The Holy Grail of Tax

8/4/2019 The Holy Grail of Tax

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Tax IA Outline

Analysis Tips:

1. Is it a receipt or disbursement?

2. Look at the relationship between the parties: buyer/seller, H&W,Parent/child, ee/er.

3. Look at the transaction setting: donative or bargained for, arms length,unintended transactions, and windfalls.

4. Look for an exchange mode.5. Look to general rule first, then to exceptions.6. What are the values?7. Focus in on what is relevant. Everything does not require hornbook

treatment.

I.

Introduction

A. Tax PolicyMeasuring the tax burden based on your ability to pay.

A matter of yield: how much revenue you want to collect and the role ofgovernment. The government can subsidize or discourage a particularactivity through the tax code. The higher the tax rate you are in, the betterthe subsidy for preferred activities.

The taxing formula reflects policy: certain non-discretionary businessexpenditures are above the line deductions while other personaldiscretionary expenditures are below the line deductions.

Implicit in the taxing formula is the government policy not to tax thosebelow the poverty line: the personal exemption and standard deductionare figured so those at the poverty line pay a zero tax rate.

The standard deduction depends upon your filing unit.

The Alternative Minimum Tax (AMT) was created for policy reasons:some wealth taxpayers were taking advantage of preferences in the code tozero out their taxes. Under the AMT, they have to pay some minimumlevel of tax.


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B. Tax PlanningAsk: What is the income/deduction?

Whose income/deduction is it?When is it taxable?

3 Basic planning ideas:1) Conversion-can we convert a dollars character from taxable to

deductible or tax it at a lower rate?2) Whos income can it be shifted from A to B3) Deferring income to other years

When you analyze a code section, try to fit it in one of these 3 categories.

C. Sources of Tax LawPrimary Sources________________

1) Internal Revenue Code (IRC) of 19862) Regulations regs - issued by the Treasury Dept/IRS*Courts give the regs tremendous difference. **Note the effectivedate of the reg, they can be retroactive. The effective dates are notin the IRC.

Secondary Sources________________

1) Courts Opinions of the U.S. Supreme Court. AppellateCourts. Then Tax Court.

2) IRS Revenue Rulings issued by the IRS to the localoffices so rules are uniform. Rev rulings are binding onthe IRS, but not the taxpayer. It is useful b/c it informsthe taxpayer of the IRS position.

3) Revenue Procedures4) Private Letter rulings like a pre-audit a private

taxpayer gives the IRS a detailed description of a

proposed transaction and asks for an advisory opinion onthe tax consequences. Not given the weight as a revenueruling, but still useful.

House report-legislative history


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D. Tax LegislationWhen the Ways and Means /Committee of congress brings a bill back tothe floor of the House, a report accompanies the bill. The report seeks toexplain to the other House members just what the bill is designed to do,

usually with illustrations. Later, when the Finance Committee reports itsbill to the Senate, another committee report emerges. In addition, the JointCommittee on Taxation (JCT) issues a bluebook explanation of the Actthat explains the ambiguities etc.. These reports are the most importantpart of the legislative history of a statute and the courts often resort tothem as guides to the meaning of the legislation. Especially in the early lifeof a statute when there arent any regulations or case law.

E. Tax ProcedureTaxpayers have a duty to file a tax return and pay the tax, if not, they arepenalized.

If there is a dispute, the IRS will send a revenue report (30 day letter)where you have 30 days to appeal it with an appellate conference. If youcontinue to dispute, you receive a Notice of Deficiency (90 day letter).Now you have 90 days to petition tax court if you wish to continue thedispute. There are no extensions to the 90-day letter. In tax court, thetaxpayer is the petitioner and the commissioner is the respondent. Duringthe 90-day process, the IRS is precluded from doing anything against you.In tax Court, you can litigate the matter before paying the deficiency, but ifyou lose, you are liable for interest and penalty all the way back.

To do it another way: if under the 30-day letter, you can pay the tax andfile an amended return asking for a refund. If after 6 months the IRS doesnot give notice of a refund, you may file in the US Court of Claims or USDistrict Court. **To go the Claims Court or US District Court route, youmust pay the full tax first.**

The IRS has power to collect only after giving notice to the taxpayer. TheIRS cannot make an assessment without giving notice or the taxpayers

DUE Process rights are violated. The notice must be timely.

**Note: In tax court, the facts are largely stipulated by the parties andnot in dispute.The Board of Tax Appeals (BTA) used to be an administrative court, but it

was later peeled out into an independent court.

et a statutorytice if you undery and continuedispute


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II. Gross IncomeA. What is GI? First begin with the Code, and then go to the Regs, then to

case law.

IRC 61 Gross Income Defined(a) Except as otherwise provided in this subtitle, gross income

means all income from whatever source derived, including (but notlimited to) the following items:

1) Compensation for services, including fees, commissions, fringebenefits, and similar items;

2) GI derived from business;3) Gaines derived from dealings in property;4) Interest5) Rents;6) Royalties;7) Dividends8) 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 GI;14) Income in respect of a decedent; and15) Income from an interest in an estate or trust.

61 is very broad and not limiting. Although the laundry list doesnt say wages, itis included in GI.

What does the Regs add to the meaning of GI?

1.61-1: (a) Gross income means all income from whatever source derived, unlessexcluded by law. Gross income includes income realized in any form, whether inmoney, property, or services. Income may be realized, therefore, in the form ofservices, meals, accommodations, stock, or other property, as well as in cash. GI isnot limited to only those items enumerated in 61.

1.61-2: Compensation for services, including fees, commissions, and similar items:

(a)(1) Wages, salaries, commissions paid salesmen, compensation for services on thebasis 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

Subtitle A

There is nolimit to theform ofincome

bor/rter


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persons in the military or Naval forces, retired pay of employees, pensions, andretirement allowances are income to the recipients unless excluded by law.

(d) (1) Compensation paid other than in cash: Except as otherwise provided, ifservices 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 inexchange for other services, the fair market value of such other services take inpayment must be included in income as compensation. If the services are renderedat a stipulated price, such price will be presumed to be the fair market value of thecompensation received in the absence of evidence to the contrary.

(d) (2) i if property is transferred by an employer to an employee or if property istransferred to an independent contractor, as compensation for services, for anamount less than its fair market value, then regardless of whether the transfer is inthe form of a sale or exchange, the difference between the amount paid for the

property and the amount of its fair market value at the time of the transfer iscompensation and shall be included in the gross income of the employee orindependent contractor. In computing the gain or loss from the subsequent sale ofsuch property, its basis shall be the amount paid for the property increased by theamount of such difference included in gross income.

1.61-14 (a) Miscellaneous items of gross income. (These are one-sentence summariesof case law.) In addition to the items enumerated in 61(a), thee are many other kidsof gross income. For example, punitive damages such as treble damages under theantitrust laws and exemplary damages for fraud are gross income (Glenshaw Glass).

Another persons payment of the taxpayers income taxes constitutes gross income tothe taxpayer unless excluded by law (Old Colony Trust). Illegal gains constitutegross income (James). Treasure trove, to the extent of its value in United Statescurrency, constitutes gross income for the taxable year in which it is reduced toundisputed possession (Cesarini).

** The general rule is all income is gross income unless excluded. The burden ofproving an exception is on the taxpayer (b/c the taxpayer has the facts). Exceptionsto gross income are narrowly construed against the taxpayer.

B. Equivocal Receipt of Financial BenefitCase law on GI


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Commissioner v. Glenshaw Glass-1955 U.S. Supreme Court Taxpayers were awarded punitive damages as a result of antitrust litigation. TPincluded compensatory damages in GI, but excluded the punitives. IRS claimed adeficiency.

I. Whether money received as exemplary damages or as punitive damages are GI.

RoA: in favor of IRS

H. A taxpayer has GI when there is1) an undeniable accession to wealth,2) clearly, realized, and3) over which the taxpayer has complete dominion.

(This is a positive definition, with these 3 things present, and then you have income.)

The income tax is source blind, and any measurable gain is within its reach. Nothing in the Code excludes punitives from GI. Gains or Profits derived from any source gives Congress full taxing power,

and is given a liberal construction by the courts. The mere fact that punitives are punishment for wrongdoing does not change

the character of what they received (taxable income).

Distinguished: Eisner v. Macomber, which had described income as the gainderived from labor, from capital, or from both combined. In Glenshaw, the court

said this definition was too limited and is not the touchstone to all questions of GI.

Important notes from Glenshaw:* The IRS subtracted the amount of attorneys fees from the punitive award tocalculate the deficiency. This net amount of the punitive award reflects thepolicy to deduct business expenses incurred in pursuit of income (Cost of DoingBusiness or CODB).

* The TPs made 3 arguments: The first is a statutory argument, that punitives arentlisted in the code as income, that is, punitives are windfalls not listed as GI (thecourt said this definition Code is broad and given liberal construction); second they

argue case law, that was Eisner (which the court distinguished), and third, theyargued when congress reenacted the statute, they didnt reject the holding inHighland (held punitives not taxable) and explicitly include punitives in GI (thecourt rejected this b/c they said congress wasnt aware of the Highland holding).

If this had been an award of personal punitives (awarded to a person rather than acompany), the court May have decided the case differently: b/c personal injury

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recoveries are treated as a return of capital and not taxable. **So the setting of thetransaction is important*

What do the elements of Glenshaw mean?:

*Assession to wealthnew wealth you didnt have before; it calls for ameasurement of the TPs personal wealth from one point in time to another (usuallyone year). Only an increase in wealth is taxed. Borrowing doesnt increase yourwealth b/c you have to repay it. A return of capital is not an increase in wealth, it isyour old wealth coming back to you. Wealth has a value in the market. Cash andnon-cash property can increase wealth.

*Clearly realizedwhen the benefit is sufficiently in hand to be taxable;realization is tied to timing: if your asset appreciates in value, your wealth mayhave increased, but you dont have income until it is sold. This sale is a closing

transaction using an exchange model. This realization concept, requiring a closingtransaction, helps avoid the constant valuation of assets you own. Self createdproperty is not income until you sell it. Unrealized appreciation of assets is notincome.

*dominion means who is in charge of the wealth or property. It is broader thanphysical possession or legal ownership and includes who controls the property issubstance. Ownership and possession are not defined in the regs, but is definedunder the c/l of the state. Dominion also supports when (timing) it is income: ex:when reduced to undisputed possession.

Cesarini v. U.S.1969 U.S.D.C. of ND of Ohio

TP found money in a piano they had purchased used. After including it in GI andpaying the tax, the TP filed for a refund, which was rejected.

I. Whether found money is GI to the finder.

RoA: for IRS.

H. Income from all sources is taxed unless the tax can point to an express exemption.Windfalls, including found money, are properly included in GI.

Rationale: 61 says all income from whatever the source, the taxpayer must point to a

specific exclusion to escape taxation.

easureove


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Rev ruling 61 treasurer trove is taxable in the year when it is reduced toundisputed possession.

Finder of lost property gets superior title when the property is found underthe c/l, so the S of L begins running when found. Possession of the moneywas undisputed when it was found in 1964.

Notes from Cesarini: The taxpayer made 3 alternate claims:1) The money wasnt income under 61; the court said all income from

whatever source derived2) If it wasnt income, the tax was due in 1957 when piano was purchased and

the s of L had run; the court said it was reduced to undisputed possessionin 1964, so that began the S of L running

3) It is a capital gain, taxed at the lower rate; the court rejected this too.Cesarini is important b/c it tells us the important interaction of federal and statelaw. State law here tells us what ownership and when there is possession.

Old Colony Trust v. Commissioner US 1929

a corporation, by resolution of the Board of Directors, agreed to pay the income taxes(and did pay) of the company president. IRS claimed a deficiency. BTA ruled forIRS, Circuit Court of appeals ruled for TP.

I.Whether the payment of an employees income taxes by an employer constitutesadditional taxable income.

RoA: reversed, in favor of IRS.

H. The discharge by a third person (or party) of an obligation is equivalent toreceipt of income by the person taxed.

Rational: Here the taxes paid by an employer upon a valuable consideration,namely, the services rendered by the employee, are part of the employeescompensation and constitutes income to the employee. It is compensation, not a gift.

Notes from Old Colony GI can be direct or indirect, the direction of the paymentdoesnt matter, and it was still compensation. Here the employee had dominionover the arrangement (dont pay me, pay the IRS or whoever, he induced thethird party.


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In an analysis, start with: what is the relationship between the parties? Here,employer and employee. What is going on? Why is it happening? Here there wasan exchange model working, even though the payments were indirect: the employeegot the equivalent to receipt of the income.

Charley v. Commissioner-USCA 9th cir 1996 TPs employer was charged by the travel agent for the TP to fly first class, but the TPwould arrange for a coach ticket, which he upgraded to first class with his frequentflyer miles he earned in connection with his business travel. He received $3,149 in hispersonal travel account from this exchange process.

I. Whether travel credits converted to cash in a personal travel account establishedby an employer constitutes GI to the employee.

RoA: Tax court was affirmed for the IRS, but the penalty reversed b/c the TP didntknow travel credits were taxable and they did not try to conceal it.

H. Travel credits which a taxpayer receives as compensation or as property with azero tax basis, is taxable as GI to the TP.

The TP was wealthier after the transaction than before (accretion of wealth isthe receipt of income)

The funds/money in the account came from the employer, so it iscompensation

TP had no basis in the frequent flyer miles, which were earned by theemployers travel.

Notes from Charley the court here began with the Code, then Glenshaw and the 3elements. The court found it as additional compensation; there was a realizationwhen the credits were converted to cash. Here there was an exchange modelworking between an employer and employee. Although the TP made a definitionalargument (it is not income), the code is source blind and the TP was wealthier.Same analysis: who are the parties and what is their relationship? Closerelationships are given more scrutiny. What is being exchanged?

Helvering v. Clifford-USSC 1940

H created a short term trust for his W, who was to have exclusive benefit ofthe net income.

However the H, as trustee, had absolute discretion over how much of the netincome was to be turned over to his W.

xam tip


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He also retained control over the assets, ex: selling, exchanging, mortgagingAlso certain items, such as extraordinary cash dividends were to be treated asprincipal, not income.

W didnt have any rights or control of over the income until it was actuallypaid to her.

IRS claimed deficiency; BTA ruled for IRS, the Circuit Court reversed.I. Under what circumstances may the grantor of a trust still be treated as an owner ofthe corpus (principal) and liable for the taxes?

RoA: Circuit court of appeals was reversed in favor of the IRS.

H. A grantor is considered owner of a trust when the trust is of a short duration,the income remains in the family, and the grantor retains practical control over thecorpus (principal).

22 (61) language gives a broad sweep. The analysis depends upon the individual terms and circumstances of the

trust. Case by case. The courts looks further than legal paraphernalia The trust was at best a temporary reallocation of income within an intimate

family group The grantor didnt feel any poorer after the trust was executed. The grantor retained control of the principal, and still had the same

bundle of rights.

Notes from Clifford: the H(grantor) still retained dominion over the property,and in substance, the owner. So dominion is a broader concept than just legalownership (here the legal owner was the trust).

C. Income Without Receipt of Cash or Property

Helvering v. Independent Life Ins. Co.-US 1934

This case raised a question whether a taxpayer must include in GI the rental value ofa building owned and occupied by the TP.

H The rental value of the building used by the owner does not constitute incomewithin the meaning of the Sixteenth Amendment. **The potential use of your ownproperty is not taxable: imputed income is not taxable.**


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Imputed income potential use of your own property not taxable b/c it is difficultto measure, also the TP doesnt have the cash to even pay the tax. If you later sell orrent the property then you have income: there is a closing transaction in anexchange model that increases wealth. Same with self-created value: if you fix up anold house you may increase your wealth by virtue of your own labor, but it isnt

taxable until you sell it when there has been an exchange model.

Dean v. Commissioner-USCA 3rd 1951

The Corporation owned by the taxpayer and his wife was indebted to thebank.

The bank required the TP to transfer the ownership of the family residence tothe corporation.

The TP continued to live there rent-free. IRS claimed deficiency, tax court ruled in favor of IRS.

I. Whether the rental value of property held in the name of a corporation of whichthe TP is the sole shareholder is GI to the TP.

RoA: TAX court ruling affirmed in favor of IRS.

H. The FMV of rental property held by a corporation and used as a personalresidence by the TP is income to the TP.

The TP has an obligation to provide a home.

The corporation existence and transfer of property was bona fide. The bank could have taken the property if the corp defaulted.Notes from Dean The courts viewed this as a barter exchange between employer(the corporation) and employee (TP), it was part of a compensation agreement.Since there was an exchange model here, the income is now no longer imputed. Itis a realized benefit received by the TP.

Non-cash transactions are income when it is compensatory or earned, true if thereis a property exchange or barter. (Dean/Charley) However, Treasure Trove that isnon-cash, such as a homerun baseball, may not be realized income b/c there has

been no exchange model. But cash treasure trove (in US currency) is income per1.61-14.

Notes on measuring wealth/income:Taxable income under an exchange model:*Cash *Non Cash barter*Non-cash compensation *Non Cash property


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Taxable income without an exchange model:*Windfalls and treasure trove (in US currency)

Not measured in wealth and is not taxable income:(b/c no exchange model or closing transaction, the income is not realized):

*Imputed income*Unrealized appreciation of assets*Self created property

Gross income includes the receipt of any financial benefit which is:I. Not a mere return of capitalII. Not accompanied by a contemporaneously acknowledged obligation to repayIII. Not excluded by a specific statutory provisionExample of a revenue ruling: situation: an individual who owned an apartment

building received a work of art created by a professional artist in return for the rent-free use of an apartment for six months. Law: Code 61 and reg 1.61-2(d)(1): thefmv of the work of art and the six months fair rental value of the apartment areincludible in the GI of the apartment owner and the artist under 61.


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III. The Exclusion of Gifts and InheritancesA. Rules of Inclusion and ExclusionCongress has specifically excluded certain items from gross income.

Explicit statutory provision takes precedence over the general definitions.Exclusions from GI are different from deductions.

102 is an exclusionary provision of the tax code. Exclusions are particular aboutthe source of the income (as opposed to the general rule of 61 that gross income issource blind). So 102 doesnt care what type of property is, the concern is with thevalue and source. Exclusions are narrowly construed against the taxpayer. The sectionuses the word property, as opposed to income: it is the value of the propertythat is excluded, but not the income derived from that property.

Property has two ways to create wealth: 1) appreciation and 2) dividends or incomegenerated from it. Income from property is not excluded as a gift 102 (b)(2).

I.R.C. 102 Gifts and inheritances.A) general rule gross income does not include the value of property

acquired by gift, bequest, devise, or inheritance.B) Income subsection (a) above shall not exclude from gross income:

1)the income from any property referred to in subsection (a); or2)where the gift, bequest, devise, or inheritance is of income from

property, the amount of such income.

(a)Where, under the terms of the gift, bequest, devise, or inheritance,the payment, crediting, or distribution thereof is to be made atintervals, then, to the extent that it is paid or credited or to bedistributed out of income from property, it shall be treated forpurposes of paragraph (2) as a gift, bequest, devise, or inheritance ofincome from property. Any amount included in the gross incomeof a beneficiary under subchapter J shall be treated for purposes ofparagraph (2) as a gift, bequest, devise, or inheritance of incomefrom property.(the income from a gift, bequest, devise, orinheritance is taxable.)

(b)Employee gifts.(i) in general. Subsection (a) shall not exclude from gross

income any amount transferred by or for an employer to, orfor the benefit of an employee.

(ii) Cross references employee achievement awards 74(c); deminimis fringes 132(e).

Reg. 1.102-1 Gifts and Inheritances.


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A) General rule. Property received as a gift or received under a will orunder statutes of descent and distribution, is not includible in grossincome, although the income from such property is includible in grossincome. An amount of principal paid under a marriage settlement is agift. However, see 71 and the regulations there under for rules relating

to alimony or allowances paid upon divorce or separation. 102 does notapply to prizes and awards (see 72 and 1.74-1) nor to scholarships andfellowship grants (see 117 and the regulations there under).

B) Income from gifts and inheritances. The income from any propertyreceived as a gift, or under a will or statute of descent and distributionshall not be excluded from gross income under paragraph (a) of thissection.

C) Gifts and inheritances of income. If the gift, bequest, devise, orinheritance is of income from property, it shall not be excluded fromgross income under paragraph (a) of this section. 102 provides a specialrule for the treatment of certain gifts, bequests, devises, or inheritanceswhich by their terms are to be paid, credited, or distributed at intervals.Except as provided in 663(a)(1) and paragraph (d) of this section, to theextent any g/b/d/I is paid, credited, or to be distributed out of incomefrom property, it shall be considered a g/b/d/I of income from property.102 provides the same treatment for amounts of income from propertywhich is paid, credited, or to be distributed under a gift or bequestwhether the gift or bequest is in terms of a right to payments at intervals

(regardless of income) or is in terms of a right to income. To the extentthe amounts in either case are paid, credited, or to be distributed atintervals out of income, they are not to be excluded under 102 from thetaxpayers gross income.

Exclusions In general - 102 does not apply to prizes and awards (including employeeachievement awards)(see74); certain de minimis fringe benefits (see 132); anyamount transferred by or for an employer to, or for the benefit of, an employee(see 102(c)); or to qualified scholarships (see 117).

Employer/employee transfers for purposes of 102(c), extraordinary transfersto the natural objects of an employers bounty will not be considered transfersto, or for the benefit of, an employee if the employee can show that the transferwas not made in recognition of the employees employment. Accordingly,102(c) shall not apply to amounts transferred between related parties (e.g.father and son) if the purpose of the transfer can be substantially attributed to


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the familial relationship of the parties and not to the circumstances of theiremployment.

Giftsgift is not defined in the code

Commissioner v. Duberstein US 1960

Duberstein: TP, a business executive gave a lead to a business associate; thelead proved fruitful and the associate gave the TP a new Cadillac.

The associate deducted the cost of the Cadillac.H. not excludable from GI. (The deduction taken by the donee indicated his intent

wasnt to make a gift but as compensation for the lead, quid pro quo)

Stanton: TP resigned from a management position with a church and the B of D voted

to pay him $20K as a gratuity and in appreciation for his services rendered,plus release from any pension claim.

Remanded to find more factsI. Whether payments made with business overtones are excluded from GI as gifts.

H. Whether a transfer of money or property constitutes a gift within the exclusion of102 is an issue of fact to be determined by the trier of fact. It is a case by case basis.

Rationale: Very Important here! It is critical to ascertain the transferors intentions. A gift proceeds from

a detached and disinterested generosity, out of affection, respect, charityor like impulses. The inquiry must be into the donors state of mind.Critical: the transferors intentions.

There needs to be an objective inquiry, you cant take the word of thedonor or donee that it is a gift. The donors characterization is notdeterminative.

Decision of the issues in these cases must be based on the application ofthe fact finding tribunals experiences with the mainsprings of humanconduct. The Statute is not complicated, the fact finder should be able tosort through it.

The c/l definition of gift and the tax definition are two different things.


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Dissent: with all the individuals using their experiences, the tax code wont beuniform.

Important notes: The IRS wanted the court to fashion a bright line test and say thatgifts should defined as transfers of property made for personal as distinguished

from business reasons. The court didnt like this broad test and rejected it asunworkable. The court relied on Cardozo: what is a business deduction is aquestion of fact.

Congress responded to this case by codifying the IRSs proposed test in 102(c):now it is a matter of law that in the employer/employee setting that transfers areincome and there is no need for a factual inquiry. The statute indicates a broadcongressional intent to deny gift classification to all transfers by employers toemployees.

IV. Congress also responded with 274(b) that limits business gifts to $25. Butunder 102(a) there is still a factual inquiry.Analysis tips from Duberstein: facts are important in determining what a gift is!!Look at the relationship of the transferor and transferee. Here, the relationship is notin a family setting, but business. Look for a quid pro quo, like the lead for a car; thetransferor didnt intend a gift b/c he deducted it; no one would have paid taxes on itif it was deemed a gift.

**Go through the 3 elements of Glenshaw, then look for exclusions. The TP hasthe burden of proving the exclusion.

The standard for review this court applies is the clearly erroneous standard. If aquestion of law, it is a de novo review, but if it is a question of fact, it must be clearlywrongin fact finding: a very high standard. So if a lower court finds the factsagainst you, you have a very hard time overturning that conclusion.

If an independent contractor, maybe not an employee.Look to see if you are under 102(a) or (c).

102 makes a distinction between the value of property given and the income generated

from property. Ex: the stock is the gift, the dividends are income.

Inheritance

Lyeth v. Hoey US 1938 TP is grandson of deceased, he challenged the will and the executors agreed to

a compromise settlement where he received more than was in the will as


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written. Under state law, the extra money is considered to be acquired bycontract and not inheritance.

I. Whether property received by an heir in fact from the estate of his ancestor,when distributed under an agreement settling a contest of the will, is acquired by

inheritance [within the meaning of 102(a)].

H. When the contestant is an heir in fact and a valid compromise agreement hasbeen made and there is a distribution to the heir from the decedents estateaccordingly, the property received is acquired by inheritance within the meaningof the statutory exemption.

Rationale:A) The construction of an exemption in the federal statute is not determined

by local law.

B) State law determines the heir status, federal law determines thecharacter of the property for income tax purpose. (state law determineswho is an heir.

C) Federal tax laws should be interpreted so to give uniform application tothe nationwide scheme of taxation. State laws vary too much and notcontusive to uniformity.

D) State laws may control only when the federal taxing act by expresslanguage or necessary implication makes its operation dependent on statelaw.

Notes: look at the origin of the claim. Here it is based on heirship. Look at therelationship between the TP, that status is determined by local law. After that,federal law kicks in. Similar to Ceseraini where state law determined what waspossession. Even if the heir has to sue, he is still heir in fact and takes aninheritance.

Death is not a taxable event for income tax purposes, not a realization.

For Gross Income, it is source blind. But for an exclusion from Gross Income, it issource dependent.

Wolder v. Commissioner - US 1974 TP and the decedent signed a K in which the TP would provide lifetime legal

services with no charge if the decedent would bequeath certain stock to him inher will.

The TP performed the services, and the decedent left him stock in her will.I. Whether the bequest in the will was inhered or postponed compensation.


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H. Obligations for services rendered under K are postponed payments and taxableas income to the recipient, whether in the form of a bequest or not.

Rationale:

A) TP did not come as an heir in fact, but as someone who performedservices.

B) The transfer is the same as in Duberstiein, look at the donors intentions,Why is she doing this?

Notes: What hat was the TP wearing? Was there a quid pro quo? Yes, it wasbargained for. Look at the facts, not at the label of distribution of inheritance. Lookat the origin of the claim (in Lythe, it was heriship, here it is payment of services).

What if an heir (ex: child) performs services also? If a child performs $20 in services

under a K, when parent dies, the estate settles the claim for $12 instead of $20. Butthen the child still receives the $8 on the residual clause of the will b/c the child is theheir in fact. The $8 has been recharacterizedas inheritance instead of forservices. Is the $8 is excludable from GI. This is a factual question! Are theexecutor and child related or is the settlement an arms length transaction. Look atsubstance, if the executor collude, the child still has income of $20!! Substancegoverns over form. If not a bona fide settlement, then it is GI.

Can services be donated or gifted to an estate? That is if the executor/heir waiveany statutory fee and take the money through inheritance? Yes, if certain conditions

are met:

Revenue Ruling 66-167:Waiving the right to receive the fee can keep the fee frombeing included in the GI of the executor/heir. The intent to waive the fee must beshown upfront at the beginningbefore the services are rendered. If you dontwaive up front, it is harder to prove you are doing it free. It doesnt look so muchlike a quid pro quo if done at the beginning. If the timing, purpose, and effect of thewaiver make it serve any other important objective, it may then be proper toconclude that the fiduciary has thereby enjoyed a realization of income by means ofcontrolling the disposition thereof, and at the same time, has also effected a taxablegift by means of any resulting transfer to a third party of his contingent beneficialinterest in a part of the assets under his fiduciary control. The intention to serve on agratuitous basis will ordinarily be deemed to have been adequately manifested if theexecutor or administrator provides the decedents principal legatees a formal waiverwithin six months after his initial appointment. If the estate deducts the fee from itsincome taxes, then a waiver cannot be intended (it does not look gratuitous).


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V. Ch 4 AwardsA) Prizes

Usually resemble a "donative arrangement" and lack of "quid pro quo." In1986 Congress broadened the tax base by denying exclusion of prizes andawards from GI under the overworked "gift" theory. These tax rules can relate

to such things as winning a company's sales or other contest, the Nobel PeacePrize, a contest to guess how many jelly beans in a jar. 74(a) expresslyincludes prizes and awards in GI but carves out two limited exceptions:

74(b) excludes the award from GI if the recipient transfers the award directlyto a governmental unit or charity. Thus the only way the winner can escapean inclusion in GI is to never receive the award. However, the designation ofthe recipient can be made before or after the taxpayer is aware of being therecipient of the award.

74(c) creates a limited exclusion for certain employee achievement awards.An award may qualify if it relates to length of service or to safety. It must bein the form of tangible personal property, be awarded as part of a meaningfulceremony, and not be mere disguised compensation. A length of serviceaward does not qualify unless the employee has been in the employer's servicefor five years or more and has not received a length of service award for thecurrent or any of the prior four years. A safety achievement award qualifiesonly if made to other than a manager, administrator, clerical employee orother professional employee and only if 10 percent or less of an employer'squalified employees receive such awards during the year so that is

discriminating and not just a part of the general pay scale. the amount ofemployee exclusion is geared to the extent to which the employer qualifies fora deduction under 274(j).

IRC 74 Prizes and awards.A) General rule Except as otherwise provided in this section or in section117 (relating to qualified scholarships), gross income includes amountsreceived as prizes and awards.B) Exception for certain prizes and awards transferred to charities . Gross

income does not include amounts received as prizes and awards madeprimarily in recognition of religious, charitable, scientific, educational,

artistic, literary, or civic achievement, but only if:1)The recipient was selected without any action on his part to enter the

contest or proceeding;(a)The recipient is not required to render substantial future services as

a condition to receiving the prize or award; and


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(b)The prize or award is transferred by the payor to a governmentalunit or organization described in paragraph (1) or (2) of 170(c)pursuant to a designation made by the recipient.

2)Exception for certain employee achievement awards.(a)Gross income shall not include the value of an employee

achievement award (as defined in 274(j)) received by the taxpayerif the cost to the employer of the employee achievement award doesnot exceed the amount allowable as a deduction to the employer forthe cost of the employee achievement award.

(b)Excess deduction award. If the cost to the employer of the employeeachievement award received by the taxpayer exceeds the amountallowable as a deduction to the employer, then gross incomeincludes the greater of

(i) an amount equal to the portion of the cost to the employer ofthe award that is not allowable as a deduction to the

employer (but not in excess of the value of the award), or(ii) the amount by which the value of the award exceeds the

amount allowable as a deduction to the employer. The remaining portion of the value of such award shall

not be included in the gross income of the recipient.(c)Treatment of Tax-exempt employers. In the case of an employer

exempt from taxation under this subtitle, any reference in thissubsection to the amount allowable as a deduction to the employershall be treated as a reference to the amount which would beallowable as a deduction to the employer if the employer were not

exempt from taxation under this subtitle.

Cross reference: for provisions excluding certain de minimis fringes from grossincome see 132(e).

Under 74(a) prizes and awards are income. This is a catchall provision whereyou are stuck unless you can meet the 4 elements of 74(b). The TP has theburden to prove an exception under 74(b)

4 elements to be met to be excluded from GU under 74(b):3)merit based4)not based on past services5)no quid pro quo for future services6)the award must be shifted off at the beginning to a charitable institution.

**don't put your hands on it or it could be poison**


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IRC 274(j) Employee Achievement Awards.General Rule. No deduction shall be allowed under section 162 or section 212 forthe cost of an employee achievement award except to the extent that such cost doesnot exceed the deduction limitations of paragraph (2).Deduction Limitations. The deduction for the cost of an employee achievement

award made by an employer to an employee(a)Which is not a qualified plan award, when added to the cost to the

employer for all other employee achievement awards made to suchemployee during the taxable year which are not qualified planawards, shall not exceed $400, and

(b)Which is a qualified award, when added to the cost to the employerfor all other employee achievement awards made to such employeeduring the taxable year (including employee achievement awardswhich are not qualified plan awards), shall not exceed $1,600.

Definitions. For purposes of this subsection

Employee achievement award. The term employee achievement awardmeans an item of tangible personal property which is-

Transferred by an employer to an employee for length of service achievement orsafety achievement,

Awarded as part of a meaningful presentation, and Awarded under condition andcircumstances that do not create a significant likelihood of the payment of disguisedcompensation.

Qualified plan award.

In general. The term qualified plan award means an employee achievement awardawarded as part of an established written plan or program of the taxpayer whichdoes not discriminate in favor of highly compensated employees (within themeaning of 414(q)) as to eligibility or benefits.

Limitations. An employee achievement award shall not be treated as a qualified planfor any taxable year if the average cost of all employee achievement awards whichare provided by the employer during the year, and which would be qualified planawards but for this subparagraph, exceeds $400. For purposes of the precedingsentence, average cost shall be determined by including the entire cost of qualifiedplan awards, without taking into account employee achievement awards of nominalvalue.

Special rules. For purposes of this subsection


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Partnerships. In the case of an employee achievement award made by a partnership,the deduction limitations contained in paragraph (2) shall apply to the partnership aswell as to each member thereof.

Length of service awards. An item shall not be treated as having been provided for

service achievement if the item is received during the recipients First 5 years ofemployment or if the recipient received a length of service achievement award (otherthan an award excludable under 132(e)(1)) during that year or any of the prior 4years.

Safety achievement awards. An item provided by an employer to an employee shallnot be treated as having been provided for safety achievement if

During the taxable year, employee achievement awards (other than awardsexcludable under 132(e)(1)) for safety achievement have previously been awarded

by the employer to more than 10% of the employees of the employer (excludingemployees described in clause (ii), or such item is awarded to a manager,administrator, clerical employee, or other professional employee.

Recall that under 102(c) a gift from employer to employee is included in grossincome. However, a gift from an employer to an employee such as a retirement giftafter a long period of service may escape gross income inclusion by qualifying as a132(a)(4) de minimis fringe benefit. 74(c) adds a partial exclusion for certainemployee awards for service or safety.

Caselaw:

Allen J. McDonnell - Tax Court 1967

facts were stipulated, so thus in Tax Court. TP was an assistant sales manager who was, with his wife, required by his

employer to go on a trip to Hawaii to keep tabs on and otherwise "guide"independent sales reps and distributors.

The reps and distributors had received their trip from the TP's employer as aprize for top sales.

The TP was randomly chosen and required to go unless he had a goodexcuse.

TP had to participate in all the scheduled activities. TP and wife didn't get toshop or swim.

I. Whether the trip was an award and additional compensation taxable to the TP.


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H. When business reasons, coupled with equally compelling businesscircumstances require the TP to devote substantially off of their time on a trip forperformance of their duties, the expenses of the trip are not GI to the TP.

Rationale:

The employer had good business reasons for sending TP.

The TP was required to go: this was a condition of his employment, so it wasn't afringe benefit. Fringes don't include what is a condition of employment.There was no compensatory flavor to it.

The wife's presence was essential. [however, now 274(m)(3) would require thespouse to be an employee also in order to be deductible.]

You don't need to find a statutory exemption for this b/c it is not income to beginwith: it is a condition of his employment.

A good assignment is still not a fringe if it is a condition of his employment.

Reg. 1.74- Prizes and Awards.

Inclusion in gross income.

74(a requires the inclusion in gross income of all amounts received as prizes andawards, unless such prizes or awards qualify as an exclusion under (b), or unlesssuch prize or award is a scholarship or fellowship grant excluded from GI by 117.Prizes and awards which are includible in GI include, but are not limited to:amounts received from radio and television giveaway shows, door prizes, andawards in contest of all types.

If the prize or award is not made in money but is made in goods or services, the fairmarket value of the goods or services is the amount ot be included in income.

Proposed Reg. 1.74 - 1 Prizes and Awards.

Exclusion from GI. and the payor transfers the prize or award to one or moregovernmental units or organizations described in 170(c) as a qualified charity.Accordingly, awards such as the Nobel prize will qualify for the exclusion if the


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award is transferred by the payor to one or more qualifying organizations pursuantto a qualified designation by the recipient.

To qualify for exclusion under this section, the recipient must make a qualifyingdesignation, in writing within 45 days of the date the prize or award is granted. A

qualifying designation is required to indicate only that a designation is being made.The document does not need to state on its face that the organizations are entitiesdescribed in 170(c) to result in a qualified designation. It is not necessary that thedocument do more than identify a class of entities from which the payor may select arecipient. However, designation of a specific nonqualified donee organization ordesignation of a class of recipients that may include nonqualified doneeorganizations is not a qualified designation.

Ex: A distinguished ophthalmologist, S, is awarded the Nobel prize for medicine.S may designate that the prize money be given to a particular university that isdescribed in 170(c)(1), or to any university that is described in that section.However, S cannot designate that the award be given to a donee that is not describedin 170(c)(1), such as a foreign medical school. Selection of such donee or inclusionof such donee on a list of possible donees on S's designation would disqualify thedesignation.

(proposed Reg. 1.74-1 continued)

Prizes and awards granted before 60 days after date of publication of final

regulations. In the case of prizes and awards granted before 60 days after the date ofpublication of final regulations, a qualifying designation may be made at any timeprior to 105 days after date of publication of final regulations.

Transferred by payor. [Summary of the provision]

1)The transfer by the payor to the qualified donee by the due date of thereturn (without regard to extensions) for the taxable year in which theitems or amounts would otherwise be includible in the recipient's GI.

2)Possession of a prize or award by any person before a designation ismade will not result in the dissallowance of an exclusion unless adisqualifying use of the items or amounts is made before the items oramounts are returned to the payor for transfer to one or more qualifieddonee organizations.


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3)"Disqualifying use" means, in the case of cash or other intangibles,spending, depositing, investing or other wise using the prize or awardso as to enure to the benefit of the recipient or any person other than thegrantor or an entity described in 170(c). In the case of tangible items,the term "disqualifying use" means physical possession of the item for

more than a brief period by any person other than the grantor or anentity described in 170(c). Thus, physical possession by the recipientmay constitute a disqualifying use if the item is kept for more than abrief period of time. For example, receipt of an unexpected tangibleaward at a ceremony that other wise comports with the requirements ofthis section will not constitute a disqualifying use unless the recipientfails to return the item to the payor as soon as practicable after receipt.

4)For purposes of this section, an item will be considered "granted" whenit is subject to the recipient's dominion and control to such an extent that

it otherwise would be includible in the recipient's GI.

5)Charitable deduction not allowable. Neither the payor nor the recipientwill be allowed a charitable deduction for the value of any prize oraward that is excluded under this section.

CH 4(B) Scholarships and Fellowships

In 1954 Congress enacted 117 with the express purpose of providing a clear-cutmethod for distinguishing between taxable and nontaxable educational grants. As inthe case of the exclusion for prizes and awards, the exclusion for scholarships and

fellowships was substantially narrowed by the Tax Reform Act of 1986.

117(a) excludes from GI amounts received as a "qualified scholarship" by a degreecandidate at an educational organization. Not all scholarships are "qualified", that isa term of art, defined internally by the code. A "continuing education" candidate isnot a degree candidate either.

Reg 1.117-6(c)(3)(i) defines scholarship or fellowship generally as an amount paidfor the benefit of student to aid him in the pursuit of study or research. However theterms do not include amounts provided by an individual to aid a relative, friend, or

other individual in pursuit of study or research if the grantor is motivated by familyor philanthropic considerations. There is no quid pro quo arrangement, withoutstrings attached.

Reg. 1.117-3(e) defines the term candidate for a degree: as an individual whetheran undergraduate or graduate, who is pursuing studies or conducting research tomeet the requirements for an academic or professional degree conferred by colleges


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or universities. A student who receives a scholarship for study at a secondary schoolor other educational institution is considered to be a candidate for a degree.

The principal requirements of the exclusion are found in the definition of a qualifiedscholarship, which is defined as any amount received as a scholarship or fellowship

grant that in accordance with the grant is used for "qualified tuition" and relatedexpenses.

Those expenses encompass tuition and enrollment fees at the educationalorganization as well as fees, books, supplies and equipment required for courses ofinstruction. there is no exclusion for amounts which cover personal living expenses,such as meals and lodging, or for travel and research.

Under 117(c), a portion of an otherwise excluded scholarship or fellowship isrequired to be included in the recipient's GI to the extent that the portion represents a

payment for teaching, research or other services by the student required as acondition for receiving the otherwise excludable amount.

Educational grants made by an employer to a current or former employee havegenerally been held taxable b/c they represent compensation for past, present orfuture services.

If an educational institution awards a scholarship but as a condition of thescholarship requires services to be performed, the scholarship is not excludable fromGI. However, the IRS has allowed an exclusion for a university athletic scholarship if

the university expects but does not require the student to participate in a particularsport, requires no particular activity in lieu of participation, and cannot terminate thescholarship if the student cannot participate.

Scholarships for room and board is not a qualified scholarship, it is not excludablefrom GI.

Thus, to qualify for the exclusion, there must still be a gratuitous or non-contractualflavor to the grant. (similar to gift in Duberstin.)

117(d) allows a "qualified tuition reduction" to be excluded from GI in the case ofeducation below the graduate level or at the graduate level if the graduate student isengaged in teaching or research activities. The reduction may be avilable to theemployees of the educational organization granting the reduction or to employees ofsome other educational organization as well.

The term "employee" is defined by reference to the broad definition of employee in132(h) which includes the employee, the employee's spouse and dependent


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children, and the surviving spouse of a decease demployee. The plan, however, mustbe non-discriminary (can't favor highly compensated.).

127 permits an employee to exclude up to $5,250 from gross income for amountspaid by employer for educational assistance, provided the education assistance

program meets certain requirements (non-discriminatinary). Assistance can includetuition, books supplies, and employer provided educational course, but does notincluded sports, hobbies. (Graduate courses used to be excluded, but as of 1/1/02,employer can provide graduate courses.)

The TP doesnt have to trace the scholarship money to payment of the tuition. If youget a $10,000 scholarship and pay $10,000 in tuition, it is assumed to be spent ontuition.

IRC 117 Qualified Scholarships.

General rule.Gross income does not include any amount received as a qualifiedscholarship by an individual who is a candidate for a degree at an educationalorganization described in section 170(b)(A)(ii).

Qualified Scholarship. For purposes of this section.In general.The term qualified scholarship means any amount received by

an individual as a scholarship or fellowship grant to the extent the individualestablishes that, in accordance with the conditions of the grant, such amount wasused for qualified tuition and related expenses.

Qualified tuition and related expenses. For purposes of paragraph (1), the termqualified tuition and related expenses means-1) tuition and fees required for the enrollment or attendance of a student at an

educational organization described in 170(b)(1)(A)(ii), and2) fees, books, supplies, and equipment required for courses of instruction at

such an educational organization.

Limitation. Subsections (a) and (d) shall not apply to that portion of any amountreceived which represents payment for teaching, research, or other services by thestudent required as a condition for receiving the qualified scholarship or qualifiedtuition reduction.

Qualified tuition reduction.In general. Gross income shall not include any qualified tuition reduction.

(2)Qualified tuition reduction. For purposes of this subsection, the term qualifiedtuition reduction means the amount of any reduction in tuition provided to anemployee of an organization described in 170(b)(1)(A)(ii) for the education (below


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the graduate level)[the graduate level limitation is deleted on 1-1-02] at suchorganization (or another organization described in 170(b)(1)(A)(ii) of:

1) such employee, or2) any person treated as an employee (or whose use is treated as an employee

use) under the rules of 132(h).

3) Reduction must not discriminate in favor of highly compensated, etc.Paragraph (1) shall not apply with respect to any qualified tuition reductionprovided with respect to any highly compensated employee only if suchreduction is available on substantially the same terms to each member of agroup of employees which is defined under a reasonable classification set upby the employer which does not discriminate in favor of highly compensatedemployees (within the meaning of 414(q)). For purposes of this paragraph,the term highly compensated employee has the meaning given such term bysection 414(q).

4) Repealed5) Special rules for teaching and research assistants. In the case of the education

of an individual who is a graduate student at an educational organizationdescribed in 170(b)(1)(A)(ii) and who is engaged in teaching or researchactivities for such organization, paragraph (2) shall be applied as if it did notcontain the phrase (below the graduate level).

Reg. 1.117-6 Proposed: Qualified scholarships.

Exclusion of qualified scholarships.

Gross income does not include any amount received as a qualified scholarship by anindividual who is a candidate for a degree at an educational organization describedin 170(b)(1)(A)(ii), subject to the rules set forth in paragraph (d) of this section.Generally, any amount of a scholarship or fellowship grant that is not excludableunder 117 is includable in the gross income of the recipient for the taxable year inwhich such amount is received, notwithstanding the provisions of 102 (relating tothe exclusion fro GI of gifts). However, see 127 and the regulations thereunder forrules permitting an exclusion from gross income for certain educational assistancepayments. See also 162 and the regulations thereunder for the deductibility as atrade or business expense of the educational expenses of an individual who is not acandidate for a degree.

If the amount of a scholarship or fellowship grant eligible to be excluded as aqualified scholarship under this paragraph cannot be determined when the grant isreceived because expenditures for qualified tuition and related expenses have not yetbeen incurred, then that portion of any amount received as a scholarship or


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fellowship grant that is not used for qualified tuition and related expenses within theacademic period to which the scholarship or fellowship grant applies must beincluded in the gross income of the recipient for the taxable year in which suchacademic period ends.

Definitions 1) Qualified Scholarship. For purposes of this section, a qualified scholarship is

any amount received by an individual as a scholarship or fellowship grant tothe extent the individual establishes that, in accordance with the conditions ofthe grant, such amount was used for qualified tuiton and related expenses (asdefined in paragraph (c)(2)of this section). To be considered a qualifiedscholarship, the terms of the scholarship or fellowship grant need notexpressly require that the amounts received be used for tuition and relatedexpenses. However, to the extent that the terms of the grant specify that anyportion of the grant cannot be used for tuition or related expenses or designate

any portion of the grant for purposes other than tuition and related expenses,such amounts are not amounts received as qualified scholarship. [portionsdesignated for room and board, and meal allowances are not qualifiedtuition.]

2) Qualified tuition and related expenses. For purposes of this section, qualifiedtuition and related expenses are

a. Tuition and fees required for the enrollment or attendance of a studentat an educational organization described in 170(b)(1)(A)(ii); and

b.

Fees, books, supplies, and equipment required for course instruction atsuch an educational organization.i. In ORDER to be treated as related expenses under this section,

the fees, books, supplies, and equipment must be required of allstudents in the particular course of instruction. Incidentalexpenses are not considered related expenses. Incidentalexpenses include expenses incurred for room and board, travel,research, clerical help, and equipment and other expenses thatare not required for either enrollment or attendance at aneducational organization, or in a course of instruction at sucheducational organization.

3) Scholarship or fellowship grant.in general. Generally, a scholarship or fellowship grant is a cash amount paid orallowed to, for the benefit of, an individual to aid such individual in the pursuitof study or research. A scholarship or fellowship grant also may be in the form ofa reduction in the amount owed by the recipient to an educational organizationfor tuition, room and board, or any other fee. A scholarship or fellowship grant


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may be funded by a governmental agency, college or universy, charitableorganization, business, or any other source. To be considered a scholarship orfellowship grant for purposes of this section, any amount received need not beformally designated as a scholarship. For example, an allowance is treated as ascholarship if it meets the definition set forth in this paragraph. However, a

scholarship or fellowship grant does not include any amount provided by anindividual to aid a relative, friend, or other individual in pursuit of study orresearch if the grantor is motivated by family or philanthropic considerations.

Inclusion of qualified scholarships and qualified tuition reductionsrepresenting payment for services.

In general. The exclusion from GI under this section does not apply to thatportion of any amount received as a qualified scholarship or qualified tuitionreduction that represents payment for teaching, research, and other services bythe student required as a condition to receiving the qualified scholarship or

qualified tuition reduction, regardless of whether all candidates for the degree arerequired to perform such services. The provision of this paragraph (d) apply notonly to cash amounts received in return for such services, but also to amounts bywhich the Tuition or related expenses of the person who performs services arereduced, whether or not pursuant to a tuition reduction plan described in 117(d).

Payment for services. For purposes of the section, a scholarship or fellowshipgrant represents payment for services when the grantor requires the recipient toperform services in return for the granting of the scholarship or fellowship. Arequirement that the recipient purse studies, research, or other activities primarily

for the benefit of the grantor is treated as a requirement to perform services. Arequirement that a recipient furnish periodic reports to the grantor for thepurpose of keeping the grantor informed as to the general progress of theindividual, however, does not constitute the performance of service. Ascholarship or fellowship grant conditioned upon either past, present, or futureteaching, research, or other services by the recipient represents payment forservices under this section.

Determination of amount of scholarship or fellowship grant representingpayment for services. If only a portion of a scholarship or fellowship grantrepresents payment for services, the grantor must determine the amount of the

scholarship or fellowship grant (including any reduction in tuition or relatedexpenses) to be allocated to payment for services. Factors to be taken into accountin making this allocation include, but are not limited to, compensation paid by-

The grantor for similar services performed by students with qualificationscomparable to those of the scholarship recipient, but who do not receivescholarship or fellowship grants;


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The grantor for similar services performed by full-time or part-time employees ofthe grantor who are not students; and

Educational organizations, other than the grantor of the scholarship or

fellowship, for similar services performed either by students or other employees.

If the recipient includes in GI the amount allocated by the grantor to payment forservices and such amount represents reasonable compensation for those services,then any additional amount of a scholarship or fellowship grant received from thesame grantor that meets the requirements of paragraph (b) of this section isexcludable from GI.

IRC 127 Educational assistance programs.

(a)Exclusion from gross income.

In general.Gross income of an employee does not include amounts paid orexpenses incurred by the employer for educational assistance to the employee if theassistance is furnished pursuant to a program which is described in subsection

(b).$5,250 maximum exclusion. If, but for this paragraph, this section wouldexclude from GI more than $5,250 of educational assistance furnished to anindividual during a calendar year, this section shall apply only to the fIRSt $5,250 of

such assistance so furnished.

Educational assistance program.In general. For purposes of this section an educational assistance program is aseparate written plan of an employer for the exclusive benefit of his employees toprovide such employees with educational assistance. The program must meet therequirements (2) through (6) of this subsection. [the program cant discriminate infavor of highly compensated employees;]

IRC 85 Unemployment compensation.General Rule. In the case of an individual, gross income includes unemploymentcompensation.

Unemployment compensation defined. For purposes of this section, the termunemployment compensation means any amount received under a law of theUnited States or of a State which is in the nature of unemployment compensation.


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IRC 86 Social security and rr benefits.In general Except as provided in paragraph (2), GI for the taxable year of any

taxpayer described in subsection (b) notwihstanding 207 of the SS Act) includessocial security benefits in an amount equal to the lesser of

one half of the social security benefits received during the taxable year, orone half of the excess described in subsection (b)(1).

(2)***Summary of the rest of the provision**Depending upon the amount of a taxpayers AGI and the amount of the SS benefitsreceived, the percentage of SS benfits that must be included in GI ranges from zero to85%. At what point is a TP well off? When a single has $25k in AGI, married is $32Kin AGI.

See p. 90 in statute book for computation details.

Temporary Assistance for Needy FamiliesGenerally, Welfare (transfer payments) generally are not includible in GI. But if it isfor work, then it is in GI.

IRS Notice 99-3: Treatment of certain payments received as temporary assistancefor needy families.

This notice addresses the federal income and employment tax consequences ofpayments received by individuals with respect to certain work activities performedin state programs under part A of title IV of the Social Security Act, as amended bythe Personal Responsibility and Work Opportunity Reconciliation Act of 1996(Temporary Assistance for Needy Families or TANF).

Payments by a governmental unit to an individual under a legislatively providedsocial benefit program for the promotion of the general welfare that are not basicallyfor services rendered are not includible in the individuals gross income and are notwages for employment tax purposes, even if the individual is required to performcertain activities to remain eligible for the payments.

However, if taking into account all the facts and circumstances, payments by agovernmental unit are basically compensation for services rendered, even thoughsome training is provided, then the payments are includible in the individualsgross income and are generally wages for employment tax purposes.


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TANF payments are not includible in gross income when three conditions aresatisfied (test):

1) The only payments received by the individual with respect to the workactivity are received directly from the state or local welfare agency (for thispurpose, an entity with which a state or local welfare agency contracts to

administer the state TANF program on behalf of the state will be treated as thestate or local welfare agency);

2) The determination of the individuals eligibility to receive any payment isbased on need; and he only payments received by the individual with respectto the work activity are funded entirely under a TANF program; and

3) The size of the individuals payment is determined by the applicable welfarelaw, and the number of hours the individual may engage in the work activityis limited by the size of the individuals payment divided by the higher of thefederal or state minimum wage.

Taxing Labor

Fringe Benefits

Remember 61(a)(1) explicitly includes fringe benefits in gross income. The SupremeCourt has stated that 61(a)(1) is broad enough to include in taxable income anyeconomic or financial benefit conferred on the employee as compensation, whateverthe form or mode by which it is effected (Smith). That is a fringe benefit. Whetheran employee is paid in dollars, property, or use of property, directly or indirectly,any form of compensation is gross income.

Looking at it from the prospective of the employer, there are some arrangements thatdo not merely serve to replace cash as compensation. The employer has a goodbusiness reason for providing the benefit conferred on the employee. That is whyCongress provided statutory exemptions for certain fringe benefits. The legislativehistory makes it clear:

1) many industries have long established practices of offering free or discountedservices to employees for encouraging employees to avail themselves of theproducts which they sell to the public.

2) Clear boundaries needed to be established from what was a tax-free fringeand one that is includible in GI.

3) Without well defined limits, employers could shift compensation to non-cashbenefits and a disproportionate tax burden would fall on those paid in cashwages.


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4) Most fringes must be nondiscriminatory. It would be fundamentally unfair toprovide tax-free treatment for economic benefits received only by highly paidexecutives.

The tax law on fringe benefits is now completely statutory. Now, the rule is, if anemployee benefit is not specifically excluded from gross income, its value must beincluded within gross income (61(a)(1)).

For purposes of fringe benefits, sole proprietors are not employees. What isexempted as a fringe benefit is a reflection of our culture and what we expect.

There is a dual approach to fringes: there is a general catch all of fringes that areexcluded (132: no additional cost, qualified employee discount, working condition,de minimis, qualified transportation and moving); and specific exclusions (119 for

meals and lodging, 127 education fringes, 106 employer paid health care, 179group term life insurance). Always look to the specific exclusion provision FIRST,that overrides a general provision.

See use the general analysis tip:Is it income? Is there an exclusion?Is there a deduction?When is it income? Can it be deferred?Whose income is it? Can it be shifted?

IRC 132 Certain Fringe Benefits.(a) Exclusions from GI. Gross income shall not include any fringe benefitwhich qualifies as a:(1) No-additional-cost service.(2) Qualified employee discount.(3) Working condition fringe.(4) De minimis fringe.(5) Qualified transporttion fringe, or(6) Qualified moving expense reimbursement.

(b) No-Additional-Cost service defined. For purposes of this section, theterm no-additional-cost service means any service provided by anemployer to an employee for use by such employee if(1) Such service is offered for sale to customers in the ordinary

course of the line of business of the employer in which theemployee is performing services, and

(2) The employer incurs no substantial additional cost (includingforgone revenue) in providing such service to the employee


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(determined without regard to any amount paid by theemployee for such service).

[Notes on 132(b): elements:1) it must be a service used by employee in the ordinary course of business. The

rationale for this is the employee is advertising the employers products by theemployee using it.

2) The business must not forgo any revenue (lose a customer) or incur extra cost(read big, look at facts to determine) to provide it. And

3) the plan cant be discriminatory. The fringe is excludable only only only if thereis equal treatment for all employees. None of the benefit is excludable if there is anydiscrimination, even the rank and file wont get the exclusion! All these elementsmust be satisfied or it is income per Glenshaw.] Examples: airline, railroad, or

subway seats, and hotel rooms furnished to employees, if they are working in thoserespective business, in a way that does not displace non-employee customers, andfree telephone service to telephone employees within existing capacity of theemployer company. The exclusion is allowed whether the services are providedfree of charge, at cost or some partial charge or under a cash rebate program.

[more notes: The services must be provided in the same line of business as that inwhich the employee is employed. If an employee is a steward for an airline ownedby a company that also owns a cruise ship, free standby airline flights for theemployee, his spouse, and dependents are excludable but a free cruise is not. This

resitriction is framed carefully to preclude an unfair advantage for employees ofconglomerates. If two companies have a written reciprocal agreement that makesservices of one available to the employees of the other, employees of one companymay exclude, as no-additional-cost services, services provided by the other, if theservices in question are in the employees line of business.]

Qualified employee discount defined. For purposes of this section:Qualified employee discount.The term qualified employee discount means anyemployee discount with respect to qualified property or services to the extent suchdiscount does not exceed:

1) in the case of property, the gross profit percentage of the price at whichthe property is being offered by the employer to customers, or

2) in the case of services, 20% of the price at which the services are beingoffered by the employer to customers.

Gross profit percentage.In general.The term gross profit percentage means the percent which:


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1) the excess of the aggregate sales price of property sold by the employer tocustomers over the aggregate cost of such property to the employer, is of

2) the aggregate sale price of such property.Determination of gross profit percentage. Gross profit percentage shall be

determined on the basis of1) all property offered to customers in the ordinary course of the line of

business of the employer in which the employee is performing services (ora reasonable classification of property selected by the employer), and

2) the employers experience during a representative period.Employee discount defined. The term employee discount means the amount bywhich

1) the price at which the property or services are provided by the employer to anemployee for use by such employee, is less than

2) the price at which such property or services are being offered by the employerto customers.

3) Qualified property or services.The term qualified property or servicesmeans any property (other than real property and other than personalproperty of a kind held for investment) or services which are offered for saleto customers in the ordinary course of the line of business of the employer inwhich the employee is performing services.

[Notes on qualified employee discounts: there is a maximum for what can beexcluded! Historically, an employee has been allowed to exclude from GI the valueof courtesy discounts on items purchased from his employer for use by the

employee.

As in the case of the no-additional-cost-services, the plan1) nondiscriminary;2) 2) in the same line of business;3) 3) applies to purchase of property and services; it usually means

consumables, but does not include real property or property held forinvestment.

It also does not include loans to employees of financial institutions. The discountmay take the form of price reduction or rebate. The ceiling of the exclusion is 20%off services (includes life insurance), or in the case of goods, by the gross profitpercentage, up to 40%.]

Is a painting investment property? That is a factual issue. If you over use adiscount, or if the discount is over the cap, you are enriched and then it iscompensation (Glenshaw). Also, if property converts too easily to cash, it maysmell too much like compensation.


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Working Condition fringe defined. For purposes of this section, the termworking condition fringe means any property or service provided to anemployee of the employer to the extent that, if the employee paid for suchproperty or services, such payment would be allowable as a deduction under162 or 167.

[note on working condition fringe: any property, not qualified, that would havebeen deductible (under 162 or 167) by the employee as a cost of doing business is aworking condition fringe. There is no reference to line of business. This helps reducethe need for booking of wash out transactions, where you got the cash but thenturned around and made a deductible purchase.

Example: as an attorney you pay $1000 to be a member of the bar, that is deductibleto the employee. If the employer pays it for you instead, it is excluded from your GI.Also, use of a company car for business travel; an employers subscription to a

business periodical, on the job training.] There is no discrimination limitation on thisdeduction.

De minimis fringe defined. For purposes of this sectionIn general. The term de minimis fringe means any property or service the value ofwhich is (after taking into account the frequency with which similar fringes areprovided by the employer to the employers employees)so small as to make accountfor it unreasonable or administratively impracticable.

Treatment of certain eating facilities.The operation by an employer of any eatingfacility for employees shall be treated as a de minimis fringe if1) such facility is located on or near the business premises of the employer, and2) revenue derived from such facility normally equals or exceeds the direct

operating costs of such facility.The preceding sentence shall apply with respect to any highly compensatedemployee only if access to the facility is available on substantially the sameterms to each member of a group of employees which is defined under areasonable classification set up by the employer which does not discriminatein favor of highly compensated employees. For purposes of subparagraph (B),an employee entitled under 119 to exclude the value of a meal provided atsuch facility shall be treated as having paid an amount for such meal equal tothe direct operating costs of the facility attributable to such meal.

[Note on de-minimis fringe: an administrative need drives this policy! If it is notroutine and difficult to value, a bookkeeping nightmare, it is deminimis. If used toomuch, it may be compensation. Ex of deminimis fringes: occasional cocktail parties


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or picnics, use of the company copying machine, occasional sporting event tickets,and low value holiday gifts.]

Qualified transportation fringe.In general. For purposes of this section, the term qualified transportation fringe

means any of the following provided by an employer to an employee:1) Transportation in a commuter highway vehicle if such transportation is in

connection with travel between the employees residence and place ofemployment.

a. Any transit pass.b. Qualified parking.c. Limitation on exclusion. The amount of the fringe benefits which are

provided by an employer to any employee and which may be excludedfrom gross income under subsection (a)(5) shall not exceed

i. $65 per month [$100 per month in taxable years beginning after12/31/01] in the case of the aggregate of the benefits describedin subparagraphs (A) and (B) of paragraph (1), and

ii. $175 per month in the case of qualified parking.2) Cash reimbursements. For purposes of this subsection, the term qualified

transportation fringe includes a cash reimbursement by an employer to anemployee for a benefit described in paragraph (1). The preceding sentenceshall apply to a cash reimbursement for any transit pass only if a voucher orsimilar item which may be exchanged only for a transit pass is not readilyavailable for direct distribution by the employer to the employee.

a. No constructive receipt. No amount shall be included in the grossincome of an employee solely because the employee may choosebetween any qualified transportation fringe and compensation whichwould otherwise be includible in gross income of such employee.

Definitions. For purposes of this subsection

Transit pass. The term transit pass means any pass, token, farecard, voucher, orsimilar item entitling a person to transportation (or transportation at a reduced price)if such transportation is

1) on mass transit facilities (whether or not publicly owned), or2) provided by ay person in the business of transporting persons for

compensation or hire if such transportation is provided in vehicle meeting therequirements of subparagraph (B)(i).

Commuter highway vehicle. The term commuter highway vehicle means anyhighway vehicle

1) the seating capacity of which is at least 6 adults (not including the driver), and2) at least 80% of the mileage use of which can reasonably be expected to be


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a. for purposes of transporting employees in connection with travelbetween their residences and their place of employment, and

b. on trips during which the number of employees transported for suchpurposes is at least of the adult seating capacity of such vehicle (notincluding the driver).

Qualified parking. The term qualified parking means parking provided to anemployee on or near the business premises of the employer or on or near a locationfrom which the employee commutes to work by transportation described insubparagraph (A), in a commuter highway vehicle, or by carpool. Such term shallnot include any parking on or near property used by the employee for residentialpurposes.

Transportation provided by employer. Transportation referred to in paragraph(1)(A) shall be considered to be provided by an employer if such transportation isfurnished in a commuter highway vehicle operated by or for the employer.

Employee. For purposes of this subsection, the term employee does not include anindividual who is an employee within the meaning of 401(c)(1).

Inflation adjustment. (see p. 124 of statute book if necessary.

Coordination with other provisions. For purposes of this section, the terms workingcondition fringe and de minimis fringe shall not include any qualifiedtransportation fringe (determined without regard to paragraph (2)).

Qualified moving expense reimbursement. For purposes of this section, the termqualified moving expense reimbursement means any amount received (directly orindirectly) by an individual from an employer as a payment for or a reimbursementof) expenses which would be deductible as moving expenses under 217 if directlypaid or incurred by the individual. Such term shall not include any payment for (orreimbursement of) an expense actually deducted by the individual in a prior taxableyear.

Certain individuals treated as employees for purposes of subsections (a)(1) [No-additional-cost services] and (a)(2) [qualified employee discount]. For purposes ofparagraphs (1) and (2) of subsection (a):

Retired and disabled employees and surviving spouse of employee treated asemployee. With respect to a line of business of an employer, the term employeeincludes

1) any individual who was formerly employed by such employer insuch line of business and who separated from service with such


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employer in such line of business by reason of retirement ordisability, and

2) any widow or widower of any indiidual who died whileemployed by such employer in such line of business or while anemployee within the meaning of subparagraph (A).

Spouse and Dependent Children.In general. Any use by the spouse or a dependent child of the employee shall betreated as use by the employee.

Dependent child. For purposes of subparagraph (A), the term dependent childmeans any child (as defined in 151(c) (3)) of the employee

1) who is a dependent of the e

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