CASE LAW
[this page mostly cases but includes a few Revenue Rulings too for completeness of major topics]
IDENTIFYING TAXABLE INCOME (identifying gross income and the exclusions from gross income)
2. Gross Income: The Scope of Section 61
2 JUDICIAL JARGON
B. Equivocal Receipt of Financial Benefit ...................................................
OLD COLONY TRUST - EE HAS ADDITIONAL INCOME WHEN ER PAYS INCOME TAX FOR EE ON SALARY OF 978, 725 IN 1918
Comm vs GLENSHAW GLASS - PUNITIVE DAMAGES ARE INCOME TO T AS UNDENIABLE ACCESSIONS TO WEALTH, CLEARLY REALIZED
CHARLEY vs Commish - TRAVEL CREDITS TO T WERE INCOME. HE KEPT THE 300 DIFFERENCE BETWEEN 1ST CLASS 500 & COACH 200
INDIANAPOLIS POWER - A SECURITY DEPOSIT IS NOT INCOME TO THE UTILITY, BUT IS LIKE A LOAN.
C. Income Without Receipt of Cash or Property .........................................
Helvering v. Independent Life Ins. Co...INDEP LIFE INS CO - FMV OF BUILDING OCCUPIED BY OWNER IS NOT INCOME TO OWNER
DEAN v. COMM - FMV OF USE OF RESIDENCE OWNED BY CORPORATION IS INCOME TO SHAREHOLDER
Revenue Ruling 79–24 .............................................................................
3 JUDICIAL JARGON Chapter 3. The Exclusion of Gifts and Inheritances ...........................
B. Gifts
Commish v DUBERSTEIN - A GIFT MUST PROCEED FROM A DETACHED AND DISINTERESTED GENEROSITY & IS DIFFICULT IN A BUSINESS CONTEXT
C. Bequests, Devises, and Inheritances
LYETH v. HOEY - COMPROMISE OF CLAIM BY HEIR IN WILL CONTEST IS NOT INCOME TO HEIR. A SETTLEMENT IN LIEU OF A TRIAL.
WOLDER v. COMM - ATTORNEY WHO RECEIVES CASH BEQUEST UNDER WILL IN LIEU OF PAYMENT FOR SERVICES HAS INCOME
A. Rules of Inclusion and Exclusion ............................................................
CHAPTER 3 ◦ EXCLUSIONS FROM INCOME ◦ Duberstein3 ◦ Stanton (part of Duberstein)3 ◦ Lyeth v. Hoey3 ◦ Wolder3
DUBERSTEIN - A GIFT MUST PROCEED FROM A DETACHED AND DISINTERESTED GENEROSITY & IS DIFFICULT IN A BUSINESS CONTEXT. Supreme Court case where IRS won and Cadillac gift was considered income to Duberstein. Client gives a professional a gift of a Cadillac. Tax court rules for IRS. Appellate court rules for taxpayer. The court gives us 8 criteria for business overtones. Bring in these criteria 1) business context 2) moral obligation to make payment doesn’t mean its a gift 3) moral duty 4) in return for services, economic benefit, 5) proceeds from generosity 6) most critical is TRANSFERORS INTENTION (recipient will always say its a gift). Another related case here is STANTON - where the courts found that the receipt was non-taxable (supreme court sent it back to lower court to decide). Both of these two cases still exist today but the decisions seem to be in opposition. Church is a 501c3 so they don’t file tax returns. Court believe the church when they said this is a gift. Stanton was decided in 1942 during WW2 - probably won’t be same answer by Courts today.
LYETH v. HOEY - COMPROMISE OF CLAIM BY HEIR IN WILL CONTEST IS NOT INCOME TO HEIR. A SETTLEMENT IN LIEU OF A TRIAL. HYPOTHETICALS ATTACHED TO THIS CASE: Grandfather gives $5m to the son. Under section 102 gifts, inheritance (generic term, each state has intestate laws deciding where assets go), bequest (“gift” once deceased), device is real property. The $5m is not taxable to the son because it is a bequest. If the grandfather leaves money to mistress and son sues to get it, AND HE WINS, then it is not taxable to the son because it is considered inheritance. Coming back to the case -> whenever there is a SETTLEMENT -> must ask what it was in lieu of and cite LYETH case. Eg a settlement could be in lieu of inheritance - so non taxable (court rules in favor of son and throws out the will which gives everything to mistress - in absence of will the money to son is simply an inheritance. If a State pays employees a gift of $5k per month, still taxable at federal level. Another Hypothetical: State law vs federal law not always the same. Remember that state’s have their own inheritance laws. Ubi Testamentum Ibi Here (where there is a will there is a way - where there is a will there is a greedy bene). Sometimes an heir is not considered as such e.g. step child gets different treatment. If the stepchild gets a payoff/settlement from the mistress (step child won’t sue her for the inheritance money) so that it is taxable because it is not in lieu of inheritance. REMEMBER: bequest come through a will or a trust - in absence of will or trust the payment is an inheritance.
LYETH case -> Whenever you hear “in lieu of” or “settlement” almost certainly referring to LYETH v HOEY. WOLDER v. COMM - ATTORNEY WHO RECEIVES CASH BEQUEST UNDER WILL IN LIEU OF PAYMENT FOR SERVICES HAS INCOME. The issue is whether it is payment for services or not. The type of services do not matter? Remember that a dollar amount needs to be in proportion to the services rendered - wealthy neighbor mows his neighbors lawn for a large sum was the example the prof gave.
4 JUDICIAL JARGON Chapter 4. Employee Benefits
A. Exclusions for Fringe Benefits ................................................................ 87 B. Exclusions for Meals and Lodging .......................................................... 98 Hatt v. Commissioner HATT, HERBERT G - FMV OF FUNERAL HOME IS NOT INCOME TO EE REQUIRED TO LIVE ON PREMISES FOR CONVENIENCE OF ER
EXCLUSIONS FROM INCOME ◦ Zarin (in Brightspace not in textbook)
CHAPTER 4 ◦ EXCLUSIONS FROM INCOME ◦ Hatt v Comissioner4 HATT, HERBERT G - FMV OF FUNERAL HOME IS NOT INCOME TO EE REQUIRED TO LIVE ON PREMISES FOR CONVENIENCE OF ER - she was in 20’s he was in 40’s. She gives him stock in company and he is majority shareholder. Is the lodging excluded or included in his income? Section 119 - required by the employer, for convenience of employer and it is on property owned by the employer. If you are the employer (because you own more than 50% of the company) and the employee this won’t work and this will be income to the employee/taxpayer.
CHAPTER 5 No case from chapter 5 is required but the one in there is McDonell vs Commissioner
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CHAPTER 6 DETERMINATION OF TAX BASIS:
Philadelphia Park Amusement6 ◦ Farid-EsSultaneh6 PHILADELPHIA PARK AMUSEMENT - FMV OF STRAWBERRY BRIDGE GIVEN IS PRESUMED = TO FMV OF FRANCHISE RECEIVED IN EXCHANGE. Company builds a bridge in 1899 and deeds the bridge to the city in 1934. They get ten year extension on the amusement park.. 1946 bridge is abandoned. What is the cost basis of the ten year extension? IRS says basis is zero in 1946 because the taxpayer had a gain or loss in 1934. Taxpayers wants to get a carry over basis from bridge to franchise because it is impossible to value the bridge and value the amusement par too. The court said if you can value either of them in 1934 then there is no basis to carry forward. THE RULE from this case - the value of what is given is considered equal to the value of what is received. And that determines whether you have gain or loss at that time. Swapping the bridge for the franchise was the “realization event”. the court ruling found that the company could use the fair market value of the franchise extension as its cost basis for the depreciation deduction. Note that the taxpayer didnt own the bridge anymore in 1946.
FARID-ES-SULTANEH - FUTURE W IN PRENUPTIAL AGREEMENT GETS BASIS IN PROPERTY RECEIVED = TO FMV OF SUPPORT RIGHTS SHE GAVE UP. She was 32 and he was 57. In 1923 she says she will release dowry and support rights. He had $375 million and $100 million in real estate. He was founder of KMart. So they married under prenuptial. He says he will give her stock under a prenup. The stock has 20 cents basis. They got divorced after five years. In 1938 she sells the stock and claims the basis was $290 (FMV at time of the gift). IRS says basis is 16 (20cents per share). She calcium her gain is $100-290. IRS says carry over basis is much bigger. Taxpayer wins the case and did not have to pay the bigger gain. Did she have gain when she got the stock when married? Revenue ruling 67-221 addresses this and says she did not have a gain in 1923 when she got married. Because she would have received the dowry and support payments under marriage so it would not have been taxable anyway. IRS 2014-21. Crypto is subject to income tax if using as a medium of exchange. Prof glossed over this. Section 1041 - husband gives money to wife there is no gain or loss. Section 1014. Husband dies. Son gets stock.. step up in basis to fair market value. LIFE INSURANCE - not taxable to the recipient. As of 817-06 if the buyer of the policy has no relationship to the insured then it is taxable. it is called VIATICAL insurance. Taxpayer buys annuity from insurance company - exclusion ratio is 60k/100k - ROC is the concept - return of capital (ROC). Invest 60k and get 100k back.
PHIL PK AMUSMNT - FMV OF STRAWBERRY BRIDGE GIVEN IS PRESUMED = TO FMV OF FRANCHISE RECEIVED IN EXCHANGE
FARID-ES-SULTANEH - FUTURE W IN PRENUPTIAL AGREEMENT GETS BASIS IN PROPERTY RECEIVED = TO FMV OF SUPPORT RIGHTS SHE GAVE UP
Philadelphia Park Amusement Co. v. United States
Farid-Es-Sultaneh v. Commissioner
7. Life Insurance Proceeds and Annuities - no notable cases(?).
Chapter 7 focuses on business and investment expense deductions, detailing Internal Revenue Code provisions that permit taxpayers to reduce taxable income via expenses incurred in trade, business, or other profit-seeking ventures. The chapter explains the criteria for ordinary and necessary business expenses under IRC Section 162 and covers investment expenses deductible under IRC Section 212, which are related to income production, management, conservation, or maintenance of property held for income production. .…….
8 JUDICIAL JARGON 8. Discharge of Indebtedness
United States v. Kirby Lumber Co. KIRBY LUMBER - BONDS REPURCHASED AT A PRICE LESS THAN ISSUE PRICE = INCOME TO CORP PURCHASER – FORGIVENESS OF DEBT
ZARIN - SETTLEMENT OF A CONTESTED GAMBLING LIABILITY IS NOT INCOME FROM CANCELLATION OF INDEBTEDNESS
RR-2008 – 34 - DISCHARGE OF STUDENT LOAN UNDER LRAP (PUBLIC SERVICE WORK) IS NOT INC. – INCLUDES REFI LOAN Revenue Ruling 2008–34 ...... 175
ZARIN - SETTLEMENT OF A CONTESTED GAMBLING LIABILITY IS NOT INCOME FROM CANCELLATION OF INDEBTEDNESS. Zarin owes the casino $3.5m and settles by paying them $500k. IRS says $3m is income. Contested liability doctrine. Zarin says the real liability is only $500k. New Jersey has compulsive gambling statute so that taxpayer wins. Las Vegas case Watanabee owed $400 million to the casinos and claimed the amount was less - compulsive gambler statute! Contested liability refers to a situation where the defendant disputes responsibility for causing the plaintiff's injuries in a personal injury case. Instead of admitting fault, the defendant argues that they were not negligent, that someone else was to blame, or that the plaintiff was partially or entirely at fault.
RR-2008 – 34 - DISCHARGE OF STUDENT LOAN UNDER LRAP (PUBLIC SERVICE WORK) IS NOT INC. – INCLUDES REFI LOAN. If you work for the city or a not for profit for ten years - and debt forgiven it is not taxable. AND IRS agreed this also applies to refinanced portion of a student loan!! Section 104a2 - damages for personal injury - car accident and T loses a leg. Court finds insurance payout non taxable because he suffered enough. T sues for emotional distress. Court said only if Tort. Congress and IRS changed the Law - 104a2 now says physical personal injury - needs to be proved.
CHAPTER 9: ENTIRE CHAPTER(!) covers the scope of gross income, including income received without cash, along with various exclusions such as gifts, inheritances, and certain fringe benefits. It also addresses property transactions, including the taxation of gains, computation of basis, and realized gain, referencing principles from Crane v. Commissioner. …….…….
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10. Separation and Divorce NO CASES
A. Alimony and Separate Maintenance Payments ................................... 193 B. Property Settlements ............................................................................. 195 Young v. Commissioner .........
11. Other Exclusions from Gross Income NO CASES
A. Gain from the Sale of a Principal Residence ........................................ 205
Senate Report No. 105–33 and Conference Report No. 105–220 ........ 206
B. Income Earned Abroad .......................................................................... 212
C. Exclusions and Other Tax Benefits Related to the Costs of Higher Education ................................................................................................ 213
D. Federal Taxes and State Activities ....................................................... 221
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IDENTIFICATION OF THE PROPER TAXPAYER
12 JUDICIAL JARGON Chapter 12. Assignment of Income
A. Introduction ............................................................................................ 229 B. Income from Services ............................................................................. 231 Lucas v. Earl .......................................................................................... 231 Commissioner v. Giannini ..................................................................... 232 Revenue Ruling 66–167 ......................................................................... 238 Revenue Ruling 74–581 ......................................................................... 240 C. Income from Property ............................................................................ 242 Helvering v. Horst .................................................................................. 242 Blair v. Commissioner ........................................................................... 246 Estate of Stranahan v. Commissioner .................................................. 249 Salvatore v. Commissioner .................................................................... 252 Revenue Ruling 69–102
LUCAS v. EARL - FRUIT IS TAXABLE TO THE TREE EVEN WHERE H & W TRY TO AGREE THAT H’S SALARY IS TAXABLE ½ TO W
GIANNINI - REFUSAL OF MONEY BY T BANK PRESIDENT BEFORE IT WAS EARNED IS NOT INCOME TO T
HORST v. HELVERING - DONOR HAS INCOME FROM GIFTED BOND COUPONS WHEN HE RETAINS THE BOND ITSELF
BLAIR - T NOT TAXABLE ON INCOME FROM TRUST HE ASSIGNED TO HIS KIDS. T DOES NOT OWN ANY CORPUS.
SALVATORE, SUSIE - GAS STATION SALE TAXABLE TO T WHO ASSIGNED TO HER KIDS AFTER THE SALE CONTRACT WAS SIGNED
CHAPTER 12 - Assignment of income.
LUCAS v. EARL - FRUIT IS TAXABLE TO THE TREE EVEN WHERE Husband & Wife TRY TO AGREE THAT Husband’S SALARY IS TAXABLE ½ TO Wife. Fruit and the tree case. The tree is the husband. The fruit is the salary. FRUIT IS TAXABLE TO THE TREE EVEN WHERE Husband & Wife TRY TO AGREE THAT Husband’S SALARY IS TAXABLE ½ TO Wife. Income must be taxed to the individual that earns it(?) what is the partnership test from the Tower case? Think it says that to be a partnership there has to be a contribution of capital or services(?).
GIANNINI - REFUSAL OF MONEY BY Taxpayer BANK PRESIDENT BEFORE IT WAS EARNED IS NOT INCOME TO Taxpayer - Board of Tax Appeals (now called…. Court?) rules for the taxpayer. He founded the precursor to Bank of America. Taxpayer didn’t send the money nor did he have the power to direct its use. He had an unqualified refusal of the property. Property which is renounced another be taxed. “HE DID NOT DIRECT IT’S DISPOSITION”. The only was never beneficially received. Going forward -> you have to renounce the money IN ADVANCE.
HORST v. HELVERING - DONOR HAS INCOME FROM GIFTED BOND COUPONS WHEN HE RETAINS THE BOND ITSELF - SO THE FATHER PAYS THE TAX BECAUSE HE RETAINS CONTROL OF THE BONDS - assignment of income case. Father gave bond coupons to the son. If T sets up a trust then he is still taxed on the income, because he still has discretion on where the income is assigned. For those who earn or otherwise create the right to receive income or enjoy the income. They mention fruit of the tree. The father gets taxed no matter how many years of coupons he gives away, if the father holds onto the bond then he pays the tax on the coupon interest. The tree is the bond. If it can be proven that the father has relinquished control of the bond then maybe the son will pay the tax on the coupons.
BLAIR - Taxpayer NOT TAXABLE ON INCOME FROM TRUST HE ASSIGNED TO HIS KIDS. Taxpayer DOES NOT OWN ANY CORPUS. Corpus is a trust’s total capital. Taxpayer owned income from a trust interest and assigned it entirely to his children. Supreme Court question - is the assignment valid for federal taxes? The IRS argument was only the income was assigned not the interest in the trust itself. Supreme Court argued against that and decided the recipients (children) were to be taxed on the income from the trust.
SALVATORE, SUSIE - GAS STATION SALE TAXABLE TO Taxpayer WHO ASSIGNED TO HER KIDS AFTER THE SALE CONTRACT WAS SIGNED. The question is whether the petitioner is taxable on all or half of the gain from sale of the property. Her and husband owned the property 50/50 but the husband died. After he died she sold the property, but then she back-dated a gift (deed) of 50% of the property to her sons, ostensibly to reduce her tax liability. What is Burnett v Leniger that is cited in the Lucas v Earl case. Note that the Commissioner at the time was named Earl - used to be cases in the IRS Commissioner’s own name. So refer to that case as Lucas (NOT EARL).
13 JUDICIAL JARGON Chapter 13. Income Producing Entities
CORLISS v. BOWERS - TRUST IN WHICH T RETAINED THE POWER TO ALTER IT IN ANY WAY IS TAXABLE TO T
MORRILL - TRUST WHICH PAID FOR KIDS TUITION WHICH T WAS OBLIGATED TO PAY FOR IS TAXABLE TO T
CLIFFORD - 5 YEAR TRUST TAXED TO T EVEN IF IRREVOCABLE BECAUSE T RETAINED A BUNDLE OF RIGHTS = TO CONTROL
CULBERTSON - EXISTENCE OF PARTNERSHIP DEPENDS ON FACTS & CIRCUMSTANCES INCLUDING FAIR RETURN TO CAPITAL & SERVICES
OVERTON - H GIVES W B STOCK $1 LIQ VALUE, NO VOTE, $150/YR DIVIDEND. HELD ASSIGNMENT OF INCOME, NOT REAL STOCK
BORGE - ENTERTAINER’S EARNINGS PAID TO HIS POULTRY CORP WERE REALLOCATED TO HIM UNDER S482.
B. Partnerships ........................................................................................... 271 Commissioner v. Culbertson ................................................................. 271 C. Corporations ........................................................................................... 278 Overton v. Commissioner ...................................................................... 279 Johnson v. Commissioner ...................................................................... 281 Borge v. Commissioner .......................................................................... 285 D. Trusts and Estates ................................................................................. 288 Corliss v. Bowers .................................................................................... 289 Helvering v. Clifford
CORLISS v. BOWERS - TRUST IN WHICH T RETAINED THE POWER TO ALTER IT IN ANY WAY IS TAXABLE TO T. Grantor transfer $1m to trustee and provides income to bene for life. Principal can be used for B’s health. Remainder goes to B’s kids. And always ask who holds the power over the trust. Who pays the tax? grantor, trust, bene’s, trustee, kids, power holder? Court held the grantor is taxable on the trust income because he held he power to control the trust.
MORRILL - TRUST WHICH PAID FOR KIDS TUITION WHICH T WAS OBLIGATED TO PAY FOR IS TAXABLE TO T CLIFFORD - 5 YEAR TRUST TAXED TO T EVEN IF IRREVOCABLE BECAUSE T RETAINED A BUNDLE OF RIGHTS = TO CONTROL.
Helvering vs Clifford - Clifford Trust rules - if the trust exists for ten years and one day then the grantor is not taxable. In 1986 the law changed and the trust must now exist for 34 years. Income to beneficiary is taxable to bene if they receive income from the trust for 34 years or more.
CULBERTSON - EXISTENCE OF PARTNERSHIP DEPENDS ON FACTS & CIRCUMSTANCES INCLUDING FAIR RETURN TO CAPITAL & SERVICES. Trial Court went for the IRS. Appellate Court for the taxpayer. Culbertson sold one half of the interest to the four sons, two days later the sons gave the father a note for what they owed him. Some of the boys worked on the ranch for a while and some did not. Reference to Tower Case - or a partnership to exist need vital services or capital. Court of Appeals reversed the decision and said that if a family partnership was entered into in good faith and without the intention of tax avoidance is sufficient to satisfy concept of partnership. Some boys contributed capital, some services, some contributed neither during the year, but they still got partnership treatment- different to the Tower case. The Appellate Court said are they really intending on carrying on the business themselves? They consider the conduct of the parties, their relationships etc. the court decided this case based on the GOOD INTENTIONS of the family. This is despite not provided capital or services.
CULBERTSON - EXISTENCE OF PARTNERSHIP DEPENDS ON FACTS & CIRCUMSTANCES - INCLUDING FAIR RETURN TO CAPITAL & SERVICES - Commissioner of Internal Revenue v. Culbertson et ux. serves as a critical affirmation of the principles established in prior cases regarding the substance over form in partnership arrangements for tax purposes. The Supreme Court's decision underscores the necessity for active economic participation by all partners within a business, especially in familial contexts where the temptation to manipulate income distribution for tax benefits is prevalent. This judgment not only clarifies the requirements for partnership recognition under the Internal Revenue Code but also reinforces the foundational tax principle that income must be taxed to its true earners. Consequently, businesses and family partnerships must structure their agreements and operations to reflect genuine economic collaboration, ensuring compliance with tax obligations and avoiding unintended tax liabilities. The most critical part of the reason the taxpayers won this is because the Tower case didnt apply - the reason it didn’t apply is because they had bona fide business intentions - this was not a tax scheme. They had an incredibly strong business purpose. They wanted the strain of cattle to remain hence required that the herd be split between 5 people. VERY STRONG PEOPLE PURPOSE.
OVERTON - Husband GIVES Wife B STOCK $1 LIQ VALUE, NO VOTE, $150/YR DIVIDEND. HELD ASSIGNMENT OF INCOME, NOT REAL STOCK - gift tax liability for the petitioner. And income tax liability too. Dividends received by wife were really income to the husband was the IRS argument. But the shares were split into A and B (A is voting and B is non voting). The Taxpayer lost - but not because pf the non-voting stock - the critical factor is the fact that the company had a buy back of the B stock at one dollar. Getting dividends of $150 per year when the shares are only worth one dollar to the taxpayer makes no sense hence the T lost the case.
BORGE - ENTERTAINER’S EARNINGS PAID TO HIS POULTRY CORP WERE REALLOCATED TO HIM UNDER S482. Victor Borge is a comedian and pianist. He had a farm where he raises hens. He started an LLC called Danica to limit his corporate liability from the farm. His corp shows a $300k loss and his personal 1040 shows $400k income from entertainment work. He assigns his “entertainment” to the LLC and he shows only $100k payment from LLC as income. section 482 gives IRS power to reallocate income and he pays tax on the $400k anyway. Appellate Court upholds the decision. Aside for Culbertson, another case where the taxpayer said they had precedent on their side but they lost was Glenshaw Glass (anti trust). Eisner McComber case ?? Capital or labor or both combined. Taxpayer said no capital or labor involved based on Eisner McComber case. Supreme Court ruled that the taxpayer owes the tax based on Glenshaw Glass. Supreme Court are saying the facts are. Not exactly the same in the two instances. Other cases mentioned in modules 1-6: There are more cases under contents - e.g. Masser Oscar swag Stanton Hamacher - Tax Court case about home office deduction that defines “for convenience of employer”. Under divorce cases - courts look at property and support rights differently - Van Kamp and Carrera. Jack Barcal teaches these in the family wealth preservation course.
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DEDUCTIONS IN COMPUTING TAXABLE INCOME (business expenses, itemized deductions)
MAIN EG IS HOME OFFICE DED. - principal place of business ◦ Soliman case (97) changed the law from 1998 onwards.
14 JUDICIAL JARGON Business Deductions
B. The Anatomy of the Business Deduction Workhorse: Section 162
1. “Ordinary and Necessary” ............................................................. 305
Welch v. Helvering ......................................................................... 305
“Expenses” ...................................................................................... 308
Midland Empire Packing Co. v. Commissioner ........................... 312
INDOPCO, Inc. v. Commissioner .................................................. 319
“Carrying on” Business .................................................................. 328
Frank v. Commissioner .................................................................. 328
WELCH - PAYMENTS BY T ON BEHALF OF HIS FORMER BANKRUPT ER WERE NECESSARY BUT NOT ORDINARY.
MIDLAND EMP PKG - CONCRETE LINING IN T’S BASEMENT WAS BOTH NECESSARY AND ORDINARY
INDOPCO, INC. - EXPENSES INCURRED BY TARGET IN FRIENDLY TAKEOVER ARE NOT 162 EXPENSES
NORWEST CORP - EXPENSES OF REMOVING ASBESTOS MUST BE CAPITALIZED IF PART OF A RENOVATION PLAN
FRANK, MORTON - TRIPS BY T TO BUY A NEWSPAPER BUSINESS WERE NON-DED PRE OPERATING EXPS
C. Specific Business Deductions
................................................................ 337 1. “Reasonable” Salaries .................................................................... 337 Exacto Spring Corporation v. Commissioner ............................... 337 Harolds Club v. Commissioner ...................................................... 344 2. Travel “Away from Home” ............................................................. 351 Rosenspan v. United States ........................................................... 351 Andrews v. Commissioner ............................................................. 359 Revenue Ruling 99–7 ..................................................................... 365 3. Necessary Rental and Similar Payments ..................................... 370 Starr’s Estate v. Commissioner ..................................................... 370
EXACTO SPRING CORP - REASONABLE COMPENSATION IS ALLOWED IF OTHER INDEPENDENT OWNERS APPROVE PAYMENT
HAROLD’S CLUB - REASONABLE COMPENSATION IS ALLOWED IF A FREE BARGAIN & REASONABLE WHEN CONTRACT IS MADE
ROSENSPAN - TRAVEL EXPS BY T WHO HAS NO HOME TO BE AWAY FROM ARE NOT DEDUCTIBLE
ANDREWS v. COMM - UNDER IRC 162 T WITH HOMES AND BUSINESS IN MA & FLA DOES NOT HAVE 2 TAX HOMES, JUST 1
HILL v. COMM - SCHOOLTEACHER MAY DEDUCT EDUCATION COSTS AT COLLEGE WHEN NEEDED TO KEEP HER CERTIFICATE
D. Other Business Deductions
................................................................... 375 1. Expenses for Education ................................................................. 375 Hill v. Commissioner ..................................................................... 376 Coughlin v. Commissioner ............................................................. 381 2. Business Losses .............................................................................. 384 3. Qualified Business Income Deduction
COUGHLIN - LAWYER MAY DEDUCT COST OF NYU TAX INSTITUTE EACH YEAR TO KEEP CURRENT
E. Depreciation
1. Introduction .................................................................................... 388 Sharp v. United States .................................................................. 398 Simon v. Commissioner
2. Depreciation and Amortization Rules for Personal Property
3. Depreciation Rules for Realty ....................................................... 421
SIMON - VIOLIN BOWS ARE SUBJECT TO ACRS DEPRECIATION EVEN IF THEY APPRECIATE AS ANTIQUES
Chapter 15. Deductions for Profit-Making, Nonbusiness Activities
A. Section 212 Expenses............................................................................. 427 Higgins v. Commissioner ....................................................................... 427 Bowers v. Lumpkin ................................................................................ 431 Surasky v. United States ....................................................................... 434 Revenue Ruling 64–236 ......................................................................... 440 Fleischman v. Commissioner ................................................................ 440 B. Charges Arising out of Transactions Entered into for Profit .............. 449 Horrmann v. Commissioner .................................................................. 449 Lowry v. United States .......................................................................... 452
Chapter 16. Deductions Not Limited to Business or Profit- Seeking Activities ............................................................................... 461 A. Introduction ............................................................................................ 461 Tax Subsidies as a Device for Implementing Government Policy: A Comparison with Direct Government Expenditures ................... 462 B. Interest ................................................................................................... 465 Revenue Ruling 69–188 ......................................................................... 465 Dean v. Commissioner ........................................................................... 468 C. Taxes ....................................................................................................... 492 Cramer v. Commissioner ....................................................................... 492 D. Bad Debts, Charitable Contributions and Casualty and Theft Losses ...................................................................................................... 496
17 JUDICIAL JARGON
ENGDAHL - HOBBY LOSS - YOU CAN CONSIDER RANCH APPRECIATION IN A HORSE BREEDING OPERATION
Chapter 17. Restrictions on Deductions
............................................... 497 A. Introduction ............................................................................................ 497 B. Section 274 Limitations ......................................................................... 500 C. Activities Not Engaged in for Profit ..................................................... 506 Engdahl v. Commissioner ...................................................................... 508 D. Restrictions on Deductions of Homes ................................................... 516 E. Deductions Limited to Amount at Risk ................................................ 523 F. Passive Activity Limitations ................................................................. 526 G. Noncorporate Excess Business Losses .................................................. 542 H. Illegality or Impropriety ........................................................................ 543 Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner ................................................................................. 545 Commissioner v. Tellier
ENGDAHL - HOBBY LOSS - YOU CAN CONSIDER RANCH APPRECIATION IN A HORSE BREEDING OPERATION
18 JUDICIAL JARGON
BANKS - T MUST PAY TAX ON CONTINGENT FEE PORTION THAT GOES TO PERSONAL INJURY ATTORNEY
Chapter 18. Deductions for Individuals Only
A. Extraordinary Medical Expenses .......................................................... 553 Gerard v. Commissioner ........................................................................ 553 Revenue Ruling 2002–19 ....................................................................... 555 B. The Concepts of Adjusted Gross Income, Itemized Deductions, and Miscellaneous Itemized Deductions ...................................................... 564 Senate Finance Committee Report No. 885 ................................. 564 C. The Standard Deduction ....................................................................... 570 D. Personal and Dependency Exemptions
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THE YEAR OF INCLUSION OR DEDUCTION
Chapter 19. Fundamental Timing Principles CHAPTER 19 JACK’S JUDICIAL JARGON
A. Introduction ............................................................................................ 581 B. The Cash Receipts and Disbursements Method .................................. 585 1. Receipts ........................................................................................... 585 Kahler v. Commissioner ................................................................ 586 Williams v. Commissioner ............................................................. 588 Cowden v. Commissioner ............................................................... 590 Hornung v. Commissioner ............................................................. 594 2. Disbursements ................................................................................ 599 Revenue Ruling 54–465 ................................................................. 599 Vander Poel, Francis & Co., Inc. v. Commissioner ...................... 602 Commissioner v. Boylston Market Ass’n ...................................... 603 Cathcart v. Commissioner ............................................................. 607 Revenue Ruling 87–22 ................................................................... 609 C. The Accrual Method ............................................................................... 612 1. Income Items .................................................................................. 612 Spring City Foundry Co. v. Commissioner ................................... 613 Revenue Ruling 2003–10 ............................................................... 614 North American Oil Consolidated v. Burnet ................................ 617 New Capital Hotel, Inc. v. Commissioner .................................... 620 2. Deduction Items ............................................................................. 628 Revenue Ruling 2007–3 ................................................................. 628 Schuessler v. Commissioner
HORNUNG, PAUL - AUTO IS INCOME TO ATHLETE WHEN HE HAD CONSTRUCTIVE RECEIPT & UNFETTERED CONTROL.
NEW CAPITAL HOTEL - RENT RECEIVED IN ADVANCE IS INCOME UPON RECEIPT
Chapter 20. How Ineluctable Is the Integrity of the Taxable Year? (NO CASES OF NOTE)
A. Taxpayer’s Restoration of Previously Taxed Income ........................... 645
United States v. Lewis ........................................................................... 645
Van Cleave v. United States ................................................................. 649
B. The Tax Benefit Doctrine ...................................................................... 654
Alice Phelan Sullivan Corp. v. United States ...................................... 654
Revenue Ruling 2019–11 ....................................................................... 657 C.
Income Averaging .................................................................................. 660 1.
Do-It-Yourself Averaging ............................................................... 660
Revenue Ruling 60–31 ................................................................... 660 2.
Statutory Deferred Compensation and Medical Insurance Arrangements ................................................................................. 669
D. The Carryover and Carryback Devices................................................. 674
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THE CHARACTERIZATION OF INCOME AND DEDUCTIONS
Chapter 21. Capital Gains and Losses
................................................... 679 A. Introduction ............................................................................................ 679 B. The Mechanics of Capital Gains ........................................................... 685 C. The Mechanics of Capital Losses .......................................................... 693 D. The Meaning of “Capital Asset” ............................................................ 698 1. The Statutory Definition ............................................................... 698 Mauldin v. Commissioner .............................................................. 698 Malat v. Riddell .............................................................................. 702 E. The Sale or Exchange Requirement ..................................................... 706 Kenan v. Commissioner ......................................................................... 706 Hudson v. Commissioner ....................................................................... 711 F. The Holding Period ................................................................................ 714 Revenue Ruling 66–7 ............................................................................. 714 Revenue Ruling 66–97 ........................................................................... 715 G. Judicial Gloss on the Statute ................................................................ 720 1. “Income” Property .......................................................................... 720 Hort v. Commissioner .................................................................... 721 Metropolitan Bldg. Co. v. Commissioner ...................................... 723 Watkins v. Commissioner .............................................................. 729 2. Correlation with Prior Transactions ............................................. 733 Arrowsmith v. Commissioner ........................................................ 733 United States v. Skelly Oil Co. ...................................................... 737 H. Statutorily Created Capital Gain and Loss Consequences ................. 742 1. In General ....................................................................................... 742 2. Section 1231 Recharacterization ................................................... 747 Wasnok v. Commissioner............................................................... 751 Williams v. McGowan
MAULDIN - DEALER STATUS & ORDINARY INCOME RESULTS TO T WHO SOLD LOTS BEC OF PURPOSE FOR WHICH LOTS WERE HELD
MALAT v. RIDDELL - PRIMARILY FOR SALE TO CUSTOMERS MEANS PRINCIPAL PURPOSE NOT JUST A SUBSTANTIAL PURPOSE
HORT - LANDLORD HAS ORD INCOME ON $ RECEIVED FOR CANCELLATION OF LEASE
METROPOLITAN BLDG - LESSEE HAS CAP GAIN ON $ RECEIVED FOR CANCELLATION OF LEASE
KENAN - APPRECIATED STOCK USED TO SATISFY A DEBT OWED BY TRUST TO BENEFICIARY IS A DISPOSITION & CG.
GALVIN HUDSON - T BUYS NOTE AT DISCOUNT. DEBTOR PAYS OFF NOTE, BUT NO CG TO T BECAUSE NOT A SALE OR EXCH
WATKINS - T SELLS PAYMENTS UNDER LOTTO CONTRACT FOR LUMP SUM IN CASH. OI NOT CG.
ARROWSMITH - CORP LIQUIDATES IN 1937 & T HAS CG. IN 1940 T PAYS $, BUT NO ORD DED BEC PMT RELATED BACK TO CG ON LIQ
TOPICS COVERED HERE ARE:
1. Analyze the taxable year, the tax benefit rule, and the claim of right doctrine
2. Analyze characterization of income
3. Analyze how different types of income are taxed
4. Distinguish between business, investment, and personal activities
5. Distinguish deductible expenses from nondeductible capital expenditures
Mauldin case summary: The U.S. tax case of Mauldin v. Commissioner is a significant case in tax law, primarily known for establishing a key standard for determining whether the gains from the sale of inherited or previously held land should be taxed as ordinary income or as a capital gain. The Core Issue: The central issue in the case was the classification of income from the sale of numerous real estate lots. The taxpayer, C.E. Mauldin, had initially purchased a 160-acre tract of land in New Mexico in 1920 with the intent of using it for cattle feeding. After facing financial difficulties and being unable to sell the entire tract, he subdivided it into smaller lots and began selling them, initially to pay for a city paving assessment. Later, Mauldin claimed he ceased active sales and entered the lumber business, holding the remaining lots for investment. However, due to the proximity of wartime facilities, the lots became highly sought after, and he continued to sell a significant number of them through unsolicited offers. Mauldin reported the income from these sales as long-term capital gains, which are taxed at a lower rate. The Commissioner of Internal Revenue determined the gains were ordinary income, subject to a higher tax rate, and the Tax Court agreed. The Ruling and its Significance: The U.S. Court of Appeals for the Tenth Circuit affirmed the Tax Court's decision, classifying the gains as ordinary income. The court reasoned that the frequency and continuity of sales indicated Mauldin was engaged in the business of selling real estate lots, even while having another occupation. The case established criteria, sometimes called the "Mauldin factors," to determine if property is held primarily for sale to customers in the ordinary course of business, which would preclude capital gains treatment. These factors include the original purpose of acquiring the property, efforts to improve or advertise it, the frequency and continuity of sales, and other facts suggesting the sales further the taxpayer's occupation. This case is a significant precedent for distinguishing between investment and business activity in real estate sales for tax purposes.
Malat v. Riddell is a 1966 U.S. Supreme Court tax case that defined the word "primarily" in the context of U.S. tax law, specifically regarding whether property is held for sale in the "ordinary course of a trade or business". The Court held that "primarily" means "of first importance" or "principally". This decision established a stricter standard for determining if profits from property sales are subject to ordinary income tax rather than more favorable capital gains tax rates. Key details of the case: The dispute: A joint venture purchased a 45-acre tract of land, originally intending to develop it for apartments. After encountering problems, they sold the property, and the petitioner sought to report the profits as capital gains. The IRS's argument: The IRS argued that the property was held "primarily for sale" and that the profits should be taxed as ordinary income. The IRS claimed the joint venture had a "dual purpose" of either developing the land for rent or selling it, depending on which was more profitable. The Supreme Court's ruling: The Supreme Court ruled that "primarily" means "of first importance" and not just a "substantial" purpose. The impact: The ruling clarified that if the primary purpose of holding the property was not for sale to customers in the ordinary course of business, the gain could be treated as a capital gain. However, the case was remanded for a new factual determination based on the new, stricter definition of "primarily".
Kenan v. Commissioner, 114 F.2d 217 (2d Cir. 1940), established that using appreciated property to fulfill a fixed-dollar (pecuniary) bequest or monetary obligation is considered a "sale or other disposition" of that property for tax purposes, resulting in a taxable capital gain for the trust or estate. Key Details of the Case: The will in question directed trustees to pay the niece a $5,000,000 sum upon reaching age 40, with the discretion to pay in cash or marketable securities. When the niece turned 40, the trustees used a combination of cash and appreciated securities to satisfy the $5,000,000 obligation. The Commissioner of Internal Revenue asserted that the appreciation of the securities resulted in a taxable capital gain for the trust, while the trustees argued it was a non-taxable distribution. The Court's Ruling: The U.S. Court of Appeals for the Second Circuit ruled for the Commissioner. The court reasoned that the niece had a claim for a fixed sum of money. By using appreciated securities to discharge this obligation, the trustees effectively conducted a "sale or other disposition" of the property. The court concluded that the trust "realized" the gain because the appreciation allowed the trust to satisfy its liability with less property. Significance: The Kenan doctrine is a crucial aspect of trust and estate taxation, requiring fiduciaries to consider the tax basis of assets when distributing them in-kind to satisfy specific monetary obligations. This differs from a bequest of specific property, which does not trigger a gain upon distribution.
Hudson case summary: Need to add text here………………………………………………………
Hort case summary: The "Hort us tax case" refers to Hort v. Commissioner, a 1941 U.S. Supreme Court case that established that a lump-sum payment received for terminating a lease is considered ordinary, taxable income, not a capital gain. The taxpayer in the case received $140,000 to cancel a lease and argued it was a capital loss, but the Court ruled the payment was a substitute for future rental income, which is taxable as ordinary income. Case background: A man inherited a building with a long-term lease. The tenant paid him $140,000 to cancel the lease early. The taxpayer reported this payment as a capital loss, arguing it was less than the value of the unreceived rent payments. Supreme Court's decision: The Court held that the payment was not a sale or exchange of a capital asset. Instead, it was the collection of ordinary income that the taxpayer would have received over the life of the lease. Key takeaway: The Hort case is significant because it clarified that a payment for the cancellation of a lease is treated as ordinary income, not a capital gain. This is because the payment is a substitute for future income that would have been taxable as ordinary income.
Metropolitan Bldg. case summary: The "Metropolitan Bldg." United States federal tax case is Metropolitan Building Company v. Commissioner, a 1960 Ninth Circuit Court of Appeals ruling that held a payment received by a lessee for relinquishing a leasehold was a capital gain, not ordinary income. The court decided that the payment was for the sale of the leasehold interest itself, a capital asset, and not a substitute for future rent. The Transaction: Metropolitan Building Company, the lessee, received $137,000 from a sublessee to terminate its lease interest before its expiration date. The Tax Dispute: The IRS Commissioner argued this payment was a substitute for future rent and should be taxed as ordinary income. The Tax Court initially agreed with the Commissioner. The Court's Decision: The Ninth Circuit reversed the Tax Court, holding that the payment was a capital gain because Metropolitan had sold its leasehold interest, a capital asset. The court distinguished this from cases where a payment was simply an advance against rent.
Watkins case summary: Watkins v. Commissioner, 447 F.3d 1269 (10th Cir. 2006)*, which established that the lump sum a lottery winner received for selling his future lottery payments was ordinary income, not a capital gain. This case involved taxpayer Roger L. Watkins, who won the Colorado State Lottery and later sold his right to future payments for a lump sum. The court held that this payment was a substitute for ordinary income that would have been received over time, and therefore was taxable as ordinary income. Taxpayer: Roger L. Watkins. Background: Watkins won over $12 million in the Colorado State Lottery, to be paid in 25 annual installments. Tax treatment: After receiving six payments, Watkins sold his interest in the remaining payments for a lump sum and reported the gain as a capital gain on his tax return. IRS position: The IRS argued that the lump sum was ordinary income. Court ruling: The Tax Court and the Tenth Circuit Court of Appeals agreed with the IRS, affirming that the payment was ordinary income because it was a substitute for the income he would have received in future payments.
Other notable "Watkins" tax cases: Watkins v. United States, 149 F. Supp. 718 (D. Conn. 1957): In this case, the court ruled that the income from licensing patents was ordinary income, not capital gains, as it was not a sale of a capital asset but a license. United States v. Watkins: This case involves a timber operator convicted of tax evasion. The appeal focused on the admissibility of evidence, including evidence of stolen timber. The Eighth Circuit affirmed the conviction, finding the evidence was properly admitted.
Arrowsmith case summary: Arrowsmith v. Commissioner, 344 U.S. 6 (1952), is a landmark United States Supreme Court federal tax case that established the principle known as the "Arrowsmith doctrine" or "relation-back doctrine". The case determined that the character of a loss in a later year must be determined by the nature of the original, related transaction in a prior year, even if the years are separate for tax accounting purposes. Key Facts: The Original Transaction (1937-1940): Two taxpayers, who were equal shareholders in a corporation, liquidated the company and reported the profits from the distribution as capital gains. The Subsequent Event (1944): A judgment was rendered against the dissolved corporation. The two former shareholders, as transferees of the corporate assets, were required to pay the judgment. The Tax Issue: The taxpayers sought to deduct the full amount of the judgment payments in 1944 as ordinary business losses. The Commissioner of Internal Revenue argued the losses should be classified as capital losses, consistent with how the original liquidation gains were treated. The Supreme Court's Decision: The Supreme Court, in a 6-3 decision, sided with the Commissioner and held that the losses must be treated as capital losses. Reasoning: The Court determined that the 1944 payment was an integral part of the original liquidation transaction. Since the distributions were initially treated as an exchange of capital assets (stock) and given preferential capital gains tax treatment, the related loss incurred later must also be capital in nature to prevent a "windfall" to the taxpayers (deducting a high-rate ordinary loss from income that had been taxed at a lower capital gains rate). The Doctrine: The "Arrowsmith doctrine" requires a transactional approach to tax treatment, meaning that later events are characterized by the "origin and character" of the claim from the initial transaction, overriding the annual accounting principle in such specific circumstances. Significance: The Arrowsmith case is a foundational element of U.S. tax law. Its principle has been applied in various contexts to ensure consistency in the tax treatment of gains and losses arising from the same transaction across different tax years, and it was later codified in part by IRC section 1341 for certain items of income received under a claim of right. The decision emphasizes that the tax consequences of a subsequent payment are tied to the original transaction's character, regardless of the taxpayer's motivation for the payment.
Chapter 22. Characterization on the Sale of Depreciable Property
PARKER - T OWNED > 80% OF VALUE OF STOCK UNDER S 1239 BECAUSE OTHER S/H STOCK WAS RESTRICTED
................................................................................................ 761 A. Introduction ............................................................................................ 761 B. Characterization Under Section 1239 .................................................. 761 United States v. Parker ......................................................................... 762 C. Recapture Under Section 1245 .............................................................. 767 Revenue Ruling 69–487 ......................................................................... 773 D. Recapture of Depreciation on the Sale of Depreciable Real Property .................................................................................................. 774
PARKER - T OWNED > 80% OF VALUE OF STOCK UNDER S 1239 BECAUSE OTHER S/H STOCK WAS RESTRICTED
Chapter 23. Deductions Affected by Characterization Principles
BUGBEE, HOWARD - T LOANED $ & HAS A DED WHEN DEBTOR FAILS TO PAY – INTENT OF PARTIES IS KEY
HASLAM, CHARLES - EE WHO GUARANTEES ER’S DEBTS HAS DED IF DONE BY EE TO PRESERVE HIS JOB
............................................................................................. 779 A. Bad Debts and Worthless Securities .................................................... 779 Bugbee v. Commissioner ....................................................................... 779 Haslam v. Commissioner ....................................................................... 788 B. The Charitable Deduction ..................................................................... 794 Revenue Ruling 83–104 ......................................................................... 794 Revenue Ruling 67–246 ......................................................................... 798 C. Casualty and Theft Losses .................................................................... 816 1. Nature of Losses Allowed .............................................................. 816 Revenue Ruling 63–232 ................................................................. 817 Pulvers v. Commissioner ............................................................... 819 Allen v. Commissioner ................................................................... 820 2. Other Aspects of Casualty and Theft Losses
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DEFERRAL AND NONRECOGNITION OF INCOME AND DEDUCTIONS
DISALLOWANCE AND NON-RECOGNITION TOPICS:
The Interrelationship of Timing & Characterization and Disallowance of Losses, Non-Recognition Provisions
1. Analyze the interrelationship of timing and characterization issues relating to installment sales transactions under IRC § 453
2. Examine disallowance of losses issues
3. Analyze non recognition provisions
Readings IRC 453 - write summary of this reading and add summary of the online videos here. Also summarize the quiz learning points. At bottom summarize the lecture. Google summaries are below.
Chapter 24. The Interrelationship of Timing and Characterization
BURNET v. LOGAN - T MAY RECOVER COST BASIS FIRST ON SALE – RARE CASE WHERE PMT WAS IN DOUBT
INAJA LAND CO - T MAY RECOVER COST BASIS FIRST ON SALE OF FLOOD EASEMENT WHERE BASIS COULD NOT BE ALLOCATED
................................................................................. 831 A. Transactions Under Section 453 ........................................................... 831 1. The General Rule ........................................................................... 831 2. Contingent Sales Price ................................................................... 833 3. Situations in Which Section 453 Is Inapplicable ......................... 836 4. Special Rules Related to Section 453 ............................................ 838 B. Transactions Outside of Section 453 .................................................... 848 1. Open Transactions ......................................................................... 848 Burnet v. Logan .............................................................................. 848 2. Closed Transactions ....................................................................... 854 C. The Original Issue Discount Rules and Other Unstated, Hidden, and Imputed Interest ............................................................................. 857 D. Property Transferred in Connection with Services ............................. 866 E. Income in Respect of Decedents ............................................................ 874 F. Special Rules for Capital Gains Invested in Opportunity Zones ........
Summary of IRC section 453:
Internal Revenue Code (IRC) Section 453 is a foundational U.S. tax law that generally mandates the use of the installment method for reporting income from an installment sale unless the taxpayer chooses to elect otherwise. The core purpose is to allow a taxpayer to defer the recognition of gain on a sale of property until the cash payments are actually received, aligning the tax liability with the cash flow from the sale.
Key Concepts
• Installment Sale: A sale of property where at least one payment is received after the tax year of the sale.
• Installment Method: Income is recognized proportionally each year based on the payments received, calculated using the gross profit percentage.
• Default Rule: The installment method is the default unless the taxpayer chooses to "elect out" on their tax return.
Exclusions and Exceptions
Certain sales do not qualify for the installment method, including:
• Sales by dealers of personal or real property, with exceptions for farm property, timeshares, and residential lots.
• Sales of inventory and marketable securities.
• Depreciation recapture, which is taxed in the year of sale.
Related Party Rules
Rules exist to prevent tax avoidance in sales to related parties. For instance, if a related person resells the property within two years, the original seller may have to recognize the remaining gain immediately. The installment method also cannot be used for sales of depreciable property to a controlled entity.
Section 453A Interest Charge
An interest charge on the deferred tax liability may apply to large installment sales (over $150,000) if the outstanding obligations exceed $5 million at year-end. This charge is calculated using the IRS underpayment rate.
For more details, taxpayers can consult IRS Publication 537, Installment Sales, available on the IRS website.
Summary of Inaja case:
In the Inaja Land Co. v. Commissioner case, the U.S. Tax Court determined that payments received for property damage or easements, when the basis of the affected portion cannot be determined, should be treated as a recovery of the property's overall basis, reducing the total basis rather than being immediately taxable income. This recovery of basis principle means that only when payments exceed the full cost basis of the property does the excess become taxable as a gain.
BURNET V LOGAN:
I. Executive Summary: The Genesis and Diminution of Cost Recovery
A. Defining the Conflict
The landmark Supreme Court decision in Burnet v. Logan, 283 U.S. 404 (1931), established a fundamental principle in U.S. federal income taxation regarding the timing of gain recognition for transactions involving highly contingent consideration. The case originated from a core conflict between the administrative requirements of the Internal Revenue Service (IRS) and the taxpayer’s entitlement to an accurate measurement of income derived from the recovery of capital investment.1
Commissioner David Burnet, on behalf of the government, asserted that the sale of corporate stock by Mrs. Logan in 1916 constituted a "Closed Transaction." The Commissioner determined that the fair market value (FMV) of the right to receive future contingent payments was ascertainable at the time of the sale, requiring Mrs. Logan to report a calculated profit in 1916 based on this estimated value.1 Mrs. Logan, conversely, maintained that the future payments were so speculative—contingent upon iron ore production with no guaranteed minimum tonnage—that their value could not possibly be known with any certainty.2 Consequently, she argued that the transaction remained "open" for tax purposes, allowing her to treat all annual receipts as a non-taxable recovery of capital until her full adjusted basis in the stock was exhausted.1
B. The Logan Holding and the Open Transaction Doctrine
The Supreme Court affirmed the position of the taxpayer. The Logan holding established the foundational rule, now known as the Open Transaction Doctrine: when the fair market value of contingent property or rights received in exchange for an asset cannot be determined, the seller is not required to close the transaction immediately.3 Instead, the gain associated with the contingent right cannot be currently taxed because the promise of future money payments was deemed "wholly contingent upon facts and circumstances not possible to foretell with anything like fair certainty".3 The Court explicitly stated that the contingent payment right was "in no proper sense equivalent to cash" and "had no ascertainable fair market value".3 The transaction was permitted to remain open, granting Mrs. Logan the right to recoup her entire capital investment—a cost recovery approach—before any subsequent receipts were considered taxable income or profit.2
IV. The Supreme Court’s Opinion: Establishing the Open Transaction Doctrine
A. The Holding
The Supreme Court, in an opinion delivered by Justice McReynolds, affirmed the decision of the Circuit Court of Appeals.2 The unanimous Court held that until the receipts realized by Mrs. Logan under the sales contract equaled her adjusted basis in the shares (including the 1913 value), those payments were a return of capital and were not taxable in part as income.2 The Court determined there was no taxable income because the capital had not, in fact, been fully returned.2
B. The Rationale: Impossibility of Valuation
The jurisprudential heart of the Logan decision lies in its uncompromising stance on the necessary precision of income calculation. The Court focused its analysis entirely on the intrinsic nature of the contingent promise. The Youngstown Company's agreement to pay 60 cents per ton of ore was dependent upon an operation that had "wholly contingent" production requirements, lacking any guarantee of maximum or minimum tonnage.2
The promise of future money payments was therefore "wholly contingent upon facts and circumstances not possible to foretell with anything like fair certainty".3 Because the future flow of income was so uncertain, the Court concluded that the contract right "had no ascertainable fair market value".3 It was thus impossible to determine the "amount realized" with any accuracy, making the imposition of tax inappropriate.
The critical legal distinction drawn by the Court was the refusal to permit administrative imposition of tax liability based on uncertain estimates. The Commissioner’s proposed deficiency required recourse to "mere estimates, assumptions, and speculation".2 The Court determined that the liability for income tax could be "fairly determined without resort to mere estimates, assumptions, and speculation" by simply waiting for the contingent payments to materialize.2 When the profit, "if any, is actually realized," the taxpayer would respond.2 This ruling established that the certainty required for income realization necessitates accuracy in the amount realized, not just administrative convenience in the timing of reporting. The Court made clear that this situation did not demand an effort to place "some approximate value upon the contract for future payments".2
The fundamental judicial constraint established here is that the tax system's reliance on annual accounting periods must yield to the reality of realization when assets are intrinsically unquantifiable. The potential for the taxpayer to "never recoup her capital investment from payments only conditionally promised" made the immediate assessment of profit based on conjecture unjustifiable.3
C. Basis Recovery for Bequeathed Interests
A secondary, but significant, aspect of the Logan decision involved the payments Mrs. Logan received corresponding to the interest she inherited from her mother, who was one of the original vendor stockholders.2 The mother died in 1917, bequeathing her interest in the future payments.2
The Commissioner had to value this inherited right for federal estate tax purposes, a valuation that presumably involved the same kind of estimates Burnet attempted to use for Logan’s original shares.2 However, the Supreme Court applied the same cost recovery rule to this bequeathed interest. The Court held that, prior to the return of the amount at which the bequest was valued for federal estate tax purposes, the payments received by the legatee were also not income.2
This extension demonstrates a key tenet of tax jurisprudence: the legal standard for determining the realization of income is distinct from the statutory requirements for estate valuation. Although the government had statutory authority and necessity to assign a value to the contingent payment right for estate tax purposes (a non-income event), that assessed value did not automatically transform the right into property with an "ascertainable FMV" sufficient for income tax realization purposes. The two tax regimes operate with different policy objectives and realization thresholds.
IX. Conclusion: The Enduring Jurisprudential Value of Burnet v. Logan
A. Reaffirming the Realization Principle
Burnet v. Logan is one of the most significant judicial decisions in the history of U.S. federal income tax, not for its practical applicability today, but for its absolute commitment to the realization principle. The Supreme Court's ruling unequivocally rejected the administrative desire to impose tax based on speculative estimates and conjectures regarding future income.2 It established that profit recognition requires certainty in the amount realized—a certainty that contingent payment obligations, lacking minimum production requirements, could not provide. The ultimate contribution of Logan is its role in clarifying the definition of "income" under the 16th Amendment, demanding the recovery of capital investment before the assessment of gain.
B. Logan as a Legal Constraint on Administration
Despite its severe practical limitation by the mandatory Installment Method of IRC § 453 and the restrictive language of the Treasury Regulations, the Open Transaction Doctrine remains a vital, fundamental safeguard. Its continued existence confirms that the taxing authority cannot assess tax liability where valuation is genuinely impossible. Logan stands as an enduring legal constraint on administrative action, guaranteeing that taxpayers have recourse in the most extreme, "rare and extraordinary" instances where statutory or regulatory valuation methodologies fail to reflect economic reality, thereby preserving the structural integrity of the tax base definition. The case demonstrates a foundational principle: administrative policy goals of timeliness must yield to the substantive requirement that tax be imposed only upon income that is capable of fair, accurate measurement.
Chapter 25. Disallowance of Losses NO NOTABLE CASES
....................................................... 881 A. Losses Between Related Taxpayers ...................................................... 881 McWilliams v. Commissioner ................................................................ 881 B. Wash Sales
Chapter 26. Nonrecognition Provisions ...............................................
.... 891 B. Like Kind Exchanges ............................................................................. 893 1. The Like Kind Exchange Requirements ....................................... 893 Bloomington Coca-Cola Bottling Co. v. Commissioner ................ 894 Commissioner v. Crichton ............................................................. 895 Leslie Co. v. Commissioner ........................................................... 897 2. Three-Cornered Exchanges ........................................................... 904 Revenue Ruling 77–297 ................................................................. 904 3. Other Section 1031 Issues ............................................................. 909 C. Involuntary Conversions ....................................................................... 913 Revenue Ruling 76–319 ......................................................................... 914 Revenue Ruling 67–254 ......................................................................... 915 Clifton Inv. Co. v. Commissioner .......................................................... 916 Revenue Ruling 71–41 ........................................................................... 920 D. Other Nonrecognition Provisions ..........................................................
BLMGTN COCA-COLA - CASH BOOT IN N/T 1031 EXCHANGE DOES NOT VOID THE ENTIRE TRANSACTION
CRICHTON - NON-TAXABLE EXCHANGE – MINERAL INTEREST WHICH WAS RE CAN BE TRADED FOR CITY LOT
LESLIE CO - SALE & LEASEBACK OF BLDG TO PRUDENTIAL RESULTS IN LOSS TO T – IRS ARGUED 1031 EXCHANGE
MASSER - T MUST SELL PARCEL 1 WHEN PARCEL 2 IS CONDEMNED. THIS IS INVOLUNTARY CONVERSION OF BOTH.
CLIFTON INVESTMENT - UNDER IRC 1033 HOTEL WAS NOT SIMILAR OR RELATED IN SERVICE OR USE TO OFFICE BUILDING
RR 67 – 254 -1033 CONDEMNATION PROCEEDS CAN BE USED TO BUILD NEW BUILDING ON LAND ALREADY OWNED
Bloomington Coca Cola case:
The historical tax case, Bloomington Coca-Cola Bottling Company v. Commissioner, addresses foundational principles of U.S. income tax law regarding the disposition of business property, focusing specifically on the distinction between a sale, an exchange, and an abandonment, and the crucial requirement for the taxpayer to bear the burden of proof.
Summary of Bloomington Coca-Cola Bottling Company v. Commissioner
Aspect Detail
Case Citation Bloomington Coca-Cola Bottling Company v. Commissioner, 189 F.2d 14
Primary Tax Issue Classification of a property disposition (Sale vs. Like-Kind Exchange) and the legitimacy of a claimed loss due to abandonment.
Tax Years at Issue Primarily focused on the treatment of a 1939 transaction for purposes of adjusting excess profits tax in later years (1943 and 1944).
I. Facts of the Transaction
In 1938, the taxpayer, Bloomington Coca-Cola Bottling Company, determined that its existing bottling plant was inadequate. In 1939, the company contracted to build a new plant for a total cost of $72,500.
The payment for the new plant was structured as follows:
1. Cash payment: $64,500.
2. Transfer of old property: The taxpayer transferred its old plant and land to the contractor, and this property was valued at $8,000 as consideration in the exchange.
The taxpayer claimed a significant loss on its tax return, seeking a deduction of the unrecovered basis in the old plant, which it contended should be recognized for tax purposes.
II. Taxpayer's Arguments and Commissioner's Determination
The dispute centered on the classification of the 1939 transfer:
1. Sale vs. Exchange: The taxpayer argued that the disposition of the old plant was an exchange of "property for like property" under Section 112(b)(1) of the Internal Revenue Code (the revenue act then in force).
2. Abandonment Claim: The taxpayer also contended that the loss incurred on the disposal of the old plant should be recognized based on the legal theory of abandonment.1
The Commissioner of Internal Revenue opposed these claims. The Commissioner determined and the Tax Court affirmed that the taxpayer's disposition of the old plant constituted a sale, not a non-recognizable exchange.1 The Commissioner adjusted the taxpayer's base period income, resulting in a tax deficiency.
III. Court's Holding and Rationale
The Tax Court sustained the Commissioner's determination, and the appellate court affirmed the decision.1 The judicial reasoning was based on a rigorous application of tax definitions and the burden of proof:
• Classification as a Sale: The court found that the facts adequately supported the conclusion that the disposition of the old plant was a sale.1 A sale involves the transfer of property for money or its equivalent. The transaction was not deemed a non-recognizable like-kind exchange because the contractor did not exchange a completed plant for the old plant and cash; rather, the old plant was sold as part of the total payment for the new construction.
• Burden of Proof: The court emphasized the fundamental tax principle that the Commissioner's determination is considered prima facie correct, and the burden of proving it wrong rests squarely upon the taxpayer.1
• Rejection of Abandonment: The court categorically rejected the taxpayer's argument for a loss based on abandonment. It held that a claim of loss due to abandonment requires "clear and convincing proof of intention to abandon and discard the property".1 Since the old plant was transferred for consideration (valued at $8,000), it was deemed sold, and the facts were therefore contrary to any claim that the property had been discarded without intent to use.
The case ultimately confirmed that the taxpayer must adhere strictly to statutory definitions and provide compelling evidence to support extraordinary claims like abandonment or non-recognition of gain or loss, particularly when opposing the Commissioner's determination.
Crichton tax case:
The Doctrine of Legal Character: Analyzing Commissioner v. Crichton and the Evolution of IRC Section 1031
I. Executive Summary: The Precedent of Crichton
The United States federal tax case of interest is Commissioner of Internal Revenue v. Crichton, officially cited as 122 F.2d 181 (5th Cir. 1941).1 This decision, rendered by the United States Fifth Circuit Court of Appeals, is a foundational element in the judicial and administrative interpretation of non-recognition transactions under the Internal Revenue Code (IRC), specifically regarding "like-kind" exchanges.
A. Core Identification and Statutory Foundation
Crichton originated under the Revenue Act of 1936, challenging the application of its Section 112(b)(1), which served as the statutory predecessor to the modern IRC Section 1031.2 This section permits the deferral of gain or loss recognition when property held for productive use in a trade or business or for investment is exchanged solely for property of a "like kind" to be held for the same purposes.3
The central legal dispute required the court to define the scope of "like kind." The Commissioner of Internal Revenue asserted a narrow interpretation, focusing on the physical or functional characteristics of the property, which would have rendered the transaction taxable. The taxpayer, however, advocated for a broad interpretation based on the legal classification of the assets.
B. Central Holding and Rule Established
The Fifth Circuit ultimately ruled in favor of the taxpayer, holding that the exchange qualified for non-recognition treatment.2 This landmark ruling established the principle that the term "like kind" refers exclusively to the nature or character of the property, not to its grade, quality, physical characteristics, or specific use.2 Consequently, if both exchanged properties fall under the broad legal classification of real property, the exchange satisfies the statutory requirement, regardless of the vast physical differences between the assets.
This principle provided the crucial clarity necessary for structuring exchanges under the statute, allowing practitioners to rely on objective legal classifications rather than subjective economic or physical comparability. The decision essentially divorced the tax treatment of the exchange from the valuation complexities involved in comparing dissimilar assets, streamlining compliance and administration.6
Table 1: Commissioner v. Crichton Case Summary and Impact
IV. The Critical Legal Analysis: State Law and Property Character
The analysis conducted by the Fifth Circuit hinged on two critical legal steps: first, determining the proper legal characterization of the assets under state law, and second, applying that characterization to the federal like-kind standard.
A. The Jurisdictional Prerequisite: Defining Property Rights
Federal tax law generally dictates the tax consequences of a transaction, but it is necessary to rely on state law to determine the creation, nature, and existence of the property rights themselves. The court recognized that it could not proceed with the federal "like-kind" determination until the classification of mineral rights was definitively established under the law of the governing jurisdiction, which was Louisiana.7
This principle of deferral to state law was solidified one year earlier by the Supreme Court in Morgan v. Commissioner, 309 U.S. 424 (1940), which explicitly acknowledged that state law creates legal interests and rights.7 Thus, the Fifth Circuit’s first task was to interpret Louisiana property law regarding mineral rights.
B. The Determination under Louisiana Law
Unlike many common law states, Louisiana operates under a civil law system. The court confirmed that under Louisiana jurisprudence, an oil, gas, and mineral right, when severed from the surface estate, constitutes an interest in land—specifically a "real right" or a servitude on the land.5 Therefore, both the improved city lot (undeniably real property) and the mineral rights (subsurface interest) were legally classified as interests in real property.
This reliance on state law meant that while the physical assets were vastly different—one a fixed structure subject to depreciation, the other an exhaustible subsurface resource subject to depletion—they shared the same fundamental legal character. This structure established a tension: the same exchange could potentially yield two different federal tax outcomes depending on whether the land was situated in a state where mineral rights were considered interests in real property versus a state where they were treated as personal property. The adoption of the Morgan rule prioritized respecting established state property classifications over achieving uniform physical or economic characteristics nationwide.
C. Applying the Federal Standard
Having established that both the urban property interest and the rural mineral rights were, in a legal sense, interests in real property, the Fifth Circuit applied the statutory requirement of "like kind." The court concluded that the exchange was simply one piece of real property for another piece of real property.5 The term "like kind," as judicially interpreted here, referred to the broad legal classification of the property—real property vs. personal property—not to the specific grade, quality, or functional utility of the asset.2
Table 3: The Morgan-Crichton Doctrine (Federal Tax Reliance on State Law)
Step in Analysis Governing Authority Function/Determination Significance
1. Property Interest Definition State Law (e.g., Louisiana) Creates and defines the specific property right (e.g., mineral interest as real property) Determines the fundamental legal character of the asset.
2. Federal Tax Classification Morgan v. Commissioner (1940) Dictates that federal courts accept the state's legal definition of the interest. Ensures proper legal basis for property rights.
3. "Like-Kind" Qualification Crichton v. Commissioner (1941) Applies the legal character test (Real for Real, Personal for Personal) under Section 1031. Allows properties with vastly different physical/economic characteristics to qualify for non-recognition.
VII. Conclusion: Crichton as the Cornerstone of Real Property Tax Deferral
Commissioner v. Crichton is arguably the singular most important judicial decision defining the scope of property eligibility under IRC Section 1031. Its holding secured the viability of the non-recognition provision by creating an easily administered, objective standard based on legal property classification. By permitting the exchange of an undivided interest in a city lot for an undivided interest in subsurface mineral rights, the Fifth Circuit established that the "like kind" test is satisfied as long as the properties share the same nature or character—specifically, real property for real property—ignoring differences in physical features, grade, quality, or functional use.2
The lasting legacy of Crichton is its formal adoption into Treasury Regulation § 1.1031(a)-1(b), which structurally embeds the doctrine into the federal tax framework. This permanently imposes a dual analytical requirement for all complex real estate exchanges: first, the property interest must be defined and characterized by state law (the Morgan prerequisite), and second, the exchange must satisfy the broad legal character test of real property for real property (the Crichton standard) under federal tax law. This dual constraint provides the necessary certainty for tax planning while enabling real estate investors the broad flexibility needed to perpetually restructure their portfolios on a tax-deferred basis.
Leslie case:
In Leslie Co. v. Commissioner, the Third Circuit Court of Appeals determined that a sale-leaseback transaction could result in a recognizable tax loss for the taxpayer. The court rejected the IRS's argument that the transaction was a non-taxable like-kind exchange under Internal Revenue Code Section 1031, finding that the fee simple and leasehold interests involved were not of "like kind". The decision allows for the recognition of losses in sale-leaseback scenarios if they represent a bona fide sale with economic substance. More information regarding like-kind exchanges is available at IRS.gov
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Masser case:
The US federal tax case Masser v. Commissioner involved the tax liability of transferees for the debts of a defunct corporation. The case is cited as Messer v. Commissioner, 438 F.2d 774 (1971), and was heard by the United States Court of Appeals for the Third Circuit.
• Case Name: Sidney Messer, Transferee v. Commissioner of Internal Revenue.
• Court: United States Court of Appeals for the Third Circuit.
• Outcome: The court addressed the transferees' challenge to their tax liability for the corporation's debts.
• Significance: The decision clarifies how tax liabilities can be transferred from a dissolved corporation to its shareholders or other transferees
Clifton case:
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RR 77-297 - Revenue Ruling 77-297 states that a multi-party (three-party) like-kind exchange can qualify for nonrecognition of gain or loss under Internal Revenue Code (IRC) Section 1031 for the taxpayer, even if an accommodating party is used to facilitate the exchange. The ruling addresses a situation where:
• Taxpayer (A) wants to exchange their ranch for another ranch, but the other owner (C) wants cash.
• An accommodating buyer (B) agrees to purchase A's ranch and cooperate in an exchange.
• B then purchases C's ranch with cash and other liabilities, and subsequently exchanges C's ranch with A's ranch.
The Internal Revenue Service (IRS) determined that the transaction qualified as a like-kind exchange for Taxpayer A because A intended to hold the replacement property for productive use in a trade or business or for investment. However, the nonrecognition provisions did not apply to the accommodating buyer (B). This is because B acquired the second ranch solely for the purpose of the exchange, and did not hold it for the requisite productive use in a trade or business or for investment intent as required by IRC Section 1031. In essence, the ruling provided formal recognition for multiparty exchanges involving an intermediary, a common structure used today with qualified intermediaries (QIs) to facilitate deferred like-kind exchange
RR 76-319 - Revenue Ruling 76-319 states that for purposes of tax-deferred involuntary conversion rules (Section 1033 of the Internal Revenue Code), a billiards center is not considered "similar or related in service or use" to a bowling center. Therefore, a taxpayer who replaces a converted bowling center with a billiards center cannot qualify for nonrecognition of gain treatment under section 1033. The ruling emphasizes a strict interpretation of the "similar or related in service or use" test for owner-users, requiring that the physical characteristics and end uses of the converted and replacement properties be closely similar. Since bowling alleys and bowling equipment are not closely similar to billiard tables and billiard equipment, the replacement property did not qualify.
RR 67-254 - Revenue Ruling 67-254 addresses the tax treatment of involuntary conversions of property, specifically concerning the use of condemnation proceeds to restore a remaining property. The ruling establishes that when a taxpayer uses proceeds from the condemnation of a portion of their property to restore the remaining part to its original function, they are considered to have acquired property "similar or related in service or use" according to Section 1033(a)(3)(A) of the Internal Revenue Code. This allows for the deferral of gain recognition on the conversion, provided the amount received does not exceed the cost of the replacement property. Key points addressed by the ruling include the requirement for an involuntary conversion, the use of funds to purchase replacement property that is "similar or related in service or use," and the qualification of restoration costs as the acquisition of replacement property for Section 1033 purposes. The ruling notes that determining if all expenditures were necessary for restoration is a question of fact to be assessed during a tax return examination.
RR 71-41 - Revenue Ruling 71-41 addresses the nonrecognition of gain under Internal Revenue Code Section 1033 when property is involuntarily converted (e.g., through condemnation) and replaced with property that is "similar or related in service or use" to the original property. The ruling specifically holds that for an investor-owner, replacement property can be considered "similar or related in service or use" even if it does not meet the stricter "like kind" exchange standard of Section 1033(g). Key Details of Revenue Ruling 71-41:
• Scenario: A taxpayer whose warehouse was condemned used the proceeds to build a gas station on other land and rented it out.
• Key Question: Does investing condemnation proceeds into a different type of rental property qualify for nonrecognition of gain under Section 1033(a)?
• Holding: Yes, the replacement qualifies.
• Reasoning: Applying the "taxpayer-owner" test, the IRS found the taxpayer's relationship to both properties was as an investor for rental income, and the business risks and management demands were considered similar. The ruling emphasizes that for an investor, the tenant's functional use of the properties is less critical than the owner's investment activities.
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CONVERTING TAXABLE INCOME INTO TAX LIABILITY (NO CASES HERE)
Chapter 27. Computations
....................................................................... 929 A. Tax Rates ................................................................................................ 929 1. Introduction .................................................................................... 929 2. Tax Rates on Ordinary Income ..................................................... 930 Explanation of Proposed Regulations on the Definition of Terms Relating to Marital Status ......................................... 937 3. Tax Rates on Income from Pass-Through Entities ...................... 940 4. Tax Rates on Net Capital Gains and Dividends .......................... 945 5. Additional Rules Related to Tax Rates ......................................... 947 B. Credits Against Tax ............................................................................... 951 1. Introduction .................................................................................... 951 2. Personal Credits ............................................................................. 953 3. Credits for Prepaid Taxes .............................................................. 956 C. The Alternative Minimum Tax ............................................................. 958
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FEDERAL TAX PROCEDURE AND PROFESSIONAL RESPONSIBILITY (NO CASES)
28. Federal Tax Procedure
...................................................... 967 A. Overview of Federal Tax Procedure ..................................................... 967 1. Introduction .................................................................................... 967 2. The Self-Assessment System ......................................................... 968 3. Administrative Procedures ............................................................ 969 4. Judicial Procedures ........................................................................ 976 5. Collection of Taxes ......................................................................... 984 B. Special Rules Applicable to Deficiency Procedures ............................. 988 1. Timing Rules, Interest and Penalties ........................................... 988 2. The Innocent Spouse Rules ........................................................... 992
C. Special Rules Applicable to Refund Procedures .................................. 996
29. Professional Responsibility Issues
............................... 1001 INDEX ............................................................................................................ 1007
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