taxed on the value of the car? If not, what amount should she be required to include in income?

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This is clearly income that Priscilla must include. Priscilla is enriched, even if she did not do anything to become enriched. In fact, we know that she has at least $28,000 of income—the price that she turned down for the car. That is, because she had the opportunity to receive $28,000 in cash, we know she has been enriched by at least $28,000. This example demonstrates even more clearly than in Benaglia that the reasons of the transferor (here, the game show) to use a noncash benefit should be irrelevant to determining whether the recipient has received income. Has Priscilla been enriched? Absolutely, and the reasons for the game show to use a car instead of cash are immaterial to answering that question. The difficult question is one of valuation—that is, how much income has Priscilla received? The theoretically correct answer is Priscilla’s subjective value of the car. But this would be a hopelessly inadministrable rule. The options here are $28,000 (amount turned down), $30,000 (cost to dealer), and $36,000 (sticker price). As a general rule, the tax code uses fair market value as the value of property received by a taxpayer. This case is a bit complicated, however, because the fair market value is unclear. Is it the sticker price? Is it the sticker price less the "discount" that normally comes in negotiations with car dealers? Or is it the price that Priscilla was actually offered? There is no clear answer under existing law, and the cases are pretty much all over the map. The important points are that (a) Priscilla has at least $28,000 in income, because this is the amount she could have taken in cash, and (b) forcing her to include $36,000 in income seems a bit unfair, as there is a strong element of forced consumption.

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Talk about Comissioner v. Kowlaski:

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Application of 119. SC held that 119 applies only to meals received "in kind," but not to cash allowance. Meal allowance to state troopers--which they coudl spend or not spend as they chose--was found to be "income" under 61, held not excludable under 119 as not furnished by the employer

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Frequent Flyer Credits

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Credits earned by business travel--clearly income b/c clearly is an accession to wealth and has some value to you, but problems with valuation. IRS says income, but not required to report. But if cash out for personal use then you need to claim as income.

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Problem: how to account/value the miles? Blackout periods, used in combo with other miles; and may never be used.

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FMV of travel tough to determine. Maybe establish a flat fee such as 100 bucks per flight. Also when does accesion of wealth occur? When you take the flight.

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What basically happened with these frequent flyer credits?

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IRS was late in the game here...and C basically said, you're not treating this as income

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What about them earned by personal travel

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Not income because no compensation (Dave, check class notes b/c you might have better explanation)

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Section 132 Fringe benefits and a great explanation by ALE

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Back to 61, all income received, including non-cash comp. The reason for 132 is that there is an element of forced consumption. So IRS has worked out when not to include as income (notes and probs on 55 and 56

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F, a flight attendant in the employ of A, an airline company, and F's spouse decide to spend their annual vacation in Europe. A has a policy whereby any of its employees, along with members of their immediate families, may take a number of personal flights annually for a nominal charge, on a standby basis. F and F's spouse take advantage of this policy and fly to and from Europe

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F and F’s spouse can exclude it from their income as a no-additional-cost service. Because they are flying on a standby basis, there is no substantial additional cost to the airline (that is, no foregone revenue). Immediate family members (spouse and dependent children) may receive the benefit without income tax consequences. See §132(h)(2)(A).

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P is the president of C, a corporation that has its executive offices situated in NY city. P is planning a week-long business trip to LA and will fly there and back on C's corporate jet. P's spouse intends to accompany P on the round trip flight for personal reasons

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Not sure I have an answer to this one

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3. B is an officer in the employ of C, a manufacturing co. C provides personalized financil planning services to all of its officers without charge.

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B must include this in income. Can this fall under any provision of §132? The employer is a manufacturing company. Because financial services are not offered to customers in the ordinary course of business, the benefit cannot qualify as a no additional cost service or a qualified employee discount. It is not a working condition fringe because the benefit is personal, not business-related; it therefore would not be deductible under §162 or §167. It is not a de minimis fringe because the costs are probably significant and could easily be accounted for. (I did not assign §132(m), but would it apply? That provision permits taxpayers to exclude from income the value of “qualified retirement planning services,” defined by the statute as “any retirement planning advice or information provided to an employee and his spouse by an employer maintaining a qualified employer plan.” “Personalized financial planning services” would seem to be different—indeed, much broader—than “retirement planning services.” Thus, these service seem to be beyond the scope of §132(m). Further, these services are only provided by C “to all of its officers,” and §132(m)(2) imposes a nondiscrimination rule. Because the services are only available to C’s officers, B cannot exclude this benefit under §132(m).)

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4. S, a senior vice president of D, a retail dept store, purchases a refridge from D's appliance dept. D has a policy whereby all employees are entitled to a 20% discount from the ticketed sales prices any item sold by the store so long as the resulting sales price, on average, approximately covers D's costs. See 132c, Regs 1.132-3c

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This appears excludable as a qualified employee discount so long as the 20% discount does not exceed the employer’s gross profit percentage for all items sold in the line of business in which the employee works. For property, the permissible discount is the "gross profit percentage," meaning the employer's profit margin (in the preceding tax year) on property sold in the line of business in which the employee works. (The profit percentage on the specific item purchased by the employee is irrelevant, unless the employer has voluntarily chosen to determine its gross profit percentage based on a narrower category of merchandise, which categorization must be “reasonable.” See Reg. 1.132–3(c).) The refrigerator is "qualified property" because it is offered for sale in the ordinary course of the line of business in which the employee works, and it is not real property or property held for investment. See §132(c)(4). Because this discount is available to all employees, it satisfies the nondiscrimination requirement of §132(j)(1).

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5. The facts are the same as in question 4 except that D's profit margin on ticketed items is only 10%, so the resultant sales price does not cover D's costs.

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Half of the discount must be included in S’s income and half is excluded as a qualified employee discount. That portion of the discount in excess of the gross profit percentage—10%—must be included in income. Ten percent counts as a qualified employee discount, but the remaining 10% does not.

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6. The facts are the same as in Question 4 except that the discount is available only to S and other officers of D.

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The entire value of the discount must be included in income. Because the discount is only available to officers of the company, it violates the nondiscrimination requirements of §132(j)(1). And notice how §132(j)(1) is worded: the exclusion does not apply at all to highly compensated employees when the benefit discriminates in favor of highly compensated employees. See also Reg. §1.132–8(a)(1). Thus, for officers of the company—presumably a highly compensated group—none of the discount is excludable.

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7. A, an assistant manager in the employ of D, a dept store, is occassionally required to work overtime to help mark down merchandise for special sales. On those occasional instances, D pays for the actual cost of A's evening meal. Such payment is pursuant to company policy whereby D will pay the actual, reasonable meal expense of a management-level employee when such an expense is incurred in connection with the performance of services either before or after such an employee's regular business hours.

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This is almost certainly excludable as a de minimis fringe. A de minimis fringe is one for which the value is "so small as to make accounting for it unreasonable or administratively impracticable." §132(e)(1). Examples include the typing of personal letters by a company administrative assistant, the occasional personal use of a copy machine, occasional company cocktail parties or picnics, transportation provided for the security of the employee, occasional entertainment tickets, coffee, donuts, and soft drinks provided employees, just to name a few. The regulations state that meals or meal reimbursement provided to employees who work late are excludable if three conditions are met: (1) they are only provided occasionally, (2) they are provided when the employee works overtime, and (3) they are provided to enable the employee to work overtime. See Reg. §1.132–6(d)(2). De minimis fringe benefits, with the exception of meals provided at a company cafeteria, need not satisfy the nondiscrimination requirements of §132(j).

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8.

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Don't think we did it

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9. The facts are the same as in Question 8 except that it now pertains to A, an associate at L, and that L offers all partners, associates, and other employees at L a choice of whether to accept parking or 75 bucks/month and A accepts parking

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Excluded as a qualified transportation fringe. Normally, when an employee is given the option of taking cash or a benefit, the doctrine of constructive receipt applies and the employee is treated as if she has taken the cash and used it to purchase the benefit in question. But §132(f)(4) expressly provides that the doctrine of constructive receipt does not apply to qualified transportation fringe benefits. Thus, the $75 value is excluded from income.

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10. The facts are the same as in Qn 9 except that L offers no cash option and provides parking only to partners and associates of the law firm

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Again excluded as a qualified transportation fringe. The nondiscrimination requirements of §132(j) only apply to no-additional-cost services and qualified employee discounts. (There are also non-discrimination rules that apply to employer-run cafeterias and the provision of qualified retirement planning services.)

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11. A is an associate in the employ of L, a prominent law firm located in a large city. In order to encourage participation in community activities and local society, L pays its associates' membership fees for various local clubs and organizations. A, taking advantage of this policy, joins a prestigious country club.

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A must include the fair market value of the membership in income unless the membership would be deductible by A as an ordinary and necessary business expense under §162 if she had incurred the expense herself. If the cost were deductible as an “ordinary and necessary” business expense, A could exclude the payment of the membership fees by L as a working condition fringe. As we will see later in the semester, this expense would not be deductible under §162. See §274(a)(3). Thus, the value of the membership could not be excluded as a working condition fringe. (It clearly flunks the requirements concerning athletic club benefits in §132(j)(4).)

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12. A, an attorney in the employ of C, a corporation, works at C's national headquarters. C maintains an on-site gymnasium which is available to all employees during normal business hours. A uses the gymnasium each working day.

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Excluded, so long as “substantially all the use of [the gymnasium] is by employees of the employer, their spouses, and their dependent children.” See §132(j)(4). Under §132(j)(4), the value of using a gym or athletics facility is excludable if facility is on the employer's premises, operated by the employer, and used almost exclusively by employees, spouses, and dependent children. See §132(j)(4)(B)(i)-(iii). Use by the employee’s spouse and dependants is also excluded. See Reg. §1.132–1(b)(3).

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Exclusion v. Deduction

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Exclusion: the item is not included in the taxpayer's income at any point
Deduction: is an adjustment to income that reduces income, subtraction from AGI to account for expense. (So in a sense, it is included and then removed)
Credit-reduction in tax liability

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Other fringe benefits
Life Insurance

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Section 79: Exception that only first 50k of group term life insurance (not true if individ plan) is excludable from EEs income; if ER decides to give EE more than average he pays for it

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Health Insurance

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i. 105 excludes from GI amounts EEs receive from their ERs as reimbursement for medical expenses and the value of services EEs receive under and ER provided health care plan. Reqs
1. no discrimination in favor of highly comp'd EEs
2. 106 complements 105 by excluding from FI the value of health and accident insurance premiums paid by ER to cover EE.
3. Note: this is better than 213 because 213 allows you to deduct for unreimbursed med expenses, but is subject to limitations.
ii. Huge provision b/c at a job--this is deductible, however, if it not through a job, it is not deductible.

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Need to check

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that last f-card

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Dependent care assistance

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need to figure out the best way to do this one too...

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Cafeteria Plans

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need it...