Chapter 3 Four Basic Concepts: Gross Income, Constructive Receipt, Economic Benefit Theory, and Assignment of Income

Chapter 3 The Four Basic Concepts Has someone received “gross income”? Has someone received “gross income”? Can a taxpayer be taxed for receiving or being deemed to receive something of value? Can a taxpayer be taxed for receiving or being deemed to receive something of value? When should the taxpayer be taxed? When should the taxpayer be taxed? Is the correct taxpayer being subject to tax? Is the correct taxpayer being subject to tax?

Objective Explain the meaning of gross income

Gross Income Income that must be included on a taxpayer’s return regardless of the source derived. Income that must be included on a taxpayer’s return regardless of the source derived. Some less well-understood examples include income from an interest in an estate or trust, income from the discharge of indebtedness. Some less well-understood examples include income from an interest in an estate or trust, income from the discharge of indebtedness. The general rule is for inclusion of all gross income unless specifically excluded from gross income by the Internal Revenue Code. The general rule is for inclusion of all gross income unless specifically excluded from gross income by the Internal Revenue Code.

What is Not Gross Income Receipt by taxpayer of principal on a debt owed to her or him. But compare interest earned on a debt. Receipt by taxpayer of principal on a debt owed to her or him. But compare interest earned on a debt. Return of capital from an investment. Return of capital from an investment. Any unrealized increase in value. Any unrealized increase in value. Example: The unrealized gain from appreciated Google stock. Example: The unrealized gain from appreciated Google stock. A gift … but examine the context of the transfer from donor to donee carefully. A gift … but examine the context of the transfer from donor to donee carefully.

Objective Explain the doctrine of constructive receipt.

Constructive Receipt Virtually all individual taxpayers are cash basis meaning income is reported in the year received or constructively received. Virtually all individual taxpayers are cash basis meaning income is reported in the year received or constructively received. Rationale for the rule …limit the ability of taxpayers to determine the most favorable year for receipt of income (eg lower tax bracket) Rationale for the rule …limit the ability of taxpayers to determine the most favorable year for receipt of income (eg lower tax bracket) Essence of the rule is simple…”Can I get the income when I want it?” Essence of the rule is simple…”Can I get the income when I want it?”

Constructive Receipt - Substantial Risk of Forfeiture (SROF) Doctrine Substantial Risk of Forfeiture (SROF) Doctrine 1. No income will be constructively received if subject to a substantial risk of forfeiture EXAMPLE Payment to TP will not be made until 5 years from now. EXAMPLE Payment to TP will not be made until 5 years from now. 2. Operation of SROF with Funded Deferred Comp. 3. Operation of SROF with Unfunded Deferred Compensation

Objective Explain the economic benefit theory.

Economic Benefit Theory Has the taxpayer received any financial or economic benefit (not specifically excluded by the Internal Revenue Code) that is current, real and measureable? Has the taxpayer received any financial or economic benefit (not specifically excluded by the Internal Revenue Code) that is current, real and measureable? The doctrine applies to a payment in kind or the equivalent of cash. The doctrine applies to a payment in kind or the equivalent of cash. Will result in the inclusion into gross income even if the employee cannot take the benefit. Will result in the inclusion into gross income even if the employee cannot take the benefit.

Economic Benefit Theory Examples of receiving an economic benefit Examples of receiving an economic benefit 1. Right to receive from employer a bonus in the form of cash or property. 2. Employer payment on your legally nonbinding pledge to your alma mater. 3. Split dollar life insurance under the economic benefit-endorsement regime. 4. Irrevocable, funded deferred compensation.

Assignment of Income Doctrine Spread in marginal rates encourages effort to shift income from higher-bracketed taxpayer to a lower-bracketed taxpayer, most often a family member. Spread in marginal rates encourages effort to shift income from higher-bracketed taxpayer to a lower-bracketed taxpayer, most often a family member. Rule 1… income is taxed to the person performing the service. Rule 1… income is taxed to the person performing the service. Rule 2…income from property is taxed to the taxpayer owning the property. Rule 2…income from property is taxed to the taxpayer owning the property.

Chapter True-False Questions 1. The doctrine of constructive receipt means income will be taxed when it is credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made available. 1. The doctrine of constructive receipt means income will be taxed when it is credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made available. 2. A mother arranges for the income from her stock portfolio to be paid directly to her son. The mother will not be taxed on the portfolio income. 2. A mother arranges for the income from her stock portfolio to be paid directly to her son. The mother will not be taxed on the portfolio income.

MiniCase Studies 3. A law school clinical faculty member is required by his employer to turn over any amounts he receives representing low income clients at the law school’s tax clinic. He receives $1,000 for the current income. Describe the consequences of his receipt of the check payable to him. 3. A law school clinical faculty member is required by his employer to turn over any amounts he receives representing low income clients at the law school’s tax clinic. He receives $1,000 for the current income. Describe the consequences of his receipt of the check payable to him. 4. President of a closely held business informs the board of directors she will not accept income for her services yet to be performed between July 1 and December 31 st. Describe the tax consequences of the $400,000 that would otherwise be payable to her. 4. President of a closely held business informs the board of directors she will not accept income for her services yet to be performed between July 1 and December 31 st. Describe the tax consequences of the $400,000 that would otherwise be payable to her.

End of Chapter 3