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Where did the Supreme Court find this new perspective? There is no direct evidence that the Supremes ever read the works of Henry Simons, Robert Haig, or Georg Schanz, but their work in attempting to articulate a tax-specific meaning of the term “income” had by 1955 become widely discussed—at least in the academic world. Henry Simons’s book (quoted in Chapter 1), which built on the prior work of Georg Schanz and Robert Haig, was published in 1938. Moreover, the Government’s Brief in Glenshaw Glass explicitly referred to the concept.5 At the least, dated Victorian notions about not spending lump-sum, non-periodic windfalls on consumption had gone by the wayside by then. When you recall my simplified restatement of the SHS notion of income from Chapter 1—wealth increases less wealth decreases that are not spent on personal consumption—you can appreciate how Glenshaw Glass can be seen as effectively incorporating SHS notions into the modern interpretation of the residual clause. For that reason, you can think of Glenshaw Glass as an example of what some refer to as “dynamic statutory interpretation,”
under which the meaning of unamended statutory language can change over time, including the meaning of the term “income” in the § 61 residual clause.6
Section A. examines the scope of “wealth accession” within the meaning of Glenshaw Glass.
Section B. explores when a clear wealth accession is deemed to be “realized.” The third Glenshaw Glass factor (referring to “complete dominion”) will be important in considering attempts to shift income among taxpayers, considered in Chapter 8.
A. What is an “accession to wealth”
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and over who have maintained a continuous domicile in the territory or State of Alaska for 25 years. Such bonus will be paid only as long as an eligible person retains a domicile in Alaska.
The purpose of the statute as stated therein is to provide an incentive to continue uninterrupted residence in the state and under no circumstances is to be considered a form, type or manner of public relief. It is also stated that the bonuses are not predicated on need.
Section 61 of the Code provides, in part, that Gross Income means all income from whatever source derived unless otherwise excluded by law.
The Internal Revenue Service has consistently held that payments made under legislatively provided social benefit programs for promotion of the general welfare are not includible in a recipient’s Gross Income. See for example, Rev. Rul. 63-136, 1963-2 C.B. 19, concerning payments under the Manpower Development and Training Act; Rev. Rul. 68-38, 1968-1 C.B. 446, involving payments under Title II-A of the Economic Opportunity Act of 1964; and Rev. Rul. 72-340, 1972-2 C.B. 31, concerning stipends paid by a city to unemployed or underemployed probationers.
The Alaska Longevity Bonus is distinguished from welfare program payments in that the benefits are payable to any Alaskan meeting the age and residency requirements regardless of financial status, health, educational background, or employment status.
Accordingly, in the instant case, benefit payments received by individuals under the Alaska Longevity Bonus Act are includible in the Gross Income of the recipients pursuant to section 61 of the Code.
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In the 1990s, Congress replaced the Aid to Families with Dependent Children (AFDC) program (often referred to as “welfare”) with the Temporary Assistance for Needy Families (TANF) program. AFDC payments were excludable from Gross Income under the so-called general welfare doctrine, and the IRS was asked whether TANF payments were similarly excludable from Gross Income because TANF requires that specified percentages of individual recipients engage in work activities and imposes penalties on the states for noncompliance with that requirement. “Work activities” was broadly defined, however, to include a range of activities, such as engaging in job search and job readiness assistance programs, community service programs, certain education programs, and the like. In Notice 99-3,7 the IRS ruled as follows:
Payments by a governmental unit to an individual under a legislatively provided social benefit program for the promotion of the general welfare that are not basically for services rendered are not includible in the individual’s Gross Income and are not wages for employment tax purposes, even if the individual is required to perform certain activities to remain eligible for the payments. See Rev. Rul. 71-425, 1971-2 C.B. 76; Rev. Rul. 75-246, 1975-1 C.B. 24. If, however, taking into account all the facts and circumstances, payments by a governmental unit are basically compensation for services rendered, even though some training is provided, then the payments are includible in the individual’s Gross Income and are generally wages for employment tax purposes. Rev. Rul. 75-246, 1975-1 C.B.
24.
7 1999-1 C.B. 271.
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Due to the flexibility TANF affords states to determine basic eligibility rules and benefit amounts, a TANF payment may be made both for the promotion of the general welfare and as compensation for services. In these cases, it is extremely difficult to characterize the basic purpose of the payments. It is also not practically feasible to determine the relative proportion of the payment each purpose represents.
In many of these cases, TANF payments are received in lieu of (and generally in amounts no greater than) payments the individual formerly received or would have received under AFDC based upon the individual’s personal and family subsistence requirements. In these cases, the primary measure of the amount received is the personal or family need of the individual recipient rather than the value of any services performed.
In cases where the following three conditions are satisfied, TANF payments will be treated as made for the promotion of the general welfare and therefore will not be includible in an individual’s Gross Income and will not be wages for employment tax purposes:
(1) The only payments received by the individual with respect to the work activity are received directly from the state or local welfare agency (for this purpose, an entity with which a state or local welfare agency contracts to administer the state TANF program on behalf of the state will be treated as the state or local welfare agency);
(2) The determination of the individual’s eligibility to receive any payment is based on need and the only payments received by the individual with respect to the work activity are funded entirely under a TANF program (including any payments with respect to qualified state expenditures …, and
(3) The size of the individual’s payment is determined by the applicable welfare law…
Neither the ruling nor the notice provide much analysis regarding the source of the so-called general welfare doctrine. Can you construct one? Is Congress’s apparent intent to protect bare subsistence income from taxation via the mechanisms studied in Chapter 1, Part B. (such as the Standard Deduction and the Personal and Dependent Exemption Deductions) relevant? How about the “ability to pay” fairness norm that was most discussed when the income tax was first adopted, as described in Chapter 3? Unemployment compensation payments are includable in Gross Income under § 85, as they are considered substitutes for what would have been includable compensation income under § 61(a)(1) had the taxpayer not lost her job.
What about Social Security payments? Unlike the TANF payments described above, Social Security payments are not need-based and thus are not excludable under the general welfare doctrine because they are payable regardless of financial status. Unlike the payments under the Alaska Longevity Bonus, however, the recipient likely made earlier payments (in the form of Social Security Tax payments) which, from one perspective, could be seen as investment in an asset (creating basis) that generates this stream of payments. Let’s think about the issue from the theoretical perspective first and then look at positive law.
The payment of Social Security tax under the payroll tax system (described in Chapter 3) during
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one’s working life is not deductible under the income tax. As a theoretical matter, therefore, the nondeduction for income tax purposes during one’s working life could conceivably be thought to create “basis” in the future payment stream, which could offset those payments on receipt—if you conceive of the system as similar to a personal retirement account. That conceptualization is controversial, however, because the Social Security system is not truly an individualized pension system but, rather, a current tax-and-transfer system. That is to say, current Social Security tax payments fund payments to current retirees (as well as certain disability and other payments); they are not set aside for the payee and invested on the payee’s account for a future stream of payments.
Thus, they are more commonly considered to be “expenses” (which do not create basis).8
If, however, we indulge in the notion that the payment of Social Security Tax and the receipt of Social Security payments in retirement are related, the resulting creation of basis with the tax payments would mean that Social Security payments would be includable in Gross Income only to the extent exceeding that basis. For ease, we could allocate 100% of each payment received to tax-free basis recovery until basis is exhausted and then include 100% of each payment thereafter.
Or, once the payment stream began, we could allocate basis over the estimated remainder of the taxpayer’s life (using actuarial tables) so that a portion of each payment is tax-free basis recovery and a portion of each payment is includable, similar to the rules found in § 72 that apply to payments received under certain annuity contracts (explored in Chapter 10). Because of the time value of money, the former system would be of greater benefit to the Social Security recipient.
Under positive law, however, neither approach is taken. Prior to 1983, Social Security payments were entirely excludable from Gross Income, perhaps on the simplifying assumption that the receipts never exceeded our hypothetical basis. In 1983, however, Congress enacted § 86, which now requires inclusion of a portion of Social Security payments received by those with Adjusted Gross Income (AGI) exceeding certain thresholds. Today, anywhere between 0% and 85% of Social Security payments can be includable under § 86, depending on AGI, filing status, and the amount of Social Security payments received.
In 1983, research showed that most recipients of Social Security payments received substantially more in lifetime benefits than they paid in taxes over their working lives. That is no longer true for the most recent class of retirees if you view Social Security payments alone. If you add in Medicare taxes paid and benefits received, however, it remains true.9 Virtually everyone today receives in kind many times more health care than they pay in Medicare Tax. For example, a two-earner married couple pays, on average, approximately $120,000 in aggregate Medicare Tax but receives Medicare services valued at $427,000.10 This observation takes us to the next question: whether the value of Medicare benefits (and other consumption benefits) received in kind ought to be included in § 61 Gross Income under the residual clause.
Consumption received in kind
You learned in Chapter 1 that the taxation of personal consumption is accomplished primarily through deduction denial. That is to say, personal consumption spending, although a wealth
8 See generally, Deborah A. Geier, Integrating the Tax Burdens of the Federal Income Tax and Payroll Taxes on Labor Income, 22 VA.TAX REV. 1 (2002).
9 C. Eugene Steuerle &Stephanie Rennane, Social Security Taxes and Benefits Over a Lifetime, at www.urban.org/UploadedPDF/social-security-medicare-benefits-over-lifetime.pdf.
10 See Bruce Bartlett, Taxing Medicare Benefits, at http://economix.blogs.nytimes.com/2013/09/17/taxing-medicare-benefits/?_r=0 (using data from the Urban Institute).
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reduction, is not deductible. Personal expenses are nondeductible under § 262(a), and the basis created on the purchase of personal-use property cannot be depreciated under §§ 167 and 168 or be deducted as a loss when the property is sold for less than basis. See § 165(c)(3). In this manner, purchased personal consumption remains in the tax base via deduction denial, resulting in taxation.
Should consumption received in kind for free from another—rather than purchased by the taxpayer—be valued and included in § 61 Gross Income? When I say “consumption received in kind,” I generally mean the value of consumption services and consumer goods received in kind, such as food, entertainment, gym memberships, health care, lodging, and the like. Some receipts—
even if considered Gross Income within the meaning of § 61—might nevertheless be excludable under a specific Code section (such as § 102 pertaining to gifts or the fringe benefit exclusions for certain forms of compensation received in kind considered in the last chapter). Thus, we are considering here only receipts that—if they do constitute § 61 Gross Income—would fail to qualify for exclusion under another Code section.
In Glenshaw Glass terms, the question is whether free consumption increases the taxpayer’s wealth. Free consumption certainly is unlike the cash punitive damages received by the Glenshaw Glass Company, easily a wealth accession. After all, free consumption is illiquid; you cannot send the free entertainment or health care to the IRS in payment of a tax. But we have seen in Chapter 5 that lack of liquidity does not prevent in-kind consumption from being treated like a wealth accession if it is received as compensation for services rendered. In that case, the consumption must be valued and included in Gross Income (absent application of an explicit statutory exclusion, such as §§ 119 or 132).
But in the compensation context, you quite incisively reply, the in-kind consumption clearly replaces what would otherwise clearly constitute a wealth increase—cash compensation. Most compensation is, in fact, paid in cash. In situations where in-kind consumption can be considered a substitute for something that would clearly constitute a wealth accession, we must be vigilant to include that in-kind consumption in Gross Income to prevent undermining the tax base. Indeed, the excerpt from the Joint Committee on Taxation reprinted in Chapter 5 expressed this very concern when it described the enactment of § 132:
Congress was concerned that without any well-defined limits on the ability of employers to compensate their employees tax-free by providing noncash benefits having economic value to the employee, new practices will emerge that could shrink the income tax base significantly. This erosion of the income tax base results because the preferential tax treatment of fringe benefits serves as a strong motivation to employers to substitute more and more types of benefits for cash compensation.11
Because of this concern, the receipt of free consumption by an employee that is not described in
§§ 119, 132, or another exclusion provision is reconstructed in substance as though (1) the employee received cash (clearly a wealth accession), which (2) the employee then used to purchase personal consumption (nondeductible under § 262) under Old Colony Trust.
Thus, one clear instance in which the receipt of consumption in kind is considered to rise to the level of a wealth accession (and thus includable in § 61 Gross Income, absent a specific statutory
11 STAFF OF THE JOINT COMM. ON TAX’N,GENERAL EXPLANATION OF THE REVENUE PROVISIONS OF THE DEFICIT REDUCTION ACT OF 1984,JCS-41-84, 840-42 (Dec. 31, 1984). (Emphasis added.)
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exclusion) is when the receipt is otherwise expressly listed as an item of Gross Income in § 61 or elsewhere, outside the residual clause: e.g., compensation under § 61(a)(1), dividend under § 61(a)(7), rent under § 61(a)(5), or a prize under § 74(a). In each of those instances, the consumption received in kind is clearly a substitute for cash, the most common forms of compensation, dividends, rent, and prizes. Of course, the taxpayer wishing to avoid inclusion can always decline the receipt and avoid the Gross Income inclusion. But if the receipt is accepted rather than declined, Congress made its intent clear that these types of receipts are includable in Gross Income by expressly listing them in the enumerated list of clearly includable Gross Income items, without regard to whether the compensation, dividend, rent, or prize is paid in cash or in kind.
In the piece below, the goody bags provided to presenters were, in essence, either a prize or compensation for services rendered. (You will read in the next chapter why exclusion as a “gift”
was not possible under the Federal income tax definition of that term.) Oscar Freebies Balloon to $80K (Don’t Tell IRS)12
Robert W. Wood
No matter who you are, it is somehow fun to receive free stuff. Perhaps it is less fun for the truly wealthy, but it’s still fun, especially if the items are downright cool and are dropped in your lap. It should be no surprise that companies flock to the celebrity appeal of the Oscars.
Who wouldn’t want to have Tom Hanks wearing your polo shirt, Sandra Bullock wearing your watch, or Cate Blanchett snacking on your protein bar? The allure is too great not to try. All sorts of products benefit from celebs giving them a try. So with a kind of effusive zeal, companies throw expensive goodies at the nominees, and this year, the volume and value for the most elite offerings has risen to over $80,000.
That’s about double the 2013 take, so the economy must be improving. Gift bags include such essentials as:
• $16,000 hair restoration procedure;
• $15,000 walking tour around Japan;
• $9,000 trip to Las Vegas;
• $6,850 train trip in the Canadian Rockies;
• $5,000 toward art from Gizara;
• $5,000 toward laser hair removal and cosmetic surgery from Ideal Image;
• $4,895 home water filtration system;
• $3,300 resort stay at the Imanta’s Ocean Casa suite in Mexico;
• $2,700 “O-Shot” procedure to stimulate a woman’s sex drive;
• $2,560 home spa system from Steamist;
• $2,000 five-night stay at the Koloa Landing Resort in Hawaii;
• $1,572 pet supplies from Epic Pet Health;
• $850 for 10 personal training sessions with Huntley Drive Fitness;
• $500 lifetime membership to a meditation gym;
12 www.forbes.com/sites/robertwood/2014/03/01/oscar-freebies-balloon-to-80k-dont-tell-irs/. Reprinted with permission of the author.
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• $290 Swiss-made watch from Slow Watch;
• $280 portable camera from Narrative Clip;
• $280 package of organic maple syrup from Rouge Maple;
• $120 pink and camo pepper guns from Mace;
• $39 in weight-loss products from Hydroxycut;
• $35 six-pack of herbal tea lollipops from Dosha Pops;
• $23 worth of reusable dry-cleaning bags from Green Garmento; and
• $6 device keeps hair from clogging in the shower from DrainWig.
Sure, winning is better. Oscars don’t have a cash prize like Olympic medals. But still, taking home an Academy Award means a recipient will make a lot more money in the future. But a gift bag worth $80,000 is hardly inconsequential, not like a Thanksgiving turkey from your employer.
That means somebody has to pay tax on it. That makes the biggest winner of them all the IRS.
In case the attendees “forget,” they will receive an IRS Form 1099 reporting the value of what they took home. Form 1099 is that irksome piece of paper that tells the IRS you were paid….
For years, the entertainment industry and the IRS locked horns repeatedly over taxes…. But eventually, the brouhaha was settled …. Now, IRS guidelines are clear. If you get a gift bag, you generally have taxable income equal to its fair market value. Can’t you argue this was a “gift” and you aren’t being paid? Nope, you lose. You must report it on your tax return.
What about gift certificates or vouchers for trips or personal services? If you redeem the certificates or vouchers, you must include the fair market value of the trip or service on your tax return.
If these are gifts, why are they income? They’re not gifts for tax purposes. The organizations and merchants don’t give them solely out of affection or respect.
Can you take a charitable contribution deduction if you “regift” a gift bag? Yes, if you donate the gift bag to a qualified charity. But the fair market value of the gifts must still be reported on your tax return.
Are there third-party reporting requirements for gift bags? Yes. Organizations and vendors distributing gift bags may have to issue Form 1099-MISC, Miscellaneous Income.
What if you make a selection in a free shopping room for participating in the show? The value of your selection is income and you must report it.
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This brings us to the obvious next step in the analysis. Suppose the consumption received in kind is not compensation for services rendered, a dividend, rent, a prize, or some other type of explicitly listed Gross Income item. In that case, the only provision that could result in inclusion in § 61 Gross Income is the residual clause, as interpreted by Glenshaw Glass: a wealth accession.
When should consumption received in kind for free that is not compensation, a dividend, etc., be considered a wealth receipt? To the average taxpayer, “wealth” connotes property or cash.
Suppose that you are a jazz fan, and you are walking down the street when you come across a jazz saxophonist who opens his case and begins to play with the hope that passersby will throw some cash into his case. You love jazz. Indeed, you went last night to a nightclub to hear a jazz performer, paying $25 for the entrance ticket to hear him. You could not deduct that $25 ticket
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price because it was a nondeductible personal expense. Must you value this free concert and include that value in § 61 Gross Income, as though you received cash (a clear wealth accession) followed by a nondeductible personal expense?
Of course not! But why not? In Chapter 1, we saw that Henry Simons described income as “the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and end of the period in question.”13 One could argue that Simons’s reference to “rights exercised in consumption” implies that the taxation of consumption under an income tax should primarily be accomplished via deduction denial, not through a Gross Income inclusion if received in kind. That is to say, a taxpayer who freely chooses to exercise his right to spend prior wealth receipt on consumption in the marketplace should be denied a deduction for that consumption under the ability to pay fairness norm described in Chapter 3, which defines the tax base according to the resources under the control of the taxpayer that are available for contribution to the fisc. Thus, the Code denies deductions (wealth reductions) for personal expenses, depreciation, and losses.
Under this deduction-denial route to taxing personal consumption, one can argue that we should tax personal consumption received in kind under Glenshaw Glass’s “wealth accession”
interpretation of the residual clause only when we are fairly confident that, under the particular facts and circumstances, the in-kind consumption is the equivalent of (1) the receipt of cash (clearly a wealth accession) followed by (2) a free-spending choice on consumption (nondeductible). In other words, if we are not confident that the taxpayer might have purchased the consumption at issue with his own resources, perhaps it is not reasonable to interpose a deemed cash step (followed by nondeduction of the personal consumption outlay), i.e., to equate the in-kind consumption receipt with a wealth receipt representing ability to pay.
Notice that this is the same sort of reasoning that we explored in the last chapter in trying to construct an analytical framework regarding where the lines are drawn in §§ 119 and 132 in the compensation context. We suggested there, for example, that the convenience of the employer test for meals and lodgings provided to an employee (i.e., substantial noncompensatory business reasons) could be seen as a more administrable proxy test for determining whether we can be fairly confident that the taxpayer would have freely purchased the same consumption on his own.
If consumption is received in kind outside of a market transaction, such as the free jazz concert enjoyed on the street by a passerby, we cannot be so sure that the consumption receipt is the equivalent of a cash receipt followed by a free-spending choice to purchase the personal consumption. Similarly, the lack of a marketplace transaction means that the value of self-provided services does not produce Gross Income, even though economists sometimes count this value as income. Thus, when you grow your own vegetables to consume, you do not include the value of the consumed vegetables in Gross Income.14 Nor do you include the imputed rental income generated by owner-occupied housing (considered further in Chapter 18), even though economists (and some other countries) count it as income.
With this background, let’s return to the receipt of medical care received under the Medicare program. Unlike the free jazz concert, the receipt of health care under the Medicare program is an identifiable marketplace transaction, with the government paying for the services rendered to you.
Nevertheless, the government has never argued that the value of this in-kind consumption is
13 HENRY SIMONS,PERSONAL INCOME TAXATION 50 (1938).
14 See Morris v. Comm’r, 9 B.T.A. 1273 (1928).