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

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

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

3. Objective Explain the meaning of gross income

4. Gross Income • 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. • The general rule is for inclusion of all gross income unless specifically excluded from gross income by the Internal Revenue Code.

5. 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. • Return of capital from an investment. • Any unrealized increase in value. Example: The unrealized gain from appreciated Google stock. • A gift … but examine the context of the transfer from donor to donee carefully.

6. Objective Explain the doctrine of constructive receipt.

7. Constructive Receipt • 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) • Essence of the rule is simple…”Can I get the income when I want it?”

8. Constructive Receipt - • Substantial Risk of Forfeiture (SROF) Doctrine • 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. • Operation of SROF with Funded Deferred Comp. • Operation of SROF with Unfunded Deferred Compensation

9. Objective Explain the economic benefit theory.

10. 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? • 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.

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

12. 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. • Rule 1… income is taxed to the person performing the service. • Rule 2…income from property is taxed to the taxpayer owning the property.

13. 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. • 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.

14. 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. • 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 31st. Describe the tax consequences of the $400,000 that would otherwise be payable to her.

15. End of Chapter 3