Chapter 3
Four Basic Concepts:
Gross Income, Constructive
Receipt, Economic Benefit Theory, and
Assignment of Income
Chapter 3 The Four Basic Concepts
 Has someone received “gross income”?
 Can a taxpayer be taxed for receiving or being deemed to
receive something of value?
 When should the taxpayer be taxed?
 Is the correct taxpayer being subject to tax?
Objective
Explain the meaning of gross income
Gross Income
 Income that must be included on a taxpayer’s return
regardless of the source derived.
 Some less well-understood examples include income from an
interest in an estate or trust, income from the discharge of
indebtedness.
 The general rule is for inclusion of all gross income unless
specifically excluded from gross income by the Internal
Revenue Code.
What is Not Gross Income
 Receipt by taxpayer of principal on a debt owed to her or him. But
compare interest earned on a debt.
 Return of capital from an investment.
 Any unrealized increase in value.
Example: The unrealized gain from appreciated Google stock.
 A gift … but examine the context of the transfer from donor to donee
carefully.
Objective
Explain the doctrine of constructive receipt.
Constructive Receipt
 Virtually all individual taxpayers are cash basis meaning
income is reported in the year received or constructively
received.
 Rationale for the rule …limit the ability of taxpayers to
determine the most favorable year for receipt of income (eg
lower tax bracket)
 Essence of the rule is simple…”Can I get the income when
I want it?”
Constructive Receipt •
1.
Substantial Risk of Forfeiture (SROF) Doctrine
No income will be constructively received if subject to a
substantial risk of forfeiture
EXAMPLE Payment to TP will not be made until 5 years from
now.
2.
Operation of SROF with Funded Deferred Comp.
3.
Operation of SROF with Unfunded Deferred Compensation
Objective
Explain the economic benefit theory.
Economic Benefit Theory
 Has the taxpayer received any financial or economic
benefit (not specifically excluded by the Internal
Revenue Code) that is current, real and measureable?
 The doctrine applies to a payment in kind or the
equivalent of cash.
 Will result in the inclusion into gross income even if the
employee cannot take the benefit.
Economic Benefit Theory
•
Examples of receiving an economic benefit
1. Right to receive from employer a bonus in the form of cash or
property.
2. Employer payment on your legally nonbinding pledge to your alma
mater.
3. Split dollar life insurance under the economic benefit-endorsement
regime.
4. Irrevocable, funded deferred compensation.
Assignment of Income Doctrine
 Spread in marginal rates encourages effort to shift income
from higher-bracketed taxpayer to a lower-bracketed
taxpayer, most often a family member.
 Rule 1… income is taxed to the person performing the
service.
 Rule 2…income from property is taxed to the taxpayer
owning the property.
Chapter True-False Questions
 1. The doctrine of constructive receipt means income will
be taxed when it is credited to the taxpayer’s account,
set apart for the taxpayer, or otherwise made available.
 2. A mother arranges for the income from her stock
portfolio to be paid directly to her son. The mother
will not be taxed on the portfolio income.
MiniCase Studies
 3. A law school clinical faculty member is required by his
employer to turn over any amounts he receives representing
low income clients at the law school’s tax clinic. He receives
$1,000 for the current income. Describe the consequences of
his receipt of the check payable to him.
 4. President of a closely held business informs the board of
directors she will not accept income for her services yet to be
performed between July 1 and December 31st. Describe the tax
consequences of the $400,000 that would otherwise be
payable to her.
End of Chapter 3