Even if income falls under the classical definition of gross income, there are certain types of income that Congress has excluded from fitting the classical definition. Previously, we have explored other statutory exclusions, including gifts, COD income, meals and lodging (from employers), and fringe benefits. This article explores a few more (and there are even more we won’t cover). These include annuity, life insurance, scholarships, and personal injuries.
Annuity and Life Insurance
§§ 72 and 101.
An annuity is an investment product where a financial instution agrees to make set payments starting at a set date. The taxpayer will contribute the finances, then the financial instution will invest the money until the payments start. §72 will exclude a portion of the annuity (because you were already taxed for part of it). To calculate the excluded portion, you take the basis (investment) divided by the expected return (payment x life expectancy); this number will then multiply by the payment received. If the beneficiary outlives the product, then the full amount is taxed.
Life insurance policies are excluded unless (1) a person pays to be a beneficiary (whatever they pay for is the basis, anything above that is the gain), or (2) any installment payments representing interest can be taxed.
Scholarships and Fellowships
§§ 74; 117
Bingler v. Johnson
394 U.S. 741 (1969).
Facts
The taxpayers worked for Westinghouse Electric Corp. and participated in a “work-study” program. The program consisted of two parts. First, the taxpayer would remain employed at Westinghouse and be paid a 40 hour week but be permitted to leave for 8 hours per week to attend school. Second, after obtaining an undergraduate degree, participants could obtain an “education leave” to continue an advanced degree. Participants would be paid 80–90 percent of their salary while in school. To ensure the education was beneficial to the company, participants were required to submit their dissertation idea to the company for approval, and students were expected to return to Westinghouse after graduation for a substantial period of time.
The taxpayers participated in the program, received payments, and sought to exclude them as gross income by defining the payments as a scholarship. At trial, the jury was instructed to determine whether the program acted as “compensation” or a scholarship. The jury ruled that the program resulted in taxable compensation. On appeal, the court determined that the regulation relied on was invalid and so the verdict was also invalid. This appeal followed.
Analysis
The basis of this appeal relies on the definition of a scholarship. If § 117 applies to all funds received for education, then the taxpayers argument would have been successful. Unfortuantely, Congress did not define “scholarship” in § 117, instead leaving the definition to the regulations to decide. The reguations ultimately use the basic definition of a scholarship as funds received with no strings attached, solely for educational purposes.
Here, there were strings attached. Participants were expected to receive oversight from the company regarding their education. Projects were to be approved and frequently reported to the company. After graudation, participants were required to return to the company for a period of time. Without agreeing to these terms, the participants would not have received the funds. As such, this was not a scholarship that can be excluded under the Section. Instead, this is taxible compensation.
Compensation for Injuries and Sickness
Amos v. Commissioner
T.C. Memo. 2003–329.
Facts
Rodman played for the Bulls. During a game, he fell into the crowd and twisted his ankle. Expressing his frustration, he kicked Amos, a cameraman in the crowd. Amos then left the game in an ambulance and complained of pain at the hospital. Later, Amos sought out a personal injury attorney. The attorney contacted Rodman’s counsel and together they reached a settlement. Amos was to receive 200,000 and both parties agreed not to disparage the other.
Amos excluded the entire 200,000 on his tax return, resulting in the IRS issuing a deficiency notice.
Analysis
If a taxpayer seeks to include compensation for injuries, the taxpayer must prove (1) the cause of action giving rise to the compensation is “based upon tort or tort type rights” and (2) the damages were received to to personal injuries or sickness.” Additionally this recovery must be based on physical injuries. When there is a settlement agreement, the court will look at the agreement to determine the intent of the payer (i.e., whether the purpose of the payment was to compensate for injuries or for another reason).
Here the court looks at the settlement agreement and determines the primary purpose of the agreement was to compensate Amos for his injuries. However, skeptical Rodman was of the injuries, that does not change the fact that the purpose was to compensate for injuries. Thus, the court holds that 120,000 of the settlement was for injuries and that 80,000 could be taxable.
