Case Study

TAX 6025 Concepts of Federal Income

Tax

Lesson 4 Exclusions for Gifts & Inheritance

and Transfers Between Spouses

Instructor: Alexander Martini

Disclaimer

• The views expressed during this course are those of the instructor in his personal capacity and do not represent those of the IRS Office of Chief Counsel or the Internal Revenue Service.

Big Picture

• Gross Income • Undeniable accession to wealth, clearly realized, over which the

taxpayer has complete dominion (Glenshaw Glass test) • Not a return of capital, loan, or excluded by a specific statutory

provision (exclusion)

• General Rule – gross income • Exception – exclusion • Exceptions to the exception • Limitations on the exception

Exclusions

• An exclusion from gross income means that the item is simply not included in gross income, so that it never enters the computation of taxable income. • Although REALIZED, it is not RECOGNIZED

• Interpret narrowly: exclusions are matters of legislative grace, and in order for an item to be excluded from gross income, it must meet the specific requirements of a statute allowing an exclusion.

• Exclusions are generally found in I.R.C. §§ 101 through 139I

In General

• Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance. I.R.C. § 102(a)

• Gift • Commissioner v. Duberstein, 363 U.S. 278 (1960)

• From Decedent • Devise: real property under will • Bequest: personal property / cash under will • Inheritance: through intestacy

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Exceptions - Income

• The following are not excluded from gross income (I.R.C. § 102(b)): • the income from any property received by gift • the amount of such income where the gift, bequest, devise, or inheritance is

of income from property

• Examples • Father gifts corporate bond to daughter. Gift is excluded from daughter’s

gross income, but interest income earned after gift date is taxable to her. • Taxpayer inherits an income interest in a trust. The value of the trust interest

is excluded gross income, but the income received is taxable.

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Exceptions – Employee Gifts

• The following are not excluded from gross income (I.R.C. § 102(c)): • any amount transferred by or for an employer to, or for the benefit of, an

employee. But see Prop. Reg. § 1.102-1(f)

• The following employee gifts are not included in gross income • Employee achievement awards (I.R.C. § 74(c) and § 274(j)) • Length of service or safety achievement • Part of a meaningful presentation • Conditions and circumstances that do not create a significant likelihood of the

payment of disguised compensation • Fringe benefits (I.R.C. § 132(e))

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Problems Page 76

1.Employer gives all of her employees, except her son, a case of wine at Christmas, worth $120. She gives Son, who also is an employee, a case of wine, worth $700. Does Son have gross income?

2.The congregation for whom Reverend serves as a minister gives her a check for $5,000 on her retirement. Does Reverend have gross income?

3.Employee receives a $5,000 trip on Employee’s 50th birthday. To pay for the cost of the trip, Employer contributed $2,000, and fellow employees of Employee contributed $3,000. Does Employee have gross income?

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Bequest, Devise, or Inheritance

• Lyeth v. Hoey, 305 U.S. 188 (1938) • Money received by heir from the compromise of a will contest is received

through inheritance and is excluded from gross income.

• Wolder v. Commissioner, 493 F.2d 608 (2d Cir. 1974) • Where a bequest is made by contract in exchange for services, its receipt is not

excludable from gross income.

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Problems Pages 84-85

• (a)Father leaves Daughter $20,000 in his will.

• (b)Father dies intestate, and Daughter receives $20,000 worth of real estate as his heir.

• (c)Father leaves several family members out of his will and Daughter and others attack the will. As a result of a settlement of the controversy Daughter receives $20,000.

• (d)Father leaves Daughter $20,000 in his will stating that the amount is in appreciation of Daughter’s long and devoted service to him.

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Transfer Between Spouses or Incident to Separation and/or Divorce

• Section 1041(a): “No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of)--

(1) a spouse, or (2) a former spouse, but only if the transfer is incident to the divorce.”

• Section 1041(b)(1): “In the case of any transfer of property described in subsection (a) . . . for purposes of this subtitle, the property shall be treated as acquired by the transferee by gift”

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Prior Sections 71 and 215

• Section 71: Gross income includes amounts received as alimony or separate maintenance payments. • such payment is received by (or on behalf of) a spouse under a divorce or separation

instrument, • the divorce or separation instrument does not designate such payment as a payment

which is not includible in gross income • the payee spouse and the payor spouse are not members of the same household at the

time such payment is made, and • there is no liability to make any such payment for any period after the death of the

payee spouse

• Section 215: there shall be allowed as a deduction an amount equal to the alimony or separate maintenance payments paid during such individual's taxable year

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Repeal of Sections 71 and 215 Amendment of Section 61

• The 2017 amendments apply to: • (1) any divorce or separation instrument executed after December 31,

2018, and • (2) any divorce or separation instrument executed on or before such

date and modified after such date if the modification expressly provides that the amendments made by this section apply to such modification

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Child Support

• Under current and prior law, receipt of child support does not result in gross income, and payment does not give rise to a deduction.

• Section 71(c): payments treated as child support if: • Instrument designates the amount as child support; or • There is a reduction in amount related to a contingency involving a

child (such as attaining a specified age, marrying, dying, leaving school, or a similar contingency)

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Problem Page 194

Payor Spouse, who pays tax at a flat 30 percent rate, is required to pay Payee Spouse $100,000 per year as alimony or separate maintenance under a pre-2019 divorce instrument. Assume Payee Spouse pays tax at a flat 15 percent rate. Payor Spouse wants to amend the divorce instrument to have the post-2018 law apply (i.e. Sections 71 and 215 would no longer apply to the payments). You represent Payee Spouse. (a)If Payor Spouse requests a reduction in the payments under the agreement to $70,000, what is your reaction? (b)What result in (a), above, both spouses pay a flat 30 percent rate? (c)What result in (a), above, if Payor Spouse pays tax at a flat 30 percent rate and Payee Spouse, who inherited money, pays a flat 35 percent rate15