Chapter 2 p.39
Income In Kind
How is the concept of “income” defined?
Consider the Haig-Simons (economist’s) definition of income:
“Accession to wealth” – consisting of:
1) Consumption (occurring during the measurement period), and
2) Increase (if any) of the value of the person’s property rights (during that measurement period).
Basic Code Structure & Tax Code Definition
a) Code §1 – the tax imposing provision (for individuals) & Code §11 (for corporations).
b) §61 - statutory definition of “gross income” – all income “from whatever source derived.”
§61(a)(2) business income
§61(a)(3) property gains
§61(a)(4) interest, etc.
c) §63(a) – defining “taxable income”
Old Colony Trust Co.
Employer pays the employee’s tax liability, i.e., employer pays all the employee’s “debt” to IRS.
What happens to the employee’s “net worth”?
Held: Discharge of this debt of the employee to IRS was gross income to the employee.
Really a three party transaction (with the IRS)? What is the “bracket stacking” problem?
Note: Does the corporate resolution (and the corp’s payment obligation) present a “pyramiding” problem? What is that?
Economic Substance Doctrine p.44
IRC § 7701(o) – codifies the economic substance doctrine, i.e., a tax “common law” concept.
Transaction must satisfy:
Objective test – meaningful change in
economic position apart from income tax.
Subjective test – substantial nontax purpose
for entering into transaction (e.g., business”).
And, accuracy-related penalty – 20%.
Benaglia v. Commr.
“Tax Common Law”? P.44
Taxpayer hired as manager of a hotel & lived (with spouse) in the hotel. Meals were provided without charge. Gross income to the manager for the FMV of these items (& to the wife)?
Held: These items were primarily “for the convenience of the employer” and, therefore, no GI inclusion. Cf., person who must pay for food – a violation of concept of “horizontal equity”?
If inclusion: (1) retail fair market value; (2) cost to employer; (3) a subjective value to taxpayer? See dissent, next slide.
Benaglia v. Commr.
P.46 - Dissent
Dissent notes the employment contract letter. He says one of the terms of their deal is to include availability of living quarters & meals.
Should this “deal point” be conclusive on the gross income inclusion for FIT?
How much? A valuation issue: but, TXP states his cost to live elsewhere would be $3,600.
Is this an appropriate valuation?
What about the benefit to (nonemployee) wife?
Turner v. Commr.
Valuation issue p.48
Taxpayer wins steamship tickets to Brazil.
Tickets are nonrefundable and nontransferable.
Tickets are actually exchanged for other tickets.
What was the value for the tickets received?
The retail price of original tickets was $2,200.
But, the tax value was settled for $1,400.
What is the argument supporting a lesser valuation? Tickets as not an essential item to them? Because tickets were non-transferable?
Haverly case p.51
Benefits from a 3rd Party
School official receives unsolicited sample books for review and possible adoption by the school and purchase by students. Not items for his personal consumption.
Inclusion in his gross income? (2) If
inclusion, is a business expense deduction
available? (3) If given to charity (e.g., school’s library) can a charitable deduction be claimed? Deduction even if no earlier inclusion of FMV of books in GI? Rev. Rul. 70-498, p. 65 (timing).
Code §119 Meals & Lodging GI Exclusion p.53
Tax provision for a statutory exclusion. Requirements for a Code §119 exclusion:
For the convenience of employer; &
On the business premises. What are the
employer’s “business premises”?
Tax planning by the employment attorney: How negotiate the employee’s employment contract (considering the §119 potential application)? See the Benaglia case dissent.
“Employee” Status is Required for §119
This §119 treatment is not available to a “self-employed” person.
What about §119 for the only employee of a corporation solely owned by the employee?
How then “required” to live in the premises?
If §119 then a “double benefit” for income tax:
(1) no inclusion in gross income of employee, but, (2) a tax depreciation deduction (& other costs) to the corporation when the property is made available to the employee for housing.
Meals & Lodging Provided to Employees p.54
Example: Employer pays cash rent directly to the apartment owner to enable occupancy of the apartment by the employee (& not §119).
Can this rent be excluded from GI since not received in cash by the employee? Should this device enable her to save federal income tax?
Should the employer’s deduction be impacted?
What about other direct, substitute payments to the employee as “compensation”? E.g., an auto or shares of stock?
Employer Owned Lodging Used by Employee
Example: Employer provides to an employee the free use of an employer owned apartment (which has a rental value of $1,000 per month).
How determine this fair market value at $1,000 per month? Is this value (in the form of apartment availability) includible in the employee’s gross income? Note Turner case.
Does the employer have both (1) a wage expense deduction and (2) gross (rental) income (as the property owner), plus a depreciation deduction?
Code §107 p.54
Rental value of parsonages – exclusion for:
1) Rental value
Housing (i.e., cash) allowance.
Is this provision constitutional?
Support of religion & violation of the establishment clause?
Note: Exclusion is limited to a “minister of the gospel.” Does a potential for abuse exist in this context (see problem 6d)?
US Sup. Ct. p.55
Meal cash allowance – not furnished “in kind.” Therefore, not fitting within Code §119.
But, is a tax “common law” exclusion available in this situation?
What are the “business premises” for this purpose for the state troopers? What about a “leased” location (i.e., table) at a restaurant?
How structure (if at all) arrangements for the state troopers to fit within the §119 exclusion?
Sibla case p.65
Payments for Mess Meals
Firemen required to contribute into non-exclusionary food operation at fire station.
Ninth Circuit holds payments are both
1) Deductible under §162(a) (as ordinary and necessary business expenses; not personal expense); Tax Court affirmed, and/or
Excludible from GI under §119; meals
provided in kind by the employer; even though cash payment mandated – correct result?
3) Note: Anthony Kennedy dissent.
Noncash Benefits p.72
Reg. § 1.61-1(a) – gross income includes income realized in any form, whether money, property or services. Income may be realized in the form of services, meals, accommodations, corporate stock, a partnership interest, or other property.
What about “barter” transactions?
What are the administrative problems when noncash transactions occur?
But, consider importance of “economic substance,” rather than mere “form.”
GI Exclusion for Fringe Benefits - §132 p.72
Statutory exclusion for certain items:
No additional cost services - §132(b).
- See §132(h) re others treated as employees,
including parents when air transportation.
- See §132(j) re affiliates of airlines.
- See §132(i) re reciprocal agreements.
Employee discounts - §132(c).
- Discount by the “gross profit percentage”
- Discount for services @ 20 percent.
GI Exclusion for Fringe Benefits - §132, cont.
Working condition fringes - §132(d).
If employee paid item, would be a business expense deduction. Use of company automobile; security protection.
4) De minimis fringes - §132(e). E.g., use of employer photocopy machine; periodic meals.
Other items, e.g., parking, moving expense reimbursement, on premises gym.
§132(j)(1) - Nondiscrimination rules apply for §132(a)(1)&(2).
Frequent Flyer Credits
Gross Income? p.77
Frequent flyer credits can be traded for (1) other airline tickets, (2) flight upgrades, or (3) other (non-airline) merchandise.
Are these reductions of the cash price of future flight costs when these credits are earned?
What if (1) the initial travel is for business, paid by the employer, but (2) the employee gets the mileage credit? Is this credit compensation?
Gross income when other than airline benefits?
Issuance of IRS Form 1099 to account holder?
Consider the imputed rental value received from occupying one’s own residence (and the benefit from mortgage interest cost deduction).
Cf., what income tax result from investing an equivalent amount in U.S. Treasury bonds?
Same ability to pay for each investment?
But, possible lower rents to the non-home owner when living in a depreciable apt. building?
Cf., other personal investments: vacation homes, yachts, paintings.
Imputed Income from Services p.79
Imputed income is derived from one’s services for that person’s own behalf. Is this GI?
How services for one’s self: (1) lawyer prepares own last will; (2) individual paints his/her house; or (3) person tends one’s garden (& harvests vegetables and flowers).
What about the services provided at home by the “stay at home spouse”? E.g., child care.
Allow a special deduction/credit where both spouses work and incur additional costs? § 21.
Imputed Income from One’s Own Leisure? p.79
Impute value from one’s failure to work, but what could have been earned, while enjoying leisure?
Will different types of leisure have different values for inclusion in gross income?
Possible remedy: Impose a greater income tax rate on property income than on personal service income?
Rev. Rul. 79-24 p.80
Swap of lawyer’s services for house
painting service. Members of a “barter club.”
Receipt of a painting in exchange for free
rent for an apartment.
In each situation the exchanged items are includible in gross income under §61, as valued at FMV. Reg. §1.61-2(d)(1).
See §6045 re barter exchanges and required information reporting (IRS Form 1099-B).
3) Free checking for a bank account?
Withholding Obligation on Employers, etc.? p. 85
Do noncash items constitute wages subject to withholding at source? § 3401(a). What happens to employee’s cash flow when additional withholding from cash payments?
Alternative: Deny an income tax deduction to the employer when no income inclusion for the employee is attributable to the fringe benefit? P. 86.