WHAT IS INCOME?

RECEIPT OF ECONOMIC BENEFITS: SECTION 61

Cesarini v. United States

Rule of Law: All income is subject to tax unless an express exemption applies.

Facts: The Cesarinis (plaintiffs) purchased a used piano at an auction in 1957. In 1964, they
discovered $4,467.00 in cash hidden inside the piano. They reported the sum as income in their
1964 income tax return. In 1965, they filed an amended income tax return, in which they
removed the sum of $4,467.00 and requested a refund of the $836.51 in taxes they paid for the
found money. The Commissioner of Internal Revenue refused to refund the money and the
Cesarinis filed suit in this court.

Issue: Whether certain income is subject to tax where an express exemption does not apply.

Holding and Reasoning (Young, J.): Yes. The money discovered by the Cesarinis is taxable gross
income because there is no express provision of the Tax Code that exempts it from taxation.
Section 61(a) of the Tax Code defines gross income as all income from whatever source
derived. This court must determine whether this definition includes found money. The United
States Supreme Court has often ruled that the language used in the provision allows Congress
to broadly use its power to tax. Treasury Regulation 1.61-14 further states that treasure trove,
or found money, is gross income, while IRS Revenue Ruling 61-53-1 confirms that found money
is indeed taxable income. Although the Tax Code does exempt certain items from the definition
of gross income, this list does not include found money. Accordingly, this court finds that found
money is gross income for the purposes of taxation. Here, the Cesarinis found $4,467.00 in cash.
Under the broad definition of gross income found in 61(a), the found money is taxable income
unless some express provision of the Tax Code exempts the found money from taxation. The
Cesarinis fail to identify any such exemption. Therefore, this court finds that the money found
by the Cesarinis is subject to taxation and that the Cesarinis are not entitled to a refund of
$836.51. Alternatively, the Cesarinis argue that even if the found money qualifies as taxable
income, it was only taxable in 1957 and that by 1964, the statute of limitations had expired so
that the found money was no longer taxable. However, in Ohio as well as in a majority of other
jurisdictions, income tax is only payable when the income is actually known to the taxpayer.
Although the Cesarinis bought the piano in 1957, they did not discover the money in the piano
until 1964. Therefore, the found money was taxable in 1964 and the Cesarinis properly paid
$836.51 in taxes for the found money.

Old Colony Trust Co. v. Commissioner

Rule of Law: Payment by an employer of an employees income taxes constitutes taxable gain
to the employee.
Facts: William M. Wood (defendant) served as the president of the American Woolen Company
from the years 1918 to 1920. In 1916, the American Woolen Company adopted a resolution to
pay the income taxes of the companys officers. For earnings in 1918, Wood owed $681,169.88
in federal taxes. For earnings in 1919, Wood owed $351,179.27 in federal taxes. In accordance
with its 1916 resolution, the American Woolen Company paid Woods taxes for both years. The
Board of Tax Appeals found that the tax payments made by the company on Woods behalf
constituted additional income.

Issue: Does payment by an employer of an employees income taxes constitute taxable gain to
the employee?

Holding and Reasoning (Taft, C.J.): Yes. Any payment made for services rendered by an employee
constitutes taxable income to the employee. Whether the employer makes the payment directly
to the employee or on behalf of the employee to a third party is inconsequential. Thus, where an
employer makes a payment to a third party to discharge the employees financial obligations,
that payment is still financial gain to the employee, for which the federal government may
impose a tax. Wood entered into his services as president in 1918 and 1919 with the
understanding that the company would pay his taxes for those years. The company paid these
taxes in consideration of his services as president of the company, and therefore, the payments
did not constitute a non-taxable gift. Therefore, the companys payment of the taxes is income
for which Woods owes tax.

Commissioner v. Glenshaw Glass Co.

Rule of Law: Punitive damages are taxable as gross income.

Facts: This case concerns punitive damages collected by two companies, Glenshaw Glass Co.
(Glenshaw) and William Goldman Theatres, Inc. (Goldman Theatres) (defendants). Glenshaw
was involved in a suit against a manufacturing company, in which Glenshaw requested
exemplary damages for the defendants alleged fraud and treble damages for injury to
Glenshaws business. In 1947, the parties settled and Glenshaw received $324,529.94 in
punitive damages. Glenshaw did not include the punitive damages in its income tax return for
that year. The Commissioner found that Glenshaw owed tax on the punitive damages. The Tax
Court disagreed, stating that punitive damages were not taxable. Goldman Theatres similarly
received punitive damages when it won an action for federal antitrust violations committed by
Loews, Inc. The trial court found that Goldman Theatres had sustained $125,000 in loss of
profits and awarded $375,000 in treble damages. Goldman Theatre reported $125,000 of the
award as gross income for that year, believing that the punitive two-thirds of the award were
not subject to taxation. The Tax Court agreed. The Court of Appeals for the Third Circuit
consolidated the two cases and affirmed the Tax Courts decisions. The Supreme Court granted
certiorari.

Issue: Are punitive damages taxable as gross income?

Holding and Reasoning (Warren, C.J.): Yes. Section 22 of the Internal Revenue Code of 1939
describes gross income as income derived from any source whatever. This Court has often
ruled that the broad language used in this definition allows Congress to exercise the full
extent of its taxing power. Thus, unless Congress expressly exempts a type of gain from
taxation, this Court must assume that it falls within the definition of gross income. Under this
definition, even windfalls, such as punitive damages, are gross income subject to taxation.
Here, Glenshaw and Goldman Theatres experienced considerable increases in wealth. The
money they acquired cannot be shielded from taxation simply because they were taken as
punishment from wrongdoers. Congress has made no provision or given any evidence of its
intent to exempt punitive damages from taxation. In fact, legislative history reveals that
Congress intends for statutory gross income to be all-inclusive. Therefore, the punitive damages
received by Glenshaw and Goldman Theatres are taxable as gross income. The Court of Appeals
for the Third Circuit is reversed.

Charley v. Commissioner

Rule of Law: An employees conversion of frequent flyer miles into cash in a travel account
created by an employer constitutes gross income.

Facts: Philip Charley (defendant) served as President of Truesdail Laboratories (Truesdail).

Charley frequently traveled for business and accrued many frequent flyer miles. At the time,
Truesdail had an unwritten policy that any frequent flyer miles accrued during business travel
were the personal property of the employees who accrued them. Throughout 1998, Charley
took four business trips. Each time, Truesdail paid its travel agent funds to obtain first class
airfare for Charley. But rather than purchasing a first class ticket, Charley instructed the agent to
purchase a coach ticket with the funds. Charley would then upgrade the ticket to first class using
his frequent flyer miles. The remainder of the original funds from Truesdail (the difference
between a first class ticket and a coach ticket) was deposited into Charleys personal travel
account. In this manner, Charley sold his frequent flyer miles to Truesdail and received cash in
exchange. By the end of the year, Charley had $3,149.93 deposited into his personal travel
account. He did not report the amount on his tax return. The Tax Court ruled that the frequent
flyer miles were taxable income.

Issue: Does an employees conversion of frequent flyer miles into cash in a travel account
created by an employer constitute gross income?

Holding and Reasoning (Farris, J.): Yes. According to 61 of the Internal Revenue Code, gross
income is income from virtually any source. In Commissioner v. Glenshaw, 348 U.S. 426 (1955),
the Supreme Court described gross income as a clear attainment of wealth, over which the
taxpayer has complete control. Charley concedes that the frequent flyer miles belonged to him
and that he exercised complete control over them, but argues that a taxable event did not
occur. This court ultimately finds that Charley undeniably acquired wealth that is subject to
taxation. Two theories support this finding. First, this court can view the frequent flyer miles
converted to cash as additional compensation. Under this theory, Truesdail gave Charley
property in the form of a travel account. By allowing the travel agent to deposit the difference
between first class and coach airfare into Charleys travel account, Truesdail compensated
Charley in that amount. As compensation, the cash is taxable. In the alternative, this court can
assume that the frequent flyer miles always belonged to Charley, and that their conversion into
cash was a disposition of his personal property. Under 631(a)(3) of the Internal Revenue Code,
gains from the disposition of property constitute gross income. Such gains are calculated by
subtracting the propertys adjusted basis from the amount realized. The adjusted basis is
typically the cost of the property paid by the owner. The amount realized is the amount
received by the owner for the property. Here, Charley paid nothing for the frequent flyer miles.
Thus, the adjusted basis is zero. Charley received $3,149.93 for the frequent flyer miles. Since
the adjusted basis is zero, the entire $3,149.93 is taxable gain. Therefore, under either theory,
the conversion of the frequent flyer miles into cash constitutes taxable income. The Tax Court is
affirmed.

BUT NOTE: IRS RELEASED A NEWS THAT IT WILL NOT TAX FREQUENT FLIER MILES

IMPUTED INCOME:

Helvering v. Independent Life Insurance Co.

Rule of Law: The rental value of a building occupied by its owner is not taxable as gross
income.

Facts: [Information not provided in casebook excerpt.]

Issue: Is the rental value of a building occupied by its owner taxable as gross income?

Holding and Reasoning (Butler, J.): No. While the Sixteenth Amendment gives Congress the
power to levy a tax on incomes without apportionment, Article I, 9 of the Constitution
requires that direct taxes be apportioned among the states. The rental value of the building
here does not constitute income as governed by the Sixteenth Amendment. It is a direct tax
governed by Article I, 9, which requires apportionment. Thus, Article I, 9 precludes a tax on
the rental value of the building as income.

Dean v. Commissioner

Rule of Law: A taxpayer who resides in property belonging to a corporation of which the
taxpayer and his wife are the sole shareholders should include the rental value of the
property as gross income.

Facts: Dean (defendant) and his wife owned and occupied property. They were also the sole
shareholders of Nemours Corporation. As president, Dean was on Nemours Corporations
payroll. In 1931, the couple transferred the property to the corporation, but continued to live
there. The Commissioner determined that Dean owed income taxes on the rental value of the
property. The Tax Court ruled in the Commissioners favor.

Issue: Should a taxpayer who resides in property belonging to a corporation of which the
taxpayer and his wife are the sole shareholders include the rental value of the property as
gross income?

Holding and Reasoning (Goodrich, J.): Yes. Under Chandler v. Commissioner (1941), a taxpayer
who resides free of charge in a property owned by a corporation, of which he is an employee
and shareholder, receives income in an amount equal to the fair rental value of the property. In
this case, Dean had a legal duty to provide a home for his family. He did so by occupying
property provided free of charge by Nemours Corporation. As an officer of the corporation, the
rent-free occupancy of the property constituted compensation to Dean. Therefore, the rental
value of his occupancy must be included as gross income. The decision of the Tax Court is
affirmed.

Commissioner v. Duberstein

Rule of Law: A transfer is not a gift if made out of obligation or anticipation of future benefits.

Facts: Duberstein and Stanton (defendants) were unrelated taxpayers who failed to include as
gross income the receipt of what they believed to be gifts. Duberstein was president of
Duberstein Iron & Metal Company, which conducted business with Mohawk Metal Corporation
(Mohawk). Berman, the president of Mohawk, would occasionally ask Duberstein for the names
of people who might be interested in purchasing Mohawks products. On one occasion,
Duberstein did provide the names of potential customers for Berman. Berman later contacted
Duberstein, stating that Dubersteins tips had proven so valuable that Berman wished to provide
him with a car in appreciation. Mohawk later denoted the value of the car as a business
expense on its corporate tax return. Believing that the car was a gift, Duberstein did not include
the value of the car as gross income on that years tax return. The Commissioner found a
deficiency in Dubersteins return in the amount of the cars value. The Tax Court agreed. The
Court of Appeals for the Sixth Circuit reversed. In a separate case, Stanton was an employee of a
church for approximately ten years. In 1942, he left the church to begin his own business. Upon
his resignation, his employer passed a resolution to grant him a total of $20,000 in appreciation
for his services, to be dispensed in monthly installments. The resolution relieved the employers
of any obligation to pay Stanton a pension or retirement benefit, although the employer did not
have any such obligation at the time. Stanton was not required to perform any further services
for the church. He did not report the receipt of the monthly installments on his income tax
return for that year. The Commissioner found a deficiency in the amount of the monthly
installments. Stanton paid the deficiency but subsequently sued in the United States District
Court for the Eastern District of New York for a refund. The District Court found the payments
were a gift and ruled in Stantons favor. The Court of Appeals for the Second Circuit reversed.
The United States government sought review of both cases, requesting clarification of what
constitutes a gift. The United States Supreme Court granted certiorari.

Issue: Is a transfer a gift if made out of obligation or anticipation of future benefits?

Holding and Reasoning (Brennan, J.): No. Gifts received are excluded from gross income. But
precisely what constitutes a gift is not a simple determination. If the transfer is made from a
sense of obligation or in exchange for services, the transfer is not a gift. The transfer must be
entirely voluntary. But even a voluntary transfer is not necessarily a gift. The transferor must
lack any ulterior motive or desire to secure a benefit. In other words, the transfer must be made
out of a detached and disinterested generosity. Furthermore, the transferors mere
characterization of the transfer as a gift is insufficient. The controlling factor is the transferors
intent. Courts must look to the transferors dominant purpose in making the transfer to
determine whether the transfer is truly a gift. The Government seeks a more definite test to
determine whether a transfer is a gift, and suggests that only transfers made in a personal
context, as opposed to a business context, should qualify as a gift. Although indeed rare that a
transfer in a business context is truly a gift, the Governments proposed test is too broad to
serve as a universal rule of law. Whether a transfer is a gift is a determination that is governed
by the particular facts of any given case. Because this issue is determined on a case-by-case
basis, appellate courts must review a fact-finders decision with considerable deference. An
appellate court should only overturn a judges decision if it is clearly erroneous or a jurys
decision if no reasonable person could reach the same conclusion. In Dubersteins case, the Tax
Courts decision was not clearly erroneous. Although Berman and Duberstein characterized the
transfer as a gift, and although Berman had no legal or moral obligation to make the transfer,
the trial court was nevertheless justified in finding the transfer was not a gift. The transfer was
made primarily in response to the assistance provided by Duberstein, or perhaps in order to
secure Dubersteins continued assistance. Thus, the judgment of the Court of Appeals for the
Sixth Circuit is reversed. In contrast, this Court finds that the decision of the district court in
Stantons case was insufficiently supported. The district court made a cursory finding that the
transfer was a gift, without determining sufficient facts or indicating a legal standard that an
appellate court could review. Therefore, this Court vacates the judgment of the Court of Appeals
for the Second Circuit and remands the case back to the district court.

Concurrence/Dissent (Frankfurter, J.): The majoritys restatement of already existing law is likely
to confuse the lower courts. The lower courts should simply be left to apply the language
already established by previous case law. The majority also indicates that fact-finders should
rely on their personal experiences with human conduct when making tax determinations.
However, given the vast diversity of human experiences, such an approach is likely to destroy
attempts at uniformity in tax law. To the extent that this Court has applied what prior case law
has already established, the Court properly reversed the judgment in Dubersteins case. But the
decision in Stantons case should have been affirmed.
Lyeth v. Hoey

Rule of Law: Property is exempt from income as an inheritance even if the property is
distributed according to a compromise agreement settling a contest of the decedents will.

Facts: After the death of his grandmother in 1931, the petitioner (defendant) was deemed one
of several heirs to her estate. The grandmothers will left small legacies to each of her heirs and
left the remainder of her estate, which equaled to over $3,000,000, to the trustees of the
Endowment Trust. The grandmothers heirs contested the will in probate court, alleging lack of
testamentary capacity and undue influence. Before a jury could hear the case, the parties
entered into a compromise agreement by which the bequest to the Endowment Fund was
invalidated. Under the terms of the compromise agreement, the heirs received $200,000, the
Endowment Fund received $200,000, and the heirs and the trustees of the Endowment Fund
equally divided the remainder of the estate. The probate court approved the compromise
agreement and the petitioner received his share of the estate in 1933. The Commissioner
valued the petitioners share at $141,484.03 and deemed it income. The petitioner paid a
$56,389.65 tax on the amount and subsequently filed a claim for a refund. The claim was
rejected. The petitioner then brought suit in the District Court, which held in his favor. The Court
of Appeals, relying on Massachusetts inheritance law, reversed. The United States Supreme
Court granted certiorari.

Issue: Is property exempt from income as an inheritance even if the property is distributed
according to a compromise agreement settling a contest of the decedents will?

Holding and Reasoning (Hughes, C.J.): Yes. Under the Revenue Act of 1932, property received
by inheritance is excluded from gross income. Where property is distributed according to the
terms of a decedents will, there is no question that the property received is an inheritance.
But in situations where the validity of a will is contested, interested parties may reach a
compromise agreement that overrules the will. It is unclear whether property is inheritance if it
is distributed according to the terms of a compromise agreement, rather than the decedents
will. Because this is an issue involving Congress power to tax, it is governed by the intent of
Congress, and not the intent of state legislatures. Thus, the Court of Appeals erred in relying on
Massachusetts inheritance law to determine that the petitioner did not receive the property by
inheritance. Examining congressional intent behind the Revenue Act, it is apparent that
Congress intended to consider all acquisitions from a decedents estate as an inheritance. Here,
the petitioners status as heir suggests the distribution should be deemed an inheritance. The
petitioner only had the power to contest the will and enter into a compromise agreement
because of his status as an heir. Furthermore, the petitioner only received his share of the
estate, as distributed according to the compromise agreement, due to his status as an heir.
The form of distribution does not change the nature of the petitioners status as heir, by which
he was entitled to receipt of the property. It is apparent that had the petitioners contest of the
will led to a judgment, rather than a compromise agreement, any distribution to the petitioner
according to the judgment would be an inheritance. It should make no difference that the
property was distributed according to a compromise agreement rather than a judgment of the
probate court. For these reasons, this Court finds that the property distributed to the petitioner
is an inheritance exempt from income. The Circuit Court of Appeals is reversed and the District
Court is affirmed.

Wolder v. Commissioner

Rule of Law: A bequest made in return for lifetime legal services constitutes taxable income.

Facts: Around October 3, 1947, Victor R. Wolder (defendant) and Marguerite K. Boyce entered
an agreement. The agreement specified that Wolder, an attorney, would provide legal services
for Boyce free of charge for the rest of her life. In return, Boyce would bequeath any securities
she might obtain should a corporation by the name of White Laboratories undergo a merger or
consolidation. White Laboratories subsequently merged with Schering Corporation. Boyce
received 750 shares of one type of stock and 500 shares of another. Boyce later exchanged the
500 shares for $15,845. Over the course of Boyces life, Wolder upheld the agreement by
providing legal services without charge. Boyce also upheld the agreement by bequeathing to
Wolder her 750 shares and the $15,845. The Tax Court held that the fair market value of the
shares and the $15,845 was taxable income for services rendered, and not a bequest exempt
from taxation.

Issue: Does a bequest made in return for lifetime legal services constitute taxable income?

Holding and Reasoning (Oakes, C.J.): Yes. Generally, gross income includes all income from
whatever source derived. One exception is that property acquired by bequest does not
constitute gross income. But where a bequest is made in return for services rendered, that
bequest should constitute taxable gain. Under Commissioner v. Duberstein, 363 U.S. 278
(1960), the Supreme Court held that the question of whether a transfer was a gift was
determined by the transferors primary reason for making the transfer. Similarly, in order to
determine whether a transfer should be treated as a bequest, this court must look to the intent
of the decedent in making the bequest. If the purpose of the bequest is to compensate for
services rendered, the bequest constitutes taxable income. Here, the agreement between
Wolder and Boyce contained mutual promises. It basically arranged for Boyce to provide
postponed payment for Wolders provision of lifetime legal services. Hence, Boyces true
intention in leaving the bequest was to make payment for services rendered by Wolder.
Therefore, the bequest constituted taxable gain to Wolder.