Tax Law Cases Outline
The Internal Revenue Code and IRS regulations create a labyrinth for taxpayers and legal scholars alike. Courts have sought to clarify many nuances of federal tax laws, especially those related to the qualification, classification, calculation, and timing of income and deductions. Outcomes in these cases can be unpredictable and hinge on specific facts. Below is an outline of key cases in tax law with links to the full text of virtually every case, provided free by Justia.
Scope of Income
The Sixteenth Amendment provides that Congress shall have the power to lay and collect taxes on incomes, from whatever source derived. The form of income usually is immaterial. Instead, the key is that the taxpayer has received an economic benefit.
Eisner v. Macomber 一 Income may be defined as the gain derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital.
Commissioner v. Glenshaw Glass Co. 一 Congress has applied no limitations as to the source of taxable receipts, nor restrictive labels as to their nature. Punitive damages are income because these are undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion.
James v. U.S. 一 Embezzled money is taxable income of the embezzler in the year of the embezzlement.
Collins v. Commissioner 一 Larceny of any kind resulting in an unrestricted gain of money to a wrongdoer is a taxable event.
Gilbert v. Commissioner 一 When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition (express or implied) of an obligation to repay and without restriction as to their disposition, they have received income that they are required to return, even though it may still be claimed that they are not entitled to the money and may still be adjudged liable to restore its equivalent.
Exclusions From Income
Common types of exclusions from gross income include fringe benefits, meals and lodging furnished for the convenience of the employer, and gifts and other gratuitous transfers. Tax laws also exclude items such as punitive damages, health insurance benefits, and limited amounts of child care and tuition assistance.
Townsend Industries, Inc. v. U.S. 一 The question of whether the per-employee cost of a company-sponsored trip amounts to taxable wages turns on whether each employee could have deducted these costs as business expenses.
Benaglia v. Commissioner 一 The value of meals and lodging is not income to an employee, even if it may relieve them of an expense that they would otherwise bear, if these were not provided as compensation for their services or for their personal convenience, but solely because they could not otherwise perform the services required of them.
Commissioner v. Kowalski 一 A cash meal allowance for state police troopers is not subject to exclusion from gross income because Section 119 covers meals furnished by the employer, but not cash reimbursements for meals.
American Airlines, Inc. v. U.S. 一 A fringe benefit does not qualify as a de minimis fringe unless accounting for the benefit would be unreasonable or administratively impractical.
Adams v. U.S. 一 The language “on the business premises of the employer” infers a functional rather than spatial unity.
Hargrove v. Commissioner 一 Living quarters physically located off the worksite are not integral to the employer’s business unless the employee does significant work for the employer or the employer conducts a significant portion of its business at the living quarters.
J. Grant Farms, Inc. v. Commissioner 一 In deciding whether an employee was required to accept lodging furnished to them as a condition of employment, the proper inquiry is whether the lodging was furnished to them because the nature of their job required that they be available for duty at all times.
Commissioner v. Duberstein 一 A gift in the statutory sense proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity, or similar impulses. What controls is the intention with which payment, however voluntary, has been made. There must be an objective inquiry as to whether what is called a gift amounts to it in reality.
Olk v. U.S. 一 In general, receipts by taxpayers engaged in rendering services contributed by those with whom the taxpayers have some personal or functional contact in the course of the performance of the services are taxable income when in conformity with the practices of the area and easily valued.
Capital Appreciation and Recovery of Basis
In computing a gain or loss, a gain is the excess of the amount realized from a sale over the adjusted basis for determining gain, and the loss is the excess of the adjusted basis for determining loss over the amount realized.
Taft v. Bowers 一 Nothing in the Constitution lends support to the theory that gain actually resulting from the increased value of capital can be treated as taxable income in the hands of the recipient only so far as the increase occurred while they owned the property.
Inaja Land Co. v. Commissioner 一 When it is impossible or impractical to apportion basis among several portions of a property, a taxpayer need not recognize any capital gain until the entire cost basis of the property has been recovered.
Gladden v. Commissioner 一 When a purchaser pays a premium for land based on a realistic expectation that water rights will attach to that land in the future, the purchaser may claim a cost basis equal to the premium paid upon the sale of the later-acquired water rights.
Debts and Taxes
Debt is not considered income for tax purposes because the taxpayer has an obligation to repay it, so it is not an “accession to wealth.” They will not be able to get a deduction for principal paid on a loan, but they may get a deduction for interest paid.
U.S. v. Kirby Lumber Co. 一 When a corporation purchased and retired some of its own bonds for less than their par value, which it had received for them when issued, the difference was a taxable gain or income.
Zarin v. Commissioner 一 If a taxpayer disputed the amount of a debt in good faith, a subsequent settlement of the dispute would be treated as the amount of debt cognizable for tax purposes. The excess of the original debt over the amount determined to have been due is disregarded for both loss and debt accounting purposes.
Diedrich v. Commissioner 一 A donor who makes a gift of property on condition that the donee pay the resulting gift taxes realizes taxable income to the extent that the gift taxes paid by the donee exceed the donor’s adjusted basis in the property.
Crane v. Commissioner 一 The amount realized on a sale of property for cash subject to an existing mortgage is the amount of the cash realized plus the amount of the mortgage, even though the seller had acquired the property subject to the mortgage, which they never assumed, and the buyer neither assumed nor paid the mortgage.
Commissioner v. Tufts 一 When a taxpayer sells or disposes of property encumbered by a non-recourse obligation exceeding the fair market value of the property sold, they may be required to include in the “amount realized” the outstanding amount of the obligation. The fair market value of the property is irrelevant to this calculation.
The Realization Requirement
Under Section 1001 of the tax laws, a realization event occurs when the taxpayer engages in a sale or other disposition of property. A court may need to consider whether this transaction was a sham or otherwise an abuse of the realization requirement.
Cesarini v. U.S. 一 Treasure trove, to the extent of its value in U.S. currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession.
Haverly v. U.S. 一 When a tax deduction is taken for the donation of unsolicited samples, the value of the samples received must be included in the taxpayer’s gross income.
Cottage Savings Ass’n v. Commissioner 一 The gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or as loss sustained. Properties are materially different if their respective possessors enjoy legal entitlements that are different in kind or extent.
Knetsch v. U.S. 一 A transaction was a sham when it did not appreciably affect the taxpayer’s beneficial interest except to reduce their tax. In other words, there was nothing of substance to be realized by the taxpayer from the transaction beyond a tax deduction.
Goldstein v. Commissioner 一 Congress could not have intended to permit a taxpayer to reduce their taxes by means of an interest deduction that arose from a transaction that had no substance, utility, or purpose beyond the tax deduction.
Sheldon v. Commissioner 一 Loans or other financing transactions will merit respect and give rise to deductible interest only if there is some tax-independent purpose for the transactions.
Fender v. U.S. 一 When taxpayers had sufficient dominion over a bank to ensure that the apparent loss from their sale of bonds to the bank could be recaptured through a repurchase of the bonds, they did not suffer a real economic loss as is necessary for a deduction under Section 165.
Frank Lyon Co. v. U.S. 一 When there is a genuine multiple-party transaction with economic substance that is compelled or encouraged by business or regulatory realities, that is imbued with tax-independent considerations, and that is not shaped solely by tax-avoidance features to which meaningless labels are attached, the government should honor the allocation of rights and duties effectuated by the parties.
General Deductions
Above the line deductions are subtracted from gross income to calculate adjusted gross income. From that amount, a taxpayer can subtract below the line deductions and deductions for personal exemptions. Below the line deductions may consist of the standard deduction or itemized deductions.
Dyer v. Commissioner 一 For a loss to be deductible as a casualty loss, it must appear that the casualty was of a similar character to a fire, storm, or shipwreck.
Chamales v. Commissioner 一 Only physical damage to property or the permanent abandonment of property will be recognized as deductible under Section 165.
Blackman v. Commissioner 一 Casualty loss deductions are disallowed when national or state public policies would be frustrated by the consequences of allowing the deduction.
Taylor v. Commissioner 一 Doctor-recommended activities may not constitute deductible medical expenses when the expenses did not fall within the parameters of medical care.
Ochs v. Commissioner 一 When a wife could no longer care for her children due to an illness, the costs of services related to caring for the children that the husband incurred as a result were non-deductible family expenses rather than medical expenses.
Morrissey v. U.S. 一 “Affecting a function of the body” means materially influencing or altering an action for which the taxpayer’s own body is specifically fitted, used, or responsible.
Ottawa Silica Co. v. U.S. 一 A transfer is removed from the realm of deductibility under Section 170 if the benefits received (or expected to be received) by the donor are substantial. Benefits are substantial if they are greater than those that inure to the general public from transfers for charitable purposes.
Bob Jones Univ. v. U.S. 一 To warrant exemption under Section 501(c)(3), an institution must fall within a category specified in that section, and it must demonstrably serve and be in harmony with the public interest. The institution’s purpose must not be so at odds with the common community conscience as to undermine any public benefit that might otherwise be conferred.
Babilonia v. Commissioner 一 Donations to a charitable organization are deductible only if made out of a detached and disinterested generosity. A contribution may not be deducted when the expectation of personal benefit is the primary motive.
Deductions Related to Business Activities
A taxpayer can claim a deduction for ordinary and necessary expenses paid or incurred in carrying on a trade or business. Necessary is broadly interpreted as essentially “helpful.” Sometimes the distinction between business and personal expenses can be blurry.
U.S. v. Gilmore 一 The origin and character of the claim with respect to which an expense was incurred, rather than its potential consequences on the fortunes of the taxpayer, is the controlling basic test of whether the expense was business or personal, and thus whether it is deductible under Section 23(a)(2).
Welch v. Helvering 一 Payments on the debts of a corporation, made by its former officer after its discharge in bankruptcy and for the purpose of strengthening their own business standing and credit, were not ordinary and necessary expenses of their business.
Gilliam v. Commissioner 一 When a passenger in an airplane on a trip to fulfill a business obligation committed acts that would have been criminal but for his temporary insanity, and he injured a fellow passenger, he was not entitled to deduct the amounts paid in defense of a criminal prosecution and in settlement of a civil claim arising from the incident under Section 162.
Olive v. Commissioner 一 The test for determining whether an activity constitutes a trade or business is whether the activity was entered with the dominant hope and intent of realizing a profit.
Commissioner v. Groetzinger 一 To be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity, and the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify.
Storey v. Commissioner 一 An analysis of whether a taxpayer engaged in an activity for profit revolves around nine non-exclusive factors. These are the manner in which the taxpayer carried on the activity, the expertise of the taxpayer or their advisers, the time and effort expended by the taxpayer in carrying on the activity, the expectation that the assets used in the activity may appreciate in value, the success of the taxpayer in carrying on other similar or dissimilar activities, the taxpayer’s history of income or loss with respect to the activity, any amount of occasional profits that are earned, the financial status of the taxpayer, and whether elements of personal pleasure or recreation are involved.
U.S. v. Correll 一 Traveling expenses incurred in the pursuit of business while away from home include the cost of meals only if the trip requires sleep or rest.
Rudolph v. U.S. 一 When a trip paid by an employer was in the nature of a bonus, reward, and compensation for a job well done, the value of the trip was properly included in the income of the employee. Furthermore, since the trip was primarily a pleasure trip in the nature of a vacation, its cost was personal and not deductible.
Commissioner v. Flowers 一 Traveling expenses of an employee resulting from the fact that they choose for reasons of personal convenience to maintain a residence in a city other than the city in which their post of duty is located are not deductible as travel expenses in pursuit of business.
Hantzis v. Commissioner 一 A taxpayer who pursues temporary employment away from the location of their usual residence, but who has no business connection with that location, is not away from home for the purposes of Section 162(a)(2).
Pevsner v. Commissioner 一 The cost of clothing is deductible as a business expense only if the clothing is of a type specifically required as a condition of employment, it is not adaptable to general usage as ordinary clothing, and it is not so worn. Under an objective test, no reference is made to the individual taxpayer’s lifestyle or personal taste. Instead, adaptability for personal or general use depends on what is generally accepted for ordinary street wear.
Popov v. Commissioner 一 In determining whether a home office is a taxpayer’s principal place of business, a court should consider the relative importance of the activities performed at each business location and the time spent at each place.
Moller v. U.S. 一 To be a trader rather than an investor, a taxpayer must direct their activities to short-term trading, rather than the long-term holding of investments, and income must be principally derived from the sale of securities, rather than from dividends and interest paid on those securities.
Moss v. Commissioner 一 A taxpayer is permitted to deduct the whole price of a business meal, provided that the expense is different from or in excess of that which would have been made for the taxpayer’s personal purposes. However, the IRS has every right to insist that the meal be shown to be a real business necessity.
Carroll v. Commissioner 一 The cost of education may be deducted as a business expense if it involves maintaining or improving skills required by the taxpayer in their employment, unless the education is necessary to meet the minimum educational requirements for qualification in their employment, or the education will lead to qualifying them in a new trade or business.
Capital Expenditures
While deductions for capital expenditures are disallowed, various provisions of the tax laws provide allowances for depreciation and other ways of mitigating the lack of a deduction.
Encyclopaedia Britannica, Inc. v. Commissioner 一 While maybe some creators or buyers of capital goods, such as some authors and publishers, may deduct as current expenses what realistically are capital expenditures, they may not do so when the expense is tied to producing or acquiring a specific capital asset.
Midland Empire Packing Co. v. Commissioner 一 A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. Replacements, alterations, improvements, and additions prolong the life of the property, increase its value, or make it adaptable to a different use.
Income Assignment
In general, a taxpayer cannot contract to shift tax consequences to another party. Issues involving income assignment usually arise when there is a transfer without adequate consideration, such as when someone gives away income from services, income-producing property, or the right to proceeds from the sale of income-producing property.
Lucas v. Earl 一 The tax law can tax salaries to those who earned them and provide that the tax cannot be escaped by anticipatory arrangements and contracts, however skillfully devised, to prevent the salary when paid from vesting even for a second in the person who earned it.
Teschner v. Commissioner 一 When a taxpayer had no power to dispose of income, but they had a power to appoint or designate its recipient, the existence or exercise of such a power did not alone give rise to taxable income in their hands.
Commissioner v. Giannini 一 One who is entitled to receive at a future date interest or compensation for services and who makes a gift of it by an anticipatory assignment realizes taxable income as much as if they had collected the income and paid it to the object of their bounty.
Blair v. Commissioner 一 A beneficiary of a testamentary trust was not liable for a tax on the income that he had assigned to his children prior to the tax years, and that the trustees had paid to the children. The person who is to receive the income as the owner of the beneficial interest is to pay the tax.
Helvering v. Horst 一 The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to someone else is the enjoyment and hence the realization of the income by the party who exercises it.
Salvatore v. Commissioner 一 The tax consequences that arise from gains from a sale of property are not finally to be determined solely by the means employed to transfer legal title. A sale by one person cannot be transformed for tax purposes into a sale by another person by using the latter as a conduit through which to pass title. In other words, the form of a transaction cannot be permitted to prevail over its substance.
Heim v. Fitzpatrick 一 Rights retained by an inventor of a new type of rod end and spherical bearing that he assigned to his wife and children were sufficiently substantial to justify the view that they were given income-producing property. The inventor assigned not just a bare right to receive future royalties, but instead the power to bargain for the fixing of royalties on new types of bearings and a reversionary interest in his invention and patents by reason of his option to cancel the agreement if certain conditions were not fulfilled.
Marriage and Family Issues
Couples are no longer considered married for federal tax purposes when they get a divorce, unless they got a divorce only for tax avoidance. When a married couple separates or divorces, they can shift tax consequences by private agreement. Alimony payments are generally deductible to the payor and included in the income of the recipient.
Druker v. Commissioner 一 The marriage penalty is not unconstitutional, since it is not an attempt to interfere with the individual’s freedom to marry.
U.S. v. Windsor 一 The federal estate tax exemption for surviving spouses must be available to same-sex partners.
Estate of Borax v. Commissioner 一 A declaration of invalidity of a divorce decree by a jurisdiction other than the jurisdiction that decreed the divorce is of no consequence under provisions of the tax law governing payments to an ex-spouse under a separation agreement.
Harlow v. Commissioner 一 A letter signed only by a husband was only a unilateral offer to make payments for the support of his wife and was not a written separation agreement that permitted a deduction for alimony payments.
Commissioner v. Lester 一 Periodic payments received by a wife after a divorce decree in discharge of a legal obligation imposed on the husband under a written instrument incident to the divorce are included in the gross income of the wife. However, this rule does not apply to a part of any such periodic payment that the terms of the written instrument fix, in terms of a portion of the payment, as a sum payable for the support of minor children of the husband. To fit within this exception, the written agreement providing for periodic payments to the wife must specifically designate the amounts or parts thereof allocable to the support of the children.
Farid-es-Sultaneh v. Commissioner 一 When the inchoate interest of a woman in the property of her affianced husband greatly exceeded the value of the stock transferred to her, relinquishing that interest was a fair consideration. This prevented her from taking the shares as a gift under the income tax law, since it precluded the existence of a donative intent.
Capital Assets
Capital assets are defined as property held by a taxpayer, whether or not connected with their trade or business, but do not include certain items excluded by statute, which produce ordinary gains and losses. Categories of exclusions from capital assets are broadly construed by courts.
Miller v. Commissioner 一 The mere fact that a taxpayer may have released a claim to an alleged property right does not mean that they sold such property, especially when it does not appear that they owned any such property.
Malat v. Riddell 一 The word “primarily,” as used in Section 1221(1), means “of first importance,” or “principally.”
Bynum v. Commissioner 一 A taxpayer’s purpose at the time of acquisition has evidentiary weight, but the end question is the purpose of the “holding” at the time of the sale.
Continental Can Co., Inc. v. U.S. 一 In determining the “primarily” issue, the basic question is the primary purpose of holding as of the date of the sale. When a company is regularly engaged in the dual business of selling and renting its machines at that date, income resulting from either activity satisfies the “primarily” concept.
International Shoe Machine Corp. v. U.S. 一 In a dual enterprise involving both leases and sales of the same type of goods, “primarily” invokes a contrast not between selling and leasing but between selling and investing.
Mafco Equipment Co. v. Commissioner 一 Assets were not held primarily for sale to customers in the ordinary course of business when their sale was not precipitated by a generalized intent to change the purpose for which the assets were acquired, but instead by an unwilling abandonment of the objective of realizing rental income from these items that was dictated by the necessities of the circumstances.
U.S. v. Winthrop 一 The tests mentioned most often in determining whether land was held primarily for sale to customers in the ordinary course of business are: the nature and purpose of the acquisition of the property and the duration of the ownership; the extent and nature of the taxpayer’s efforts to sell the property; the number, extent, continuity, and substantiality of the sales; the extent of subdividing, developing, and advertising to increase sales; the use of a business office for the sale of the property; the character and degree of supervision or control exercised by the taxpayer over any representative selling the property; and the time and effort that the taxpayer habitually devoted to the sales.
Biedenharn Realty Co., Inc. v. U.S. 一 Once an investment does not mean always an investment, and an investor can become a seller by their subsequent activities. The court considered factors such as the frequency and substantiality of sales over an extended time, the significant improvement of the basic subdivisions, the acquisition of additional properties, and the use of brokers in finding that real estate sales were ordinary income in this case.
Suburban Realty Co. v. U.S. 一 A taxpayer who engages in frequent and substantial sales is almost inevitably engaged in the real estate business. The frequency and substantiality of sales are highly probative on the issue of holding purpose because the presence of frequent sales ordinarily belies the contention that property is being held for investment rather than for sale. The frequency of sales may often be a key factor in determining the “ordinariness” question.
Bramblett v. Commissioner 一 The frequency and substantiality of sales over a substantial period of time are the most important factors in determining whether property is held primarily for sale. The conjunction of these factors will usually conclude the capital gains issue against the taxpayer. However, other relevant considerations include improvements to the property, solicitation and advertising efforts, and brokerage activities.
Adam v. Commissioner 一 Only occasional purchases and sales of real estate or stocks with the hope of realizing a gain on their subsequent increase in value, without more, does not constitute a trade or business.
U.S. v. Wood 一 The tax liability of a seller of securities depends on whether they are best classified as a dealer, a trader, or an investor. A dealer may hold securities primarily for sale, while traders and investors do not.
Corn Products Refining Co. v. Commissioner 一 Congress intended that profits and losses arising from the everyday operation of a business should be considered as ordinary income or loss, rather than capital gain or loss.
Arkansas Best Corp. v. Commissioner 一 A taxpayer’s motivation in purchasing an asset is irrelevant to the question of whether it falls within the broad definition of “capital asset” in Section 1221.
Hort v. Commissioner 一 If a payment was a substitute for rent, which is characterized as gross income, it must be regarded as ordinary income. It is immaterial that, for some purposes, the contract creating the right to such payments may be treated as property or capital.
Commissioner v. P.G. Lake, Inc. 一 Consideration received for an assignment of an oil payment right was taxable as ordinary income, rather than a long-term capital gain, when the present consideration received by the taxpayer was paid for the right to receive future income, rather than for an increase in the value of the income-producing property.
Commissioner v. Gillette Motor Transport, Inc. 一 When a trucking company received compensation from the government for the fair rental value of its facilities during a period when they were controlled by the government, this was ordinary income rather than a capital gain that resulted from an involuntary conversion of capital assets consisting of real or depreciable personal property used in its trade or business.
Bell’s Estate v. Commissioner 一 When taxpayers sold life interests in trust property, rather than income or naked rights to receive income, the considerations received by them were not ordinary income but instead were the proceeds of sales of capital assets.
Commissioner v. Ferrer 一 A common characteristic of cases held to come within the capital gain provision is that the taxpayer had an estate in, an encumbrance on, or an option to acquire an interest in property that, if held itself, would be a capital asset. The taxpayer had something more than an opportunity, afforded by contract, to obtain periodic receipts of income, by dealing with another party, or by rendering services, or by virtue of ownership of a larger estate.
Trantina v. U.S. 一 When the property right asserted concerns the contractual right to perform a service and receive compensation for the service, a payment made to terminate the contract cannot be considered a capital asset unless the contract confers something more than the right to perform services or receive compensation for services performed.
Bellamy v. Commissioner 一 It is well established that not everything that can be called property in the ordinary sense, and that is outside the statutory exclusions, qualifies as a capital asset. A capital asset is something in which the taxpayer has an investment, and hence a basis.
Lattera v. Commissioner 一 In deciding whether capital gains treatment or ordinary income treatment is appropriate, a court should determine whether the asset bears a family resemblance to items in either of those categories. If it does not, a court should look at the nature of the sale. If it is a horizontal carve-out, ordinary income treatment applies. If it is a vertical carve-out, ordinary income treatment applies if the sale is a lump sum payment for a future right to earned income, while capital gains treatment applies if it is a lump sum payment for a future right to earn income.
Williams v. McGowan 一 Congress plainly meant to comminute the elements of a business and did not regard the whole as “capital assets.”
The Arrowsmith Principle
Two successive transactions that are integrally related should be treated as parts of the same transaction so that the subsequent event relates back and receives the same effect and treatment as the prior event.
Arrowsmith v. Commissioner 一 When a later transaction is sufficiently related to an earlier transaction, the later transaction will be treated as having the same character as the earlier transaction.
Cummings v. Commissioner 一 The Arrowsmith principle forbids the windfall that would result if income taxed at a special lower rate when received were deductible on repayment at a different and more favorable rate.
The Sale or Exchange Requirement
There cannot be a taxable gain or loss unless a sale or exchange occurs. A key principle in this area is that a taxpayer who transfers appreciated property as collateral for a loan does not recognize gain on the transfer, but they must report a gain or loss if they sell appreciated property.
Yarbro v. Commissioner 一 The phrase “sale or exchange” may include an abandonment.
National-Standard Co. v. Commissioner 一 The payment of a debt does not constitute a sale or exchange because the maker of the note or the debtor acquires no property in the transaction other than discharge of the obligation.
Foote v. Commissioner 一 Tenure is not a capital asset, and a professor’s release of his tenure was not a sale or exchange. The amount received by the professor on the termination of his contract was taxable as ordinary income rather than capital gain.
Commissioner v. Brown一 It does not follow from the fact that there was no risk-shifting from seller to buyer that a transaction was not a sale but instead a device to collect future earnings at capital gains rates for which the price set was excessive.
Grodt & McKay Realty, Inc. v. Commissioner 一 In determining whether the benefits and burdens of ownership have passed, courts may consider factors such as whether legal title passes, how the parties treat the transaction, whether an equity was acquired in the property, whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments, whether the right of possession is vested in the purchaser, which party pays the property taxes, which party bears the risk of loss or damage to the property, and which party receives the profits from the operation and sale of the property.
Calloway v. Commissioner 一 In determining whether a transfer constitutes genuine indebtedness, courts may need to look beyond the parties’ terminology to the substance and economic realities.
Diedrich v. Commissioner 一 A donor who makes a gift of property on condition that the donee pay the resulting gift taxes realizes taxable income to the extent that the gift taxes paid by the donee exceed the donor’s adjusted basis in the property.
Freda v. Commissioner 一 When the recovery in a lawsuit represents damages for lost profits, it is taxable as ordinary income. If it represents a replacement of capital destroyed or injured, the money received is a return of capital and not taxable.
Non-Recognition Rules
A taxpayer does not need to report the gain or loss on a transaction when a non-recognition rule applies. Situations that implicate these rules include exchanges of like kind properties, to which a mandatory non-recognition rule applies, and involuntary conversions, for which the rule may be elective.
Bloomington Coca-Cola Bottling Co. v. Commissioner 一 In a sale, the property is transferred in consideration of a definite price expressed in terms of money. In an exchange, the property is transferred in return for other property without the intervention of money. However, the presence in a transaction of a small amount of cash to adjust certain differences in value of the properties exchanged will not necessarily prevent the transaction from being considered an exchange.
California Federal Life Insurance Co. v. Commissioner 一 The test for determining whether exchanged properties are of like kind is whether the property is of the same nature or character. A mere difference in grade or quality of the properties does not disqualify the exchange. However, the lenient treatment of real estate exchanges does not apply to the exchange of personal property.
Carlton v. U.S. 一 When a ranch property was transferred not for title to other properties but instead for cash and an assignment of the other party’s contract rights to those properties, the receipt of cash on transferring the ranch property transformed the intended exchange into a sale.
Biggs v. Commissioner 一 The language in Carlton does not establish as an absolute prerequisite to a Section 1031 exchange that the purchaser have title to the exchange property.
Tecumseh Corrugated Box Co. v. Commissioner 一 For the purposes of Section 1033, a threat of condemnation exists if the taxpayer might reasonably believe from representations of government agents and from surrounding circumstances that condemnation was likely to take place if they did not sell their property.
Clifton Investment Co. v. Commissioner 一 That which the taxpayer receives from their properties and that which the properties demand of the taxpayer must both be considered in determining whether the properties are similar or related in service or use to the taxpayer.
Davis v. U.S. 一 In deciding whether Section 1033(a) applies, the trier of fact must determine from all the circumstances whether the taxpayer has achieved a sufficient continuity of investment to justify non-recognition of the gain, or whether the differences in the relationship of the taxpayer to the two investments compel the conclusion that the taxpayer has taken advantage of the condemnation to alter the nature of their investment for their own purposes.
Liant Record, Inc. v. Commissioner 一 When the taxpayer-owner uses the converted property, it is correct to compare the actual physical service or use that the end user makes of the converted and replacement properties. However, if the taxpayer-owner is an investor rather than a user, it is not the lessees’ actual physical use but the nature of the lessor’s relation to the land that must be examined.
Timing Rules
Timing rules in the tax system control when income and gains are reportable, as well as when expenditures and losses are deductible. The timing for when an item of income is taxed or a deduction allowed depends on the accounting method used by the taxpayer.
Burnet v. Sanford & Brooks Co. 一 Any system of taxation should produce revenue ascertainable and payable to the government at regular intervals. Only by such a system is it practicable to produce a regular flow of income and apply methods of accounting, assessment, and collection capable of practical operation. The computation of income annually as the net result of all transactions within the year is a familiar practice.
Fidelity-Philadelphia Trust Co. v. Commissioner 一 Unclaimed and dormant deposits in a taxpayer bank represented income when the bank transferred that amount from its deposit liability account to surplus.
Alice Phelan Sullivan Corp. v. U.S. 一 The return or recovery of property that was once the subject of an income tax deduction must be treated as income in the year of its recovery. The only limitation on that principle is the tax benefit rule, which permits exclusion of the recovered item from income so long as its initial use as a deduction did not provide a tax saving.
Rosen v. Commissioner 一 The application of the tax benefit rule does not depend on whether the taxpayer retained a right of reversion. Since the taxpayers had taken charitable deductions when they transferred the property, they were required to treat the value of the property on its return as income in the year in which it was returned.
North American Oil Consolidated v. Burnet 一 If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income that he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.
U.S. v. Lewis 一 When a taxpayer reported an amount received as an employee bonus, and he claimed it in good faith and used it unconditionally as his own, but he was required to return half of the amount to his employer after it was decided that the bonus had been computed improperly, the claim of right doctrine meant that the entire amount was income in the year when it was received, and the taxpayer was not entitled to recompute his tax for that year.
U.S. v. Skelly Oil Co. 一 Under Section 1341, the deduction allowable in the year of repayment must be reduced by the percentage depletion allowance granted to the taxpayer in the years of receipt as a result of the inclusion of the later-refunded items in their “gross income from the property” in those years. The tax law should not be interpreted as allowing a deduction for refunding money that was not taxed when it was received.
Pike v. Commissioner 一 To become entitled to relief under Section 1341, a taxpayer must prove that they were not entitled to the unrestricted use of the amount received in the prior year.
Wood v. U.S. 一 Drug smuggling proceeds were taxable income, and a taxpayer was not entitled to a loss deduction for these proceeds when they were forfeited to the federal government.
Cash Method
Taxable income is computed under the method of accounting on the basis of which the taxpayer regularly computes their income if that method clearly reflects income. The cash method provides that items of income are included in the year in which they are received, while items of deduction are taken in the year in which they are paid.
Ross v. Commissioner 一 The doctrine of constructive receipt was conceived to prevent a taxpayer from choosing the year in which to return income merely by choosing the year in which to reduce it to possession. The Treasury may subject income to taxation when the only thing preventing its reduction to possession is the volition of the taxpayer.
Carter v. Commissioner 一 Income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.
Hornung v. Commissioner 一 The doctrine of constructive receipt did not apply to a car when the dealership at which the car was located was closed, the car had not been set aside for the taxpayer’s use, and delivery was not dependent solely on his volition.
Commissioner v. Mott 一 To hold that a taxpayer is chargeable with receiving compensation that he might have received but did not receive would be contrary to the aims and purposes of the tax laws.
Schniers v. Commissioner 一 A cash basis farmer realizes income only when they actually or constructively receive income from the sale of the crops. They are not required to sell the crops in the year in which they harvest the crops, nor are they required to contract for immediate payment if they decide to sell the crops in the year of harvest.
Commissioner v. Oates 一 When general insurance agents amended their agency agreement with the insurance company at retirement, the amended contract was a novation, the old contract was extinguished, and the taxpayer had no right to demand any additional compensation other than that which was listed in the new contract.
Commissioner v. Olmsted Incorporated Life Agency 一 The application of Oates extends beyond situations in which the contract is not transferable and the rights under it non-assignable.
Alsop v. Commissioner 一 When an agent receives and misappropriates funds for their own use, there is no constructive receipt by the principal because the agent is not acting on behalf of the principal, so the rule that receipt of income by the agent is equivalent to receipt by the principal does not apply. The amount of the embezzled funds recovered by litigation is taxable income to the principal in the year of recovery.
Donohue v. Commissioner 一 The rule in Alsop does not apply when the principal received a definite economic benefit from the receipt of the money prior to its embezzlement.
Lavery v. Commissioner 一 The receipt of a check is equivalent to the receipt of cash.
Kahler v. Commissioner 一 All items of gross income shall be included in the taxable year in which they were received by the taxpayer. It is immaterial that delivery of a check is made too late in the taxable year for the check to be cashed in that year. A taxpayer realizes income when the check is received.
Kuehner v. Commissioner 一 When a promise to pay was secured, unconditioned, and fixed in amount, it could have been properly regarded as the equivalent of cash.
Reed v. Commissioner 一 To meet the cash equivalency requirement for income recognition, a cash basis taxpayer’s contractual right to future payment must be reflected in a negotiable note, bond, or other evidence of indebtedness that, like money, commonly and readily changes hands in commerce. In addition to being readily transferable, the evidence of indebtedness received by the taxpayer must be intended as present payment of the amount owed.
Cowden v. Commissioner 一 If a promise to pay of a solvent obligor is unconditional and assignable, not subject to set-offs, and of a kind that is frequently transferred to lenders or investors at a discount not substantially greater than the generally prevailing premium for the use of money, this promise is the equivalent of cash.
Williams v. Commissioner 一 A note received only as security, or as an evidence of indebtedness, and not as payment, may not be regarded as income at the time of receipt.
Pulsifer v. Commissioner 一 Under the economic benefit theory, an individual on the cash receipts and disbursements method of accounting is currently taxable on the economic and financial benefit derived from the absolute right to income in the form of a fund that has been irrevocably set aside for them in trust and is beyond the reach of the payor’s debtors.
Cleaver v. Commissioner 一 When there was effectively a borrowing of principal and a borrowing of required interest, both represented by the notes executed by a taxpayer on the cash basis, there could be no deduction by him on account of interest paid until he had paid the notes.
Burgess v. Commissioner 一 Interest may be considered paid even though the taxpayer may have paid it with money subsequently borrowed from the initial lender, as long as the money subsequently borrowed actually passed into the hands or bank account of the taxpayer, was commingled with other funds of the taxpayer, and thus became subject to the taxpayer’s unrestricted control.
Battelstein v. IRS 一 Cash basis taxpayers are entitled to a deduction for interest paid on indebtedness only if that interest is paid within the taxable year. When taxpayers defer payment of interest obligations, these interest obligations cannot be claimed for tax purposes as interest obligations paid.
Estate of Spiegel v. Commissioner 一 When a donor delivered two checks to a charitable donee in a certain year, but the checks were not cashed until the following year, and one of the checks was not cashed until after the donor’s death, the charitable deduction could be applied to the year in which the checks were delivered.
Estate of Hubbell v. Commissioner 一 There was no deduction from the income of a decedent during his lifetime for the amount of a check given by him to the state for taxes when payment was refused upon presentation after his death because of his death.
Commissioner v. Boylston Market Ass’n 一 A taxpayer who keeps their books and files their returns on a cash basis should deduct for each tax year the pro rata portion of the prepaid insurance applicable to that year.
Accrual Method
Under the accrual method of accounting, an item of income is taxed in the year in which it is earned, regardless of when it is received. Meanwhile, items of expense are deducted in the year in which they are incurred, regardless of when they are paid.
Spring City Foundry Co. v. Commissioner 一 Keeping accounts and making returns on the accrual basis, as distinguished from the cash basis, import that it is the right to receive, rather than the actual receipt, that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues.
Hallmark Cards, Inc. v. Commissioner 一 When an accrual method of accounting is utilized, an item of income is included in the taxpayer’s gross income for the accounting period during which all the events have occurred that fix the taxpayer’s right to receive the item of income, and the amount thereof can be determined with reasonable accuracy. The “all events” test is not satisfied until title and risk of loss pass to the buyer.
Flamingo Resort, Inc. v. U.S. 一 The existence of a legal liability to pay is not a universal prerequisite to the existence of a fixed or unconditional right to receive payment.
Georgia School-Book Depository, Inc. v. Commissioner 一 To prove that there is no reasonable expectancy that a claim would ever be paid, there must be a definite showing that an unresolved and allegedly intervening legal right makes receipt contingent or that the insolvency of the debtor makes it improbable.
Westpac Pacific Food v. Commissioner 一 Cash advances in exchange for volume purchase commitments, subject to pro rata repayment if the volume commitments are not met, are not income when received.
Commissioner v. Indianapolis Power & Light Co. 一 When a utility company required customers with suspect credit to make deposits with it to assure prompt payment of future electric bills, the deposits were not advance payments for electricity and were not taxable income to the utility company upon receipt. The company did not have the requisite complete dominion over them when they were made, which is the crucial point for determining taxable income.
Oak Industries, Inc. v. Commissioner 一 When a taxpayer acquires deposits subject to an express obligation to repay, the taxpayer does not have complete dominion over the deposits.
RCA Corp. v. U.S. 一 The Commissioner acted within his discretion in requiring a taxpayer to report its prepaid service contract income on receipt. Since its service contracts obligated it to perform services only upon a customer’s demand, the taxpayer could not know the extent of the performance that a customer might ultimately require or the amount of income that it would ultimately earn from the contract. Federal revenues should not be subject to the vicissitudes of customers’ future demands for services.
American Automobile Ass’n v. U.S.一 When an accounting method presents an accurate image of the total financial structure but fails to respect the criteria of annual tax accounting, it may be rejected by the Commissioner even if it was in accordance with generally accepted commercial accounting principles and practices.
Schlude v. Commissioner 一 It was proper for the Commissioner to include as income of a dance studio in a particular year advance payments by way of cash, negotiable notes, and contract installments falling due but remaining unpaid during that year.
Artnell Co. v. U.S. 一 The Tax Court erred in deciding that proceeds of advance sales of tickets for baseball games and revenues for related future services were income when received, regardless of the merits of the accounting method employed.
U.S. v. General Dynamics 一 When the filing of claims is a condition precedent to liability, an accrual-basis taxpayer providing medical benefits to its employees cannot deduct at the close of the taxable year an estimate of its obligation to pay for medical care obtained by employees or their qualified dependents during the final quarter of the year, claims for which have not been reported to the employer.
Dixie Pine Products Co. v. Commissioner 一 To truly reflect the income of a given year, all the events must occur in that year that fix the amount and the fact of the taxpayer’s liability for items of indebtedness deducted though not paid. This cannot be the case when the liability is contingent and contested by the taxpayer.
U.S. v. Hughes Properties, Inc. 一 The “all events” test requires that before an expense can be regarded as “incurred” for federal income tax purposes, a liability must be fixed and absolute. Identification of the payee may be irrelevant if the obligation to pay exists. The event creating liability is the event that fixes the amount irrevocably.
Installment Sales Method
The installment sales method is available to non-dealers who sell real property or non-inventory personal property if payment of at least part of the purchase price is deferred to a future year.
Burnet v. Logan 一 When a taxpayer might never recoup her capital investment from payments only conditionally promised, she properly demanded the return of her capital investment before assessment of any taxable profit based on conjecture.
Deferred Compensation
Employers may pay compensation to employees in a year after the year in which their services are rendered. This can spread income over a longer span of years and sometimes provide employees with income during retirement, which can confer tax advantages.
Gullett v. Commissioner 一 The doctrine of constructive receipt should be sparingly used. Amounts due from a corporation but unpaid are not to be included in the income of an individual reporting their income on a cash receipts basis unless it appears that the money was available to them, the corporation was able and ready to pay them, their right to receive was not restricted, and their failure to receive resulted from the exercise of their own choice.
Sproull v. Commissioner 一 Any economic or financial benefit conferred on an employee as compensation in the taxable year is taxable to the employee in that year.
This outline has been compiled by the Justia team for solely educational purposes and should not be treated as an independent source of legal authority or a summary of the current state of the law. Students should use this outline as a supplement rather than a substitute for course-specific outlines.
