Code to focus on: 26 USC § 61(a).
Regulations to focus on: Treas. Reg. §§ 1.61–2(d)(1); 1.61–14(a).
§ 61(a) provides a list of 14 items included in gross income, but this list is not exhaustive. So, what else qualifies as income? Economists disagree on the definition, but a starting point might be the Haig-Simons definition. They define income as “Consumption + Change in Wealth.” Note that the chage in wealth is that, it is not wealth, but the change. It is also important to note that this definition is not the one used for tax purposes today. The main reasons being (1) it would be difficult to track consumption, (2) sometimes wealth may change but no cash is available—making paying taxes very difficult, and (3) if the wealth decreases then there is no way of determining whether the tax payer should receive a deduction or be stuck paying higher taxes.
The problems with this definition have caused the Supreme Court to address what is defined as income.
Defining Gross Income
Eisner v. Macomber
252 U.S. 189 (1920).
Question
Does Macomber’s additional shares of stock recieved from the distribution result in gross income.
Rule
Gains must be realized to be counted as income.
Holding
No, no additional income was received.
Facts
A California oil company announced a dividend (distributing stocks to stockowners). Macomber owned 2,200 shares and received a proportional additional 1,100. Because the reception was proportional, her interest in the company assets did not grow.
Analysis
Essentially, the stock distribution only diluted what Macomber already owned. So, she had more stock, but not more assets. At this point, she had not realized the gain from the distribution. That would occur at the sale of the stock, something that had not happened yet. So, this distribution does not fall under the definition of income.
Additional Notes
This case appears to require realization to occur (some transaction where the value of the assets gained becomes apparent). Thus, the test is: “Income may be defined as the gain derived from capital, from labor, or from both combined.”
Commissioner v. Glenshaw Glass Company
348 U.S. 426 (1955).
Qeustion
“Whether money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble-damage antitrust recovery must be reported by a taxpayer as gross income.”
Rule
Income is defined as “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”
Holding
The cash received do to a lawsuit victory of punitive damages is taxible as gross income.
Facts
Two companies here were successful in arguing injuries from antitrust violations of third parties. In their success, they were compensated for their damages (there was no dispute this total was taxible) and obtained punitive damages. The punitive damages were not reported and the commissioner deemed the total deficient minus attorney fees (to be deducted).
Analysis
There was no dispute about the constitutionality of the taxation, only whether the statute permits it. The statute permits taxation to the full extent of Congress’s power. Thus, these gains were realized, gave wealth, and the taxpayers were free to spend it (complete dominion).
Additional Notes
The Glanshaw Glass case shows how the court provided another more broad definition of what may be taxed.
Finds
Cesarini v. United States
296 F. Supp. 3 (N.D. Ohio 1969).
Qeustion
Whether money found is considered gross income.
Rule
The statute is broad, but the rule comes from the regulations stating that treasure troves are considered gross income.
Holding
This is a treasure trove and should be reported as gross income.
Facts
The Cesarinis purchased a cheap piano from an acution for 15 dollars for their daughter to take piano lessons. When the went to dispose of it, they discovered nearly 4,500 dollars inside. Instead of disposing the piano, they kept it. They then reported the 4,500 as gross income. Later, they sought to amend the report to exclude the total and seek a refund. When the IRS denied the refund, the family sued.
Analysis
Because the statute is broad, and there are no exclusions, Congress is free to tax to the fully power. Further the regulations define treasure trove as taxible income in the year it was found. Thus, this is income that can be taxed.
Additional Notes
Federal and state definitions of treasure trove differ. However, the regulation is stating that you can be taxed for anything you find (even if the state does not define it as a treasure trove).
Barter and Imputed Income
Revenue Ruling 79–24
1979–1 C.B. 60.
If individuals exchange services without paying a fee, then the fair market value of the goods or services received is includable in their gross incomes. This is called a barter.
Imputed income occurs where you do something to increase your value (such as planting a garden for your use or paint your house). This type of income is not taxed.
Illegal Income
Income obtained through illegal activities (and thus illegal income) is taxed.
James v. United States
366 U.S. 213 (1961).
Question
Whether embezzled funds are to be included as gross income.
Rule
Illegal income is gross income.
Holding
Embezzled funds are to be included as gross income.
Facts
James embezzled $738,000 from his union and failed to report the embezzled funds on his tax returns.
Analysis
A previous case, Wilcox, said that embezzlement was not considered income. Another case, Rutkin, said that an extortionist was taxable income. Essentially, this court overrules Wilcox because in both embezzlement and extortion the victim has a right to recoupment in both situations. The court says this is income because Congress intended to tax both legal and illegal income. That is, treat an honest taxpayer and dishonest taxpayer equally. So, if the criminal will be taxed on the stolen goods (gain) but also is entitled to a deduction if they return the funds (loss).
