Advanced Individual Income Tax

Accounting 811: Spring, 1998

Week 4: Inclusions and Exclusions 

Outline (c) 1997-98 Robert H. Daniels

 1. Personal injury lawsuits and settlements

Sec 104(a)(2): damages for personal injuries or sickness

Note 1996 change. Nonphysical damages are taxable.

What does the Code mean?: what are "personal" injuries

Schleier case holding ADEA damages taxable

 

2. Taxability of Employment Relationship

Sec. 61 compensation, Sec. 102(c) gifts already examined

Pervasive: over 75% of income on returns is wages

Sec. 83 property for services

A very broad catch-all: Prop to anyone but service recipient

FMV (less amt paid) in service providers income

At time the property rights are not forfeitable or are transferable
Consider restrictions which never lapse in setting FMV
EG requirement to sell back at formula price

The NQSO: Stock or stock rights for services

Option not tradeable, may lapse, can't be valued
When its exercised for stock, FMV - option price is Y

The Sec. 83(b) election: include prop in Y when get, even if forfeitable

(eg. stock at bargain price that's lost if conditions not met)
Idea; nail down tax now, rather than at later FMV
Problem: no deduction if later forfeiture
Problem: 30 days to elect: 83(b)(2)

Other stock options under Sec. 422: ISO's

Bargain stock purchase plans: Sec. 423

3. Fringe benefits: non-cash compensation

Sec. 104-105-106 med insurance and reimbursements

Awkward statutory structure: interlocking sections

106 excludes e'er paid insurance from Y

Enormous exclusion: @ $60 BB and rising
Most people have no idea how much their health ins costs

105 includes the insurance payoff, except medical care reimb

e.g. sick pay is income

105(c) excludes injury compensation if not measured by days off

104(a)(1) excludes workers comp;

104(a)(3) excludes payment from insurance that is not a tax-free employer fringe

e.g. disability benefits are income if employer paid with excluded premiums.
Are not income if paid for by E'ee with after-tax dollars

Sec. 79: partial exclusion for group life

Cost of premium for $50 K insurance
Above, use IRS premium value tables
Note nondiscrimination requirement: Sec. 79(d)

Sec. 119 meals and lodging

Premises of employer, convenience of employer

if lodging, condition of employment

Herbert Hatt case

Facts

H married  woman who owned funeral home.
H got most of stock and became pres and general manager.
H moved into apartment in the funeral home.
  Phone there, met customers after regular hours
Was customary for area funeral home managers to live on premises

Procedural History: tax court

Issue: Is FMV of apartment covered by Sec. 119, or is this a "constructive dividend"

Issue: Is this a "condition of employment" for "convenience of employer"?

Holding: yes

Reasoning:

These tests overlap. True, H as pres could influence employer, but that only requires careful scrutiny

The nature of the business nedds someone on call 24 hours a day. This person needs to handle financial aspects

Comment: does company get a deduction?

Secs 121 - 129 the "classic" fringes

127 Educational assistance


129 Dependant care assistance


125 Cafeteria plans: trade off among tax exempts

Sec 132: "Generic fringes"

A fringe is income unless its exempted

Zero marginal cost

eg: airline employees on standby
what about their relatives?
Q of conglomerate line of business

Qualified discount

eg. department store employees get mark-offs
forego profit for goods; 20% for services

Working condition

eg. nice office, not lousy; free parking;
company athletic facility
here, unlike 1st 2, can discriminate: not everyone gets nice office

De minimus

not worth keeping track of
xeroxing: eg. w/ policy limiting personal to 15%
zero profit company cafeteria

transportation

4. Social Security benefits: Sec. 86

Formula (note now a 2nd tier)

Concept of the phase-out, carried to near extremes

5. Taxation of Marital dissolution

State law background

 3 types of payments incident to divorce

Alimony, child support, property settlement

Tax Background: Davis case

release of rights in exchange for appreciated property
Transferor of property has income: FMV rights rec'd
  less basis of property transferred

Caused a snarl, esp in community property states
Solution: eff. 1984

Alimony

defined:

 cash, over time, termination events: Sec. 71

taxable for recipient, and deductible for payor

note SSN matching here

Child support

 referenced to divorce decree:

 no tax, no deduct
Custodial parent claims exemption for child, unless waived

Sec. 1041: property settlement non-taxable

basis carries over

Alimony recapture Sec. 71(f)

prevents aggressive characterizations
trying to gain non-symmetric deduction and income

6. Investments: Economics of taxation: theory

Tax now, tax later, defer. W/wo a "special tax regime for certain asset types

Both an issue of deferral and also one of character of disposition

Note other countries do very differently: aggregative vs. schedular

Tax return currently w/o special treatment

eg. corporate bonds

Taxpayer reaction drives evolution of rules

Attempt to convert current Y to disposition Y

"original issue discount" : Secs. 1271-1275
Market discount: note 1993 rule change: SS 1276-1278
Amortizeable bond premium: Sec. 171

No tax on current income, tax g/l on disposition

eg. Sec. 103 exempt municipal obligations

Need to adjust discount and premium rules
eg. Sec. 171 exclusion of exempts; 1272(a)(2)(A) exclusion of exempts

Current deduction, deferral of tax on income, tax on disposition

eg. deductible IRA account: Sec. 219 and 408

is functionally the same as exemption

No deduction, no tax on income, no tax on disposition

The new (1998) Roth IRA

No deduction, deferral of tax on income, tax income element only on disposition

eg. SPDA or nondeductible IRA account: Sec. 72

Character of income on disposition

eg. capital gain rules and need to define capital assets: Sec 1221

Compare the results of various patterns

using constant rate of return (7%), time frame (20 yrs) and a 36% tax rate

return is all Y, receive principal at maturity
  PV 1000, I .64*7%, n 20, FV = 2,402.50 After/Tax return 4.48%

return is all change in maturity value: EE bonds
  PV 1000, i 7% n 20, FV 1000 +.64* excess = 2,836.60
  is equivalent to i of 5.35%, or tax rate of 23.55%

return is all exempt Y: FV 3,869.68
  7% after tax, unless ROI on exempts is driven down towards 4.48%

current deduction and deferral
  PV 1562.5 (1000 / .64); FV *.64 is 3,869.68
  is the equivalent of making the income wholly exempt

no current deduction, all deferred
  is same as return all change in maturity value
  PV 1000, i 7% n 20, FV 1000 +.64 of excess = 2836.6

implication: no reason to invest SPDA in growth stocks
  except to extent investment shifts would force taxation

   Build date 2/20/98