Federal personal income tax

  1. Some context and historical background
  2. Current significance
  3. History

Early American revenue came almost exclusively from tariffs.

Pollack v. Farmer’s Loan & Trust (1895): declared a tax on income unconstitutional.

Constitution give Congress the right to tax. Limitations on this right is also included in Article 1 § 2 and § 9. Means that any direct taxes must be apportioned among the states based on their population, so that it is equal per capita. There is no way to do this with personal income tax, so if you say that personal income tax is a direct tax, then it would be unconstitutional. Then comes the 16th Amendment passed in 1913. Allows Congress to tax with out apportionment.

  1. Progressivity
  2. The basic goals of any tax system
  3. Fairness:
  4. Horizontal equity: two similarly situated tax payers should pay the same amount. Difficulty is determining how people can be similarly situated.
  5. Vertical equity: allocated tax burdens fairly as we go up the income scale.
  6. Economic rationality (Neutrality): All things being equal, we don’t want to distort normal economic behavior…we don’t want people doing something or refraining from doing something only for tax purposes. For example, A is willing to pay $100/wk to have her house cleaned. B is willing to clean the house for take-home pay of $80. There is $20 of available surplus benefit to society available in the transaction. However, if a 25% income tax is imposed, B’s take-home pay is only $75. This would distort/destroy an economic transaction that would otherwise happen. In reality, people do things for reasons unrelated to the economic elements of the transaction. Also, there is no way to have a tax without distorting behavior in some way, so the goal is to minimize the distortion.
  7. Administrability
  1. The characteristics of income
  1. A flow: Income can only be measured in time. Since 1913, we've had the measure of the flow over one year (annual accounting principal). Usually a calendar year.
  1. Some examples
  2. Paycheck: if an employee gets $5K in cash as a monthly salary, it is definitely income. If the employee gets the same amount in a check, it is counted as income, even if it hasn't cleared yet. It is considered a "cash equivalent." There is always some level of contingency. The tax code confronts the issue to determine what level of contingency is enough. Same for direct deposits.
  3. Windfall: Outside of employee context, $5K cash found in a bag by TP is also income. Fairness (horizontal equity) because a person would have to claim the money if they got it by working, so it is fair for the TP who got the $ with no effort to also claim it.
  4. "Swag bag:" A star agrees to host an award show for free. In her room is a gift basket worth $5K. Taxable compensation? Note that precise terms of the compensation are not negotiated in advance and there is no expectation or obligation to pay/give. Yes, a quid pro quo is taxable as compensation, however, this is not an easy case and it might be difficult to agree on the FMV.
  5. Benefits in kind (Payments from 3rd parties): when an employer pays an employee's rent as part of his compensation, it is considered an "accession to wealth," and is taxable. This is fair (horizontally equity) because a similarly situated employee that gets paid the same amount in a cash salary and uses the salary to pay the landlord is in the same position.

Note that § 61 defines fringe benefits, etc. as income as the default position "unless otherwise excluded." So, exclusions such as health care benefits are income, but are not taxable because of specific exclusions in other areas of IRC.

  1. Income in Kind/Non-cash receipts
  2. Discharge of an obligation:Old Colony (p. 35)
  3. Facts: Mr. Wood is the president of the American Woolen Company. His tax liability based on his salary earned in 1918 and 1919 was paid by the Company per a company resolution. Supreme Court says that taxes paid by employer is income.
  4. Rule: The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed [CB 37]
  5. Income analysis: the fact that the expense being covered by the employer is taxes doesn't change the fact that it is a benefit.
  6. Held:It is an accession to wealth.

IRC § 61. Gross income defined.

(a) General definition. Except as otherwise provided in this subtitle [IRC Sections 1 et seq.], gross income means all income from whatever source derived, including (but not limited to) the following items:

(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;

(2) Gross income derived from business;

(3) Gains derived from dealings in property;

(4) Interest;

(5) Rents;

(6) Royalties;

(7) Dividends;

(8) Alimony and separate maintenance payments;

(9) Annuities;

(10) Income from life insurance and endowment contracts;

(11) Pensions;

(12) Income from discharge of indebtedness;

(13) Distributive share of partnership gross income;

(14) Income in respect of a decedent; and

(15) Income from an interest in an estate or trust.

CFR § 1.61-1 Gross income.

(a) General definition. Gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services. Income may be realized, therefore, in the form of services, meals, accommodations, stock, or other property, as well as in cash. Section 61 lists the more common items of gross income for purposes of illustration. For purposes of further illustration, § 1.61-14 mentions several miscellaneous items of gross income not listed specifically in section 61. Gross income, however, is not limited to the items so enumerated.

CFR § 1.61-2 Compensation for services, including fees, commissions, and similar items.

(a) In general. (1) Wages, salaries, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury fees, marriage fees and other contributions received by a clergyman for services, pay of persons in the military or naval forces of the United States, retired pay of employees, pensions, and retirement allowances are income to the recipients unless excluded by law. Several special rules apply to members of the Armed Forces, National Oceanic and Atmospheric Administration, and Public Health Service of the United States; see paragraph (b) of this section.

(2) The Code provides special rules including the following items in gross income:

(i) Distributions from employees' trusts, see sections 72, 402, and 403, and the regulations thereunder;

(ii) Compensation for child's services (in child's gross income), see section 73 and the regulations thereunder;

(iii) Prizes and awards, see section 74 and the regulations thereunder.

(3) Similarly, the Code provides special rules excluding the following items from gross income in whole or in part:

(i) Gifts, see section 102 and the regulations thereunder;

(ii) Compensation for injuries or sickness, see section 104 and the regulations thereunder;

(iii) Amounts received under accident and health plans, see section 105 and the regulations thereunder;

(iv) Scholarship and fellowship grants, see section 117 and the regulations thereunder;

(v) Miscellaneous items, see section 122.

(d) Compensation paid other than in cash--(1) In general. Except as otherwise provided in paragraph (d)(6)(i) of this section (relating to certain property transferred after June 30, 1969), if services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation. If services are paid for in exchange for other services, the fair market value of such other services taken in payment must be included in income as compensation. If the services are rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary. For special rules relating to certain options received as compensation, see §§ 1.61-15, 1.83-7, and section 421 and the regulations thereunder. For special rules relating to premiums paid by an employer for an annuity contract which is not subject to section 403(a), see section 403(c) and the regulations thereunder and § 1.83-8(a). For special rules relating to contributions made to an employees' trust which is not exempt under section 501, see section 402(b) and the regulations thereunder and § 1.83-8(a).

  1. Employer-provided food and lodging

1.Benaglia (p. 39):

2.Hired as the original manager of the Royal Hawaiian Hotel. He and his wife get a cash salary of ~$10K + they stay in the hotel and received their meals there, for a FMV of ~$7K.

  1. Possible alternatives
  2. No income or possibly no income to employee, but income to spouse
  3. FMV: too high because Benaglia wouldn't view the value as this.
  4. Cost to hotel
  5. Substitution Cost or cost of equivalent arrangements.
  6. Subjective value to Benaglia himself. What is his accession of wealth that makes him better off. Theoretically, this is the best value to use, but not practical. His 6,000th meal at the hotel is going to be worth less to him than the first, and he has to eat what they serve and arrange his life around living there. This is very difficult to administer.
  7. Holding: Board concludes that it is not income because the lodging and meals are provided for the convenience of the employer. The duties of the manager of the hotel cannot be performed unless he is always on call.
  8. Fundamental problem: what does "convenience of the employer" have to do with it. Shouldn't the question be whether the employee has received an accession to wealth? Because it is presumed that something done for the convenience of the employer, the employee doesn't value it at a high level. Prof: we shouldn't assume that the employee has received no accession to wealth, but the Board errs on the side of assuming no income.

3.Present Treatment § 119: enacted after Benaglia, largely codifies the result. Can think of 119 of both adopting and repudiating Benaglia. Adopts the convenience of the employer doctrine. However, 119 is an exception, so but for this exception, the meals/lodging would be income under § 61.

  1. Lodging is required to be accepted.

4.Questions pp. 49-50.

5.Employer Benefits are presumptively income @ FMV unless they fall into one of the exceptions. Difficulties:

  1. valuation, since emp'e doesn't necessarily value the benefits as FMV.
  2. Compliance: people don't think of these things as income. Also, people became accustomed to these benefits not being taxed before the IRC began focusing on it.

6.§ 119: can think of it as having three components

  1. Furnished
  2. On employer's premises
  3. For the convenience of employer
  4. Lodging has additional component: employee must be required to accept as a condition of e'ment. Doesn’t have to be written in K, more of a substantive question.

7.Note that this essentially repudiates Benaglia to the extent that the case was talking about the general definition of income that would be defined under § 61, before the exceptions in § 119 were codified.

8.In applying a statute, each word really matters.

  1. Business premises defined:
  2. Place where e'ee performs most of his duties
  3. Place where e'er does most of its business.

IRC § 119. Meals or lodging furnished for the convenience of the employer.

(a) Meals and lodging furnished to employee, his spouse, and his dependents, pursuant to employment. There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employer for the convenience of the employer, but only if--

(1) in the case of meals, the meals are furnished on the business premises of the employer, or

(2) in the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment.

(b) Special rules. For purposes of subsection (a)--

(1) Provisions of employment contract or state statute not to be determinative. In determining whether meals or lodging are furnished for the convenience of the employer, the provisions of an employment contract or of a State statute fixing terms of employment shall not be determinative of whether the meals or lodging are intended as compensation.

(2) Certain factors not taken into account with respect to meals. In determining whether meals are furnished for the convenience of the employer, the fact that a charge is made for such meals, and the fact that the employee may accept or decline such meals, shall not be taken into account.

(4) Meals furnished to employees on business premises where meals of most employees are otherwise excludable. All meals furnished on the business premises of an employer to such employer's employees shall be treated as furnished for the convenience of the employer if, without regard to this paragraph, more than half of the employees to whom such meals are furnished on such premises are furnished such meals for the convenience of the employer.

(d) Lodging furnished by certain educational institutions to employees.

(1) In general. In the case of an employee of an educational institution, gross income shall not include the value of qualified campus lodging furnished to such employee during the taxable year.

(2) Exception in cases of inadequate rent. Paragraph (1) shall not apply to the extent of the excess of--

(A) the lesser of--

(i) 5 percent of the appraised value of the qualified campus lodging, or

(ii) the average of the rentals paid by individuals (other than employees or students of the educational institution) during such calendar year for lodging provided by the educational institution which is comparable to the qualified campus lodging provided to the employee, over

(B) the rent paid by the employee for the qualified campus lodging during such calendar year.

The appraised value under subparagraph (A)(i) shall be determined as of the close of the calendar year in which the taxable year begins, or, in the case of a rental period not greater than 1 year, at any time during the calendar year in which such period begins.

(3) Qualified campus lodging. For purposes of this subsection, the term "qualified campus lodging" means lodging to which subsection (a) does not apply and which is--

(A) located on, or in the proximity of, a campus of the educational institution, and

(B) furnished to the employee, his spouse, and any of his dependents by or on behalf of such institution for use as a residence.

(4) Educational institution, etc. For purposes of this subsection--

(A) In general. The term "educational institution" means--

(i) an institution described in section 170(b)(1)(A)(ii) [IRC Sec. 170(b)(1)(A)(ii)] (or an entity organized under State law and composed of public institutions so described), or

(ii) an academic health center.

(B) Academic health center. For purposes of subparagraph (A), the term "academic health center" means an entity--

(i) which is described in section 170(b)(1)(A)(iii) [IRC Sec. 170(b)(1)(A)(iii)],

(ii) which receives (during the calendar year in which the taxable year of the taxpayer begins) payments under subsection (d)(5)(B) or (h) of section 1886 of the Social Security Act [42 USCS § 1395ww] (relating to graduate medical education), and

(iii) which has as one of its principal purposes or functions the providing and teaching of basic and clinical medical science and research with the entity's own faculty.

CFR § 1.119-1 Meals and lodging furnished for the convenience of the employer.

(a) Meals—

(1) In general. The value of meals furnished to an employee by his employer shall be excluded from the employee's gross income if two tests are met: (i) The meals are furnished on the business premises of the employer, and (ii) the meals are furnished for the convenience of the employer. The question of whether meals are furnished for the convenience of the employer is one of fact to be determined by analysis of all the facts and circumstances in each case. If the tests described in subdivisions (i) and (ii) of this subparagraph are met, the exclusion shall apply irrespective of whether under an employment contract or a statute fixing the terms of employment such meals are furnished as compensation.

(2) Meals furnished without a charge. (i) Meals furnished by an employer without charge to the employee will be regarded as furnished for the convenience of the employer if such meals are furnished for a substantial noncompensatory business reason of the employer. If an employer furnishes meals as a means of providing additional compensation to his employee (and not for a substantial noncompensatory business reason of the employer), the meals so furnished will not be regarded as furnished for the convenience of the employer. Conversely, if the employer furnishes meals to his employee for a substantial noncompensatory business reason, the meals so furnished will be regarded as furnished for the convenience of the employer, even though such meals are also furnished for a compensatory reason. In determining the reason of an employer for furnishing meals, the mere declaration that meals are furnished for a noncompensatory business reason is not sufficient to prove that meals are furnished for the convenience of the employer, but such determination will be based upon an examination of all the surrounding facts and circumstances. In subdivision (ii) of this subparagraph, there are set forth some of the substantial noncompensatory business reasons which occur frequently and which justify the conclusion that meals furnished for such a reason are furnished for the convenience of the employer. In subdivision (iii) of this subparagraph, there are set forth some of the business reasons which are considered to be compensatory and which, in the absence of a substantial noncompensatory business reason, justify the conclusion that meals furnished for such a reason are not furnished for the convenience of the employer. Generally, meals furnished before or after the working hours of the employee will not be regarded as furnished for the convenience of the employer, but see subdivision (ii)(d) and (f) of this subparagraph for some exceptions to this general rule. Meals furnished on nonworking days do not qualify for the exclusion under section 119. If the employee is required to occupy living quarters on the business premises of his employer as a condition of his employment (as defined in paragraph (b) of this section), the exclusion applies to the value of any meal furnished without charge to the employee on such premises.

(ii)(a) Meals will be regarded as furnished for a substantial noncompensatory business reason of the employer when the meals are furnished to the employee during his working hours to have the employee available for emergency call during his meal period. In order to demonstrate that meals are furnished to the employee to have the employee available for emergency call during the meal period, it must be shown that emergencies have actually occurred, or can reasonably be expected to occur, in the employer's business which have resulted, or will result, in the employer calling on the employee to perform his job during his meal period.