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Sec. 32 (A), NIRCGeneral Definition. - Except when otherwise provided in this Title, gross incomemeans all income derived from whatever source, including (but not limited to) thefollowing items:(1) Compensation for services in whatever form paid, including, but not limited to

fees, salaries, wages, commissions, and similar items;(2) Gross income derived from the conduct of trade or business or the exercise of a

profession;(3) Gains derived from dealings in property;(4) Interests;(5) Rents;(6) Royalties;(7) Dividends;(8) Annuities;(9) Prizes and winnings;(10) Pensions; and(11) Partner's distributive share from the net income of the general professional

partnership .

CBP-IRR-DAPPP

Sec. 36, Rev. Regs. No. 2Meaning of net income. The tax imposed by law is upon income. In thecomputation of the tax, various classes of income must be considered:

Income, in the broad sense, meaning all wealth which flows into the tax-payer otherthan as a mere return of capital. It includes the forms of income specificallydescribed as gains and profits, including gains derived from the sale or otherdisposition of capital assets. Income cannot be determined merely by reckoning cashreceipts, for the statute recognizes as income determining factor other items, amongwhich are inventories, accounts receivable, property exhaustion, and accounts

payable for expenses incurred.Gross income, meaning income (in the broad sense) less income which is bystatutory provision or otherwise exempt from the tax imposed by law.

Net income, meaning gross income less statutory deductions. The statutorydeductions are, in general, though not exclusively, expenditures other than capitalexpenditures, connected with production of income.In the case of a taxpayer other than a corporation as defined in Section 84 (b) of theCode, net income means gross income less exemptions. Ordinarily the net income isto be computed in accordance with the method of accounting regularly employed inkeeping the books of the taxpayer.

A. WHAT IS INCOME?

(See Sec. 36, Rev. Regs. No. 2 )

FISHER V. TRINIDAD

(OCT. 30, 1922)Fisher won!

["Stock dividends" are not "income," the same cannot be taxes under that provision of ActNo. 2833 which provides for a tax upon income.]

EMERGENCY RECIT: (from the internet)(Definition of Income Tax, Realization Test of Determining Income) Fisher was astockholder in Phil-Am Drug Company. The company declared a stock dividend withFishers share of the dividend amounting to P24,800. Collector of Internal Revenue Trinidaddemanded P889 income tax on said dividend, which Fisher protested against but voluntarilypaid.

ISSUE 1: WON stock dividends can be classified as income and taxable under Act No.2833 providing for tax upon income?

HELD 1: No, the receipt of stock dividends merely represents an increase in value of theassets of a corporation. The court defines stock dividends as increase in capital of corps,firms, partnerships, etc for a particular period. They represent the increase in theproportional share of each stockholder in the companys capital. It is not a distribution of thecorps profits to the stockholder. It only increases the stockholders SOURCE of income(capital), but does not increase income itself.

ISSUE 2 : Definition of income taxHELD 2 : Act No. 2833 taxed any distribution by a corporation out of its earnings or profits.From the various definitions of income tax cited, an income tax is a tax on the yearly profitsarising from property, salary, private revenue, capital invested, and all other sources ofincome. What is taxed is the profit, not the source.

ISSUE 3: When is income realized (Test of Realization)HELD 3 : Stock dividend in this case is not taxable for income because the stockholder hasreceived nothing out of the company's assets for his separate use and benefit. Instead, hisoriginal investment along with whatever gains which resulted from the use of his and otherstockholders money remains property of the company. The fact that it is not yet his, meansthe capital is still subject to business risks that can wipe out his entire investment. All he hasreceived is a stock certificate indicating the increase in his capital in the company. Thus wecan say that income has been realized when there has been a separation of the interest ofthe stockholder from the general capital of the corporation. This separation of interesthappens when the company declares a cash dividend on the shares of shareholders.

COMPLETE DIGEST

II. MEANING OF INCOME AND REALIZATION PRINCIPLE

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FACTS:- The Philippine American Drug Company was a corporation & Fisher was a stockholder

in said corporation;- Philippine American Drug Co. declared a "stock dividend"; that the proportionate

share of said stock divided of Fisher was P24,800; that the stock dividend for thatamount was issued to Fisher;

- March, 1920, Fisher, upon demand of Trinidad, paid under protest, and voluntarily, untoTrinidad the sum of P889.91 as income tax on said stock dividend.

- For the recovery of that sum (P889.91) the present action was instituted.- The defendant demurred to the petition and the demurrer was sustained, thus the

plaintiff appealed.- Fisher cited cases and in each case it was held that "stock dividends" were capitaland not an "income" and therefore not subject to the "income tax" law.

- Trinidad admits the doctrine established in the case of Eisner vs. Macomber (252 U.S.,189) that a "stock dividend" is not "income" but argues that said Act No. 2833, inimposing the tax on the stock dividend, does not violate the provisions of the JonesLaw.

- Trinidad further argues that the statute of the United States providing for tax upon stockdividends is different from the statute of the Philippine Islands, and therefore thedecision of the Supreme Court of the United States should not be followed ininterpreting the statute in force here.

ISSUES: Are the "stock dividends" in the present case "income" and taxable as such underthe provisions of section 25 of Act No. 2833?

HELD: "Stock dividends" are not "income," the same cannot be taxes under that provisionof Act No. 2833 which provides for a tax upon income.

RATIO:- We believe that the Legislature, when it provided for an "income tax," intended to

tax only the "income" of corporations, firms or individuals, as that term isgenerally used in its common acceptation; that is that the income means moneyreceived, coming to a person or corporation for services, interest, or profit frominvestments.

- We do not believe that the Legislature intended that a mere increase in the valueof the capital or assets of a corporation, firm, or individual, should be taxed as"income." Such property can be reached under the ordinary from of taxation.

FISHER ARGUMENTS- Fisher argues that there is nothing in section 25 of Act No 2833 which contravenes the

provisions of the Jones Law.- He further argues that the Act of Congress (U.S. Revenue Act of 1918) expressly

authorized the Philippine Legislatures to provide for an income tax. That fact may alsobe admitted.

COURTs OPINION:- While it permitted a tax upon income, the same provided that income shall include

gains, profits, and income derived from salaries, wages, or compensation for personalservices, as well as from interest, rent, dividends, securities, etc.

- Trinidad emphasizes the "income from dividends."

- Of course, income received as dividends is taxable as an income but an income from"dividends" is a very different thing from receipt of a "stock dividend."

- One is an actual receipt of profits; the other is a receipt of a representation of theincreased value of the assets of corporation.

- THUS "stock dividends" are not "income," the same cannot be taxed under thatprovision of Act No. 2833 which provides for a tax upon income.

- Under the guise of an income tax, property which is not an income cannot be taxed.- When the assets of a corporation have increased so as to justify the issuance of a stock

dividend, the increase of the assets should be taken account of the Government in the

ordinary tax duplicates for the purposes of assessment and collection of an additionaltax.

OTHER NOTES IN THE CASE:

TWO STATUTES CITED:- Chapter 463 of an Act of Congress of September 8, 1916, in its title 1 provides for the

collection of an "income tax." Section 2 of said Act attempts to define what is anincome.

- The definition follows: That the term "dividends" as used in this title shall be held tomean any distribution made or ordered to made by a corporation, . . . which stockdividend shall be considered income, to the amount of its cash value.

- Act No. 2833 of the Philippine Legislature is an Act establishing "an income tax."Section 25 of said Act attempts to define the application of the income tax.

- The definition follows: The term "dividends" as used in this Law shall be held to meanany distribution made or ordered to be made by a corporation, . . . out of its earnings or

profits accrued since March first, nineteen hundred and thirteen, and payable to itsshareholders, whether in cash or in stock of the corporation, . . . . Stock dividend shallbe considered income, to the amount of the earnings or profits distributed.

TAX ON INCOME- there is no question that the Philippine Legislature may provide for the payment of an

income tax, but it cannot, under the guise of an income tax, collect a tax on propertywhich is not an "income."

- The Philippine Legislature can not impose a tax upon "property" under a law whichprovides for a tax upon "income" only.

- The Philippine Legislature has no power to provide a tax upon "automobiles" only, andunder that law collect a tax upon a carreton or bull cart.

- A statute providing for an income tax cannot be construed to cover propertywhich is not, in fact income.

- The Legislature cannot, by a statutory declaration, change the real nature of a taxwhich it imposes.

STOCK DIVIDENDS AS INCOME- It is true that the statute in question provides for an income tax and contains a further

provision that "stock dividends" shall be considered income and are therefore subject toincome tax provided for in said law.

- If "stock dividends" are not "income" then the law permits a tax upon something notwithin the purpose and intent of the law.

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- Mr. Justice Wilkin said: "A dividend is defined as a corporate profit set aside, declared,and ordered by the directors to be paid to the stockholders on demand or at a fixedtime. Until the dividend is declared, these corporate profits belong to the corporation,not to the stockholders, and are liable for corporate indebtedness.

B.- The extraordinary cash dividend is a disbursement to the stockholders of accumulated

earning, and the corporation at once parts irrevocably with all interest thereon. Theother involves no disbursement by the corporation. It parts with nothing to thestockholders.

- The Stock Dividends receives, not an actual dividend, but certificates of stock whichevidence in a new proportion his interest in the entire capital.

- A stock dividend however, still being the property of the corporation and not thestockholder, it may be reached by an execution against the corporation, and sold as apart of the property of the corporation.

- Until the dividend is declared and paid, the corporate profits still belong to thecorporation, not to the stockholders, and are liable for corporate indebtedness.

- If the ownership of the property represented by a stock dividend is still in thecorporation and to in the holder of such stock, then it is difficult to understand how it canbe regarded as income to the stockholder and not as a part of the capital or assets ofthe corporation.

EISNER V. MACOMBER(252 US 189 [1920])

(Collector) Eisner won![Stock dividends are not income tax/ surplus converted to stocks actually tends to postpone

the realization of profits]

FACTS:Mrs. Macomber owned 2,200 shares in Standard Oil Company of California , whichdeclared a 50% stock dividend . She received 1,100 additional shares, 18% of whichrepresenting $19,877 surplus earnings accumulated by the company.Macomber was called upon to pay , and did pay under protest, income tax imposed on thesurplus earnings. She brought an action to the Collector, Eisner, to recover the tax she paid.

ISSUE:W/N stock dividend is an income subject to income tax

HELD: NO, not subject to income tax! stock dividend really take nothing from the property ofthe corporation and add nothing to that of the shareholder. Congress did not have the powerto re-define the term income as it appeared in the Constitution.

RATIO:Majority ruled that this stock dividend was not a realization of income by thetaxpayer-shareholder for purposes of the Sixteenth Amendment:

A "stock dividend" shows that the company's accumulated profits have been capitalized,instead of distributed to the stockholders or retained as surplus available for distribution inmoney or in kind should opportunity offer. Far from being a realization of profits of thestockholder, it tends rather to postpone such realization, in that the fund represented by the

new stock has been transferred from surplus to capital, and no longer is available for actualdistribution.The essential and controlling fact is that the stockholder has received nothing out of thecompany's assets for his separate use and benefit; on the contrary, every dollar of hisoriginal investment, together with whatever accretions and accumulations have resultedfrom employment of his money and that of the other stockholders in the business of thecompany, still remains the property of the company, and subject to business risks whichmay result in wiping out the entire investment. Having regard to the very truth of the matter,to substance and not to form, he has received nothing that answers the definition of incomewithin the meaning of the Sixteenth Amendment.

We are clear that not only does a stock dividend really take nothing from the property of thecorporation and add nothing to that of the shareholder, but that the antecedent accumulationof profits evidenced thereby, while indicating that the shareholder is the richer because of anincrease of his capital, at the same time shows he has not realized or received any incomein the transaction.The Court noted that in Towne v. Eisner , it had clearly stated that stock dividends were notincome, as nothing of value was received by Towne - the company was not worth any lessthan it was when the dividend was declared, and the total value of Towne's stock had notchanged.

Although the Federal Government had the power to tax income under the Sixteenth Amendment, the Court essentially said this did not give Congress the power to tax asincome anything other than income, i.e., that Congress did not have the power to re-define the term income as it appeared in the Constitution.The Court ordered that Macomber be refunded the tax she overpaid.

Notes (from Wikipedia):o Economic substance of a stock dividend.The stock dividend in this case was the

economic equivalent of a stock splita transaction in which the corporationmultiplies the total number of shares outstanding, but gives the new shares toshareholders in proportion to the number they previously held. For example, if acorporation declares a "two for one" stock split (and distributes no money or otherproperty to any stockholder), a stockholder who held 100 shares at $4 per sharewill now hold 200 shares with a value of $2 each, which is still $400 in value.

o Stock dividends vs. cash dividends. A shareholder's assets do not grow after thissort of stock dividend. Metaphorically, the "pie" is still the same sizebut it hasbeen sliced into more pieces, each piece being proportionately smaller. Of course,the same is true of a cash dividend: the shareholder gains cash, but thecorporation represented by his shares has also lost cash, so that these sharesimplicitly decline in value by an equal amount.

A shareholder also makes no "sale or other disposition" of stock after this sort of stockdividend. The taxpayer still owns the same proportionate percentage of the corporation heor she owned prior to the stock dividend. Again, this is also true of a cash dividend.However, several important factors distinguish a stock and cash dividend. "Overall, the aimof the tax law is to impose a tax on "dividends" when assets representing corporateearnings are transferred to the shareholders. Stock dividends, however, merely give theshareholders additional pieces of paper to represent the same equitable interest; they donot transfer assets or create new priorities among the security-holders. The total value ofthe common shares, though now spread out over a larger number of units, is left unchangedfrom its previous level. In effect, nothing of substance has occurred."

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U.S. V. KIRBY LUMBER CO.284 U.S. 1 (1931)

U.S. won![bought bonds below par value/gross income includes gains or profits and income derived

from any source whatever]

FACTS: The United States brings this action on writ of certiorari. In July 1923, KirbyLumber Co.issued its bonds for 12,126,800 USD for which it received their par value.

Later in the same year it purchased in the open market some of the same bonds atbelow than par value, with a difference of 137,521.30 USD.

ISSUES: Is the difference (between the issuing price or face value and the purchasedprice) of 137,521.30 USD taxable income or gain for the Plaintiff (Kirby Lumber) for the year1923?

HELD: YES. Justice Holmes held that the difference should be considered as taxable gainor income.

RATIO: The Revenue Act of 1921 ( November 23), c.136, s 213(a), 42 Stat. 238, grossincome includes gains or profits and income derived from any source whatever andby the Treasury Regulations authorized b s. 1303 that have been in force throughrepeated reenactments, If the corporation purchases and retires any of such bonds ata price less than the issue price or face value, the excess of the issuing price or facevalue over the purchase price is gain or income for the taxable year.

There was no shrinkage of assets and Kirby Lumber Co. clearly made a gain. The taxpayergains by offsetting the bonds. As a result, it was able to discharge (or cancel) 137,521.30USD of indebtedness, and this is part of gross taxable income.* (Unlike in Bowers v Kerbaugh, here the transaction as a whole was a loss)

NOTES: Bonds, in this sense, is a financial document. Kirby Lumber issued the bonds as adebt instrument (utang) which provides for set payments to a purchases on a set date.Simple example, Sean issued 10 bonds worth 10 pesos each and were all purchased. The100 pesos paid to Sean is Seans debt to those who purchased the bonds. If later, thesame month for example, Sean bought 5 of the bonds previously sold at 5 pesos only(below par value), the difference of 25 pesos [(10 pesos x 5 bonds) (5 pesos x 5 bonds)] isan income or gain for Sean. Because, instead of 50 pesos angutang (initial because ofissue price) for the 5 bonds, 25 pesos nalangangutang (because it is below par value). Thecancellation of the 25 pesos debt is considered taxable income.

HELVERING V. BRUUN, 309 U.S. 461 (1940)(government won) Bruun lost![A landlord does realize a taxable gain when he repossesses property improved by atenant.]

Facts:

Bruun was a landlord . He leased some property to a tenant. When the lease expired, thetenant left and Bruun took the property back. While the tenant was in possession of theproperty, they knocked down an old building and built a new building on the property. Whenthey left, Bruun got to keep the new building. The new building was assessed to be worth$51k more than the old one.

The IRS stepped in and said that Bruun's gain of a new building was a capital gain . Bruunargued that no income had been realized yet because his interest was represented by adeed, and when the tenant left, he had the exact same deed he had when the tenantarrived. So he hadn't gained anything. Bruun suggested that the IRS would have to wait

until the property was sold (aka the value was realized ). Basically, the construction of thenew building increased the value of the land, but there were other ways the value couldchange. But until the land was sold, Bruun hadn't received anything. [See Eisner v.Macomber (252 U.S. 189 (1920)), which says that in general, you don't have to report again until you sell the property (aka "severance is a prerequisite to realization").]

The IRS argued that until the day the tenant left, Bruun didn't own a new building, as soonas the lease ended, Bruun did own a new building. He had received a gain and needed topay taxes on it immediately.

Issue: WON the respondent realized a taxable gain from the forfeiture his leasehold?

Held: YES! The court held for the government: the value of the improvements made by thetenant was realized by the taxpayer in the year in which the forfeiture occurred.

Ratio:The improvements, the Court observed, were received by the taxpayer "as a result of abusiness transaction," namely, the leasing of the taxpayer's land. It was not necessary tothe recognition of gain that the improvements be severable from the land; all that had to beshown was that the taxpayer had acquired valuable assets from his lease in exchange forthe use of his property. The medium of exchangewhether cash or kind, and whetherseparately disposable or "affixed"--was immaterial as far as the realization criterion wasconcerned. In effect, the improvements represented rent, or rather a payment in lieu of rent,which was taxable to the landlord regardless of the form in which it was received. [2] "Severance" is not necessary for realization: (aka house need not be sold before it wasrealized)"It is not necessary to recognition of taxable gain that he should be able to sever theimprovement begetting the gain from his original capital. If that were necessary, no incomecould arise from the exchange of property, whereas such gain has always been recognizedas realized taxable gain."The Court added that, while not all economic gain is "realized" for taxation purposes,realization does not require that the economic gain be in "cash derived from the sale of anasset". Realization can also arise from property exchange; relief of indebtedness; or othertransactions yielding profite.g. by receiving an asset with enhanced value in a transaction,even where severance does not occur (i.e. even where "the gain is a portion of the value ofproperty received by the taxpayer in the transaction").

The US Supreme Court found for the IRS.

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o The US Supreme Court found that upon when a lease ended, the landlordrepossessed the real estate and improvements and increase in valueattributable to the improvements was taxable.

The real estate industry felt that this was very unfair to landlords. If the newbuilding was expensive, the landlord might be forced to sell the land just to be ableto afford the tax. They lobbied Congress, who passed 26 U.S. C. 109 was toprovide relief for exactly landlord's in Bruun's situation.

o Now, under 109 , gross income generally does not include improvementsmade by a tenant.

o However, it does not include "improvements other than rent." That clause

was added so the landlord and tenant couldn't conspire to improve theproperty instead of paying rent. So you can't say to a tenant, "instead of paying me rent, just

build a fancy new building that I can keep after you leave."

CIR V. GLENSHAW GLASS CO.348 U.S. 426 (1955)

(government won) GlenShaw Glass lost![gross includes includes any income from any source-even damages received]

Facts.

Glenshaw Glass manufactures glass bottles and containers and was in litigation with theHartford-Empire Company , which manufactures machinery used by Glenshaw.

Glenshaw made demands for exemplary damages for fraud and treble damages forinjury to its business for Hartfords violations of antitrust laws. The parties settled andGlenshaw received $800,000 . Of that, $324,529.94 represented punitive damages .Glenshaw did not report that amount as income for the tax year involved.

In Commissioner v. William Goldman Theatres, Inc., William Goldman sued Loews Inc.for violations of antitrust law and sought treble damages. William Goldman received$375,000 in treble damages but claimed $250,000 of that represented punitive damages and did not report it as income.

Issue. Whether money received as exemplary damages for fraud or as punitive damages ofan antitrust recovery must be considered gross income?

Held. YES! Chief Justice Warren held that the amounts should be considered gross income.Court could not ignore the plain language of the statute that gross includes includes anyincome from any source.

RATIO:US Tax Code: SEC. 22. GROSS INCOME."(a) GENERAL DEFINITION. 'Gross income' includes gains, profits, and income derivedfrom salaries, wages, or compensation for personal service . . . of whatever kind and inwhatever form paid, or from professions, vocations, trades, businesses, commerce, orsales, or dealings in property, whether real or personal, growing out of the ownership or use

of or interest in such property; also from interest, rent, dividends, securities, or thetransaction of any business carried on for gain or profit, or gains or profits and incomederived from any source whatever. . . ."Respondents contend that punitive damages, characterized as "windfalls" flowing from theculpable conduct of third parties, are not within the scope of the section. But Congressapplied no limitations as to the source of taxable receipts, nor restrictive labels as to theirnature. And the Court has given a liberal construction to this broad phraseology inrecognition of the intention of Congress to tax all gains except those specifically exempted.Here we have instances of undeniable accessions to wealth, clearly realized, and overwhich the taxpayers have complete dominion. The mere fact that the payments were

extracted from the wrongdoers as punishment for unlawful conduct cannot detract from theircharacter as taxable income to the recipients.

Dissent. Justice Douglass dissented but did not issue a separate opinion.

Discussion. The Supreme Court found no exception applicable to punitive damages.Further, the

JAMES V. U.S.366 U.S. 213 (1961)

(government won) James lost![Embezzled money is subject to income tax]

FACTS : James was an official in a labor union. He, together with another person,embezzled more than $738,000 from the union and from an insurance company doingbusiness with the union. He did not report these amounts on his tax return.

He was tried for tax evasion, and claimed in his defense that embezzled funds did notconstitute taxable income. His argument was that just as the receipt of loan proceeds isnot taxable to the borrower, the person who embezzles money should not be treated ashaving received income, since that person is legally obligated to return those funds to theirrightful owner. However, this defense was unavailing in the trial court, where Eugene Jameswas convicted and sentenced to three years in prison. Hence, this petition.

ISSUE: W/N embezzled money is subject to income tax OR whether the receipt ofembezzled funds constitutes income taxable to the wrongdoer, even though an obligation torepay exists

HELD: YES, SUBJECT TO INCOME TAX! United States Supreme Court held that moneyobtained by a taxpayer illegally was taxable income, even though the law might require thetaxpayer to repay the ill-gotten gains to the person from whom they had been taken.

RATIO:It had been a well established principle, long before either Rutkin or Wilcox, that unlawful,as well as lawful, gains are comprehended within the term "gross income." Section IIB of the Income Tax Act of 1913 provided that "the net income of a taxable person shallinclude gains, profits, and income . . . from . . . the transaction of any lawful business carriedon for gain or profit, or gains or profits and income derived from any source whatever. . . ."

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When the statute was amended in 1916, the one word "lawful" qualifying the businesscarried on was omitted. This revealed, we think, the obvious intent of that Congress to taxincome derived from both legal and illegal sources, to remove the incongruity of having thegains of the honest laborer taxed and the gains of the dishonest immune.The Court has given a liberal construction to the broad phraseology of the "gross income"definition statutes in recognition of the intention of Congress to tax all gains except thosespecifically exempted. The language of 22(a) of the 1939 Code, "gains or profits andincome derived from any source whatever," and the more simplified language of 61(a) ofthe 1954 Code, "all income from whatever source derived," have been held to encompassall "accessions to wealth, clearly realized, and over which the taxpayers have completedominion." A gain constitutes taxable income when its recipient has such control over it that,as a practical matter, he derives readily realizable economic value from it.

Notes:In Wilcox, the Court held that embezzled money does not constitute taxable income to theembezzler in the year of the embezzlement under 22(a) of the Internal Revenue Code of1939. Six years later, this Court held, in Rutkin v. United States, that extorted money doesconstitutes taxable income to the extortionist in the year that the money is received under 22(a) of the Internal Revenue Code of 1939. In Rutkin, the Court did not overrule Wilcox, butstated:"We do not reach in this case the factual situation involved in Commissioner v. Wilcox . Welimit that case to its facts. There, embezzled funds were held not to constitute taxableincome to the embezzler under 22(a)."However, examination of the reasoning used in Rutkin leads us inescapably to theconclusion that Wilcox was thoroughly devitalized.The basis for the Wilcox decision was "that a taxable gain is conditioned upon (1) thepresence of a claim of right to the alleged gain and (2) the absence of a definite,unconditional obligation to repay or return that which would otherwise constitute a gain.Without some bona fide legal or equitable claim, even though it be contingent or contestedin nature, the taxpayer cannot be said to have received any gain or profit within the reach ofSection 22(a)."Since Wilcox embezzled the money, held it "without any semblance of a bona fide claim ofright," ibid., and therefore "was at all times under an unqualified duty and obligation to repaythe money to his employer," ibid., the Court found that the money embezzled was notincludible within "gross income." But Rutkin's legal claim was no greater than that of Wilcox.It was specifically found "that petitioner had no basis for his claim . . . and that he obtained itby extortion." Both Wilcox and Rutkin obtained the money by means of a criminal act;neither had a bona fide claim of right to the funds. Nor was Rutkin's obligation to repay theextorted money to the victim any less than that of Wilcox. The victim of an extortion, like the

victim of an embezzlement, has a right to restitution. Furthermore, it is inconsequential thatan embezzler may lack title to the sums he appropriates, while an extortionist may gain avoidable title. Questions of federal income taxation are not determined by such "attenuatedsubtleties."Thus, the fact that Rutkin secured the money with the consent of his victim is irrelevant.Likewise unimportant is the fact that the sufferer of an extortion is less likely to seekrestitution than one whose funds are embezzled. What is important is that the right torecoupment exists in both situations.

B. REALIZATION REQUIREMENT

Sec. 38, Rev. Regs. 2Bases of computation. Approved standard methods of accounting will beordinarily regarded as clearly reflecting income. A method of accounting will not,however, be regarded as clearly reflecting income unless all items of gross incomeand all deductions are treated with reasonable consistency. All items of gross incomeshall be included in the gross income for the taxable year in which they are receivedby the taxpayer and deductions taken accordingly, unless in order clearly to reflect

income such amounts are to be properly accounted for as of a different period. Forinstance, in any case in which it is necessary to use an inventory, no accounting inregard to purchases and sales will correctly reflect income except an accrual method.A taxpayer is deemed to have received items of gross income which have beencredited to or set apart for him without restriction. On the other hand, appreciation invalue of property is not even an accrual of income to a taxpayer prior to therealization of such appreciation through sale or conversion of the property.(For methods of accounting and determination of accounting periodsee Sections 166 to 169 of these regulations.)

HELVERING V. BRUUN SUPRA

(government won) Bruun lost!

[A landlord does realize a taxable gain when he repossesses property improved by atenant.]

Facts:Bruun was a landlord . He leased some property to a tenant. When the lease expired, thetenant left and Bruun took the property back. While the tenant was in possession of theproperty, they knocked down an old building and built a new building on the property. Whenthey left, Bruun got to keep the new building. The new building was assessed to be worth$51k more than the old one.

The IRS stepped in and said that Bruun's gain of a new building was a capital gain . Bruunargued that no income had been realized yet because his interest was represented by adeed, and when the tenant left, he had the exact same deed he had when the tenantarrived. So he hadn't gained anything. Bruun suggested that the IRS would have to waituntil the property was sold (aka the value was realized ). Basically, the construction of thenew building increased the value of the land, but there were other ways the value couldchange. But until the land was sold, Bruun hadn't received anything. [See Eisner v.Macomber (252 U.S. 189 (1920)), which says that in general, you don't have to report again until you sell the property (aka "severance is a prerequisite to realization").]

The IRS argued that until the day the tenant left, Bruun didn't own a new building, as soonas the lease ended, Bruun did own a new building. He had received a gain and needed topay taxes on it immediately.

Issue: WON the respondent realized a taxable gain from the forfeiture his leasehold?

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Held: YES! The court held for the government: the value of the improvements made by thetenant was realized by the taxpayer in the year in which the forfeiture occurred.

Ratio:The improvements, the Court observed, were received by the taxpayer "as a result of abusiness transaction," namely, the leasing of the taxpayer's land. It was not necessary tothe recognition of gain that the improvements be severable from the land; all that had to beshown was that the taxpayer had acquired valuable assets from his lease in exchange forthe use of his property. The medium of exchangewhether cash or kind, and whetherseparately disposable or "affixed"--was immaterial as far as the realization criterion wasconcerned. In effect, the improvements represented rent, or rather a payment in lieu of rent,which was taxable to the landlord regardless of the form in which it was received. [2] "Severance" is not necessary for realization: (aka house need not be sold before it wasrealized)"It is not necessary to recognition of taxable gain that he should be able to sever theimprovement begetting the gain from his original capital. If that were necessary, no incomecould arise from the exchange of property, whereas such gain has always been recognizedas realized taxable gain."The Court added that, while not all economic gain is "realized" for taxation purposes,realization does not require that the economic gain be in "cash derived from the sale of anasset". Realization can also arise from property exchange; relief of indebtedness; or othertransactions yielding profite.g. by receiving an asset with enhanced value in a transaction,even where severance does not occur (i.e. even where "the gain is a portion of the value ofproperty received by the taxpayer in the transaction").

The US Supreme Court found for the IRS.o The US Supreme Court found that upon when a lease ended, the landlord

repossessed the real estate and improvements and increase in valueattributable to the improvements was taxable.

The real estate industry felt that this was very unfair to landlords. If the newbuilding was expensive, the landlord might be forced to sell the land just to be ableto afford the tax. They lobbied Congress, who passed 26 U.S. C. 109 was toprovide relief for exactly landlord's in Bruun's situation.

o Now, under 109 , gross income generally does not include improvementsmade by a tenant.

o However, it does not include "improvements other than rent." That clausewas added so the landlord and tenant couldn't conspire to improve theproperty instead of paying rent.

So you can't say to a tenant, "instead of paying me rent, justbuild a fancy new building that I can keep after you leave."

HELVERING V. HORST311 U.S. 112 (1940)

FACTS:! Horst , the owner of negotiable bonds, detached from them negotiable interest coupons

shortly before their due date and delivered them as a gift to his son who in the sameyear collected them at maturity.

! The Commissioner ruled that under the applicable section 22 of the Revenue Act of1934, 48 Stat. 680, 686, 26 U.S.C.A. Int. Rev. Acts, page 669, the interest paymentswere taxable, in the years when paid, to the respondent donor who reported his incomeon the cash receipts basis.

! The circuit court of appeals reversed the order of the Board of Tax Appeals sustainingthe tax because of the importance of the question in the administration of the revenuelaws and because of an asserted conflict in principle of the decision below with that ofLucas v. Earl, and with that of decisions by other circuit courts of appeals.

! ISSUE: WON the gift of interest coupons detached from the bonds is the realization ofincome taxable to the donor (or WON the donor is the one going to be taxed instead of thedonee?)

HELD: YES, Horst (father) is the one going to be taxed!RATIO:

NOTE: The Court reasoned that the power to dispose of income is the equivalent ofownership. Because he was able to separate the interest coupons from the bonds andprocure payment of the interest to his son, Paul Horst enjoyed the economic benefits of theincome. The court stated . . . . [t]he taxpayer has equally enjoyed the fruits of his labor orinvestment and obtained the satisfaction of his desires whether he collects and uses theincome . . . or whether he disposes of his right to collect it. . . . The taxpayer cannotattribute the fruit (the interest coupon) to a different tree from that which it grew on (the bonditself). If Horst had given both the bond and the interest coupons to his son, the interestwould have been taxable to his son.

! Here respondent, as owner of the bonds, had acquired the legal right todemand payment at maturity of the interest specified by the coupons and thepower to command its payment to others which constituted an economic gainto him.

! Underlying the reasoning is the thought that income is realized by theassignor because he, who owns or controls the source of the income, alsocontrols the disposition of that which he could have received himself anddiverts the payment from himself to others as the means of procuring thesatisfaction of his wants.

! Although the donor here, by the transfer of the coupons, has precluded anypossibility of his collecting them himself he has nevertheless, by his act,procured payment of the interest, as a valuable gift to a member of his family

! Such a use of his economic gain, the right to receive income, to procure asatisfaction which can be obtained only by the expenditure of money orproperty, would seem to be the enjoyment of the income whether thesatisfaction is the purchase of goods at the corner grocery, the payment of hisdebt there, or such non-material satisfactions as may result from the paymentof a campaign or community chest contribution, or a gift to his favorite son.

! Even though he never receives the money he derives money's worth from thedisposition of the coupons which he has used as money or money's worth inthe procuring of a satisfaction which is procurable only by the expenditure ofmoney or money's worth.

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! The enjoyment of the economic benefit accruing to him by virtue of hisacquisition of the coupons is realized as completely as it would have been ifhe had collected the interest in dollars and expended them for any of thepurposes named.

! To say that one who has made a gift thus derived from interest or earningspaid to his donee has never enjoyed or realized the fruits of his investment orlabor because he has assigned them instead of collecting them himself andthen paying them over to the donee, is to affront common understanding andto deny the facts of common experience.

! The power to dispose of income is the equivalent of ownership of it! The exercise of that power to procure the payment of income to another is the

enjoyment and hence the realization of the income by him who exercises it.! But it is the assignment by which the disposition of income is controlled when

the service precedes the assignment and in both cases it is the exercise of thepower of disposition of the interest or compensation with the resulting paymentto the donee which is the enjoyment by the donor of income derived fromthem.

! Unlike income thus derived from an obligation to pay interest or compensation,the income of the trust was regarded as no more the income of the donor thanwould be the rent from a lease or a crop raised on a farm after the leaseholdor the farm had been given away.

! We have held without deviation that where the donor retains control of thetrust property the income is taxable to him although paid to the donee.

! The owner of a negotiable bond and of the investment which it represents, ifnot the lender, stands in the place of the lender.

! When, by the gift of the coupons, he has separated his right to interestpayments from his investment and procured the payment of the interest to hisdonee, he has enjoyed the economic benefits of the income in the samemanner and to the same extent as though the transfer were of earnings and inboth cases the import of the statute is that the fruit is not to be attributed to adifferent tree from that on which it grew

COTTAGE SAV. ASSN V. CIR, 499 U.S. 554 (1991)

Facts: Cottage Savings Association was a savings & loan association (S&L) serving theGreater Cincinnati area. Like many other S&L's, Cottage Savings had a large number oflong-term, low-interest mortgages on its books , which declined in value as interest ratesincreased during the late 1970s.

These S&Ls could have achieved a tax savings from selling these mortgages at a loss, butthey were dissuaded from doing so because the accounting regulations of the FederalHome Loan Bank Board (FHLBB) would have required them to report these losses on theirbooks, possibly putting them into insolvency. Hoping to find another way for these S&Ls torealize their tax losses, the FHLBB promulgated a new regulation called "Memorandum R-49", under which the S&Ls would not have to show a loss on their books if they exchangedtheir mortgages for "substantially identical" mortgages held by other lenders.

Cottage Savings made a transaction pursuant to this regulation by exchanging 90%

participation interests in 252 mortgages to four other S&Ls, receiving in return 90%participation interests in 305 mortgages. All the mortgages involved in the transaction werefor homes in the Greater Cincinnati region. The fair market value of the interests exchangedby each side was approximately $4.5 million. The face value of the interests which CottageSavings relinquished was approximately $6.9 million. On its 1980 federal income tax return,Cottage Savings claimed a loss of $2,447,091, the adjusted difference between the facevalue of the participation interests it gave up and fair market value of the interests itreceived.

The Commissioner of Internal Revenue disallowed Cottage Savings' deduction , so theS&L filed a petition for redetermination in the United States Tax Court, which reversed theCommissioner's decision and permitted the deduction. The Commissioner appealed to theUnited States Court of Appeals for the Sixth Circuit, which reversed the decision of the TaxCourt, holding that even though Cottage Savings realized a loss in the transaction, ithad not actually realized the loss during the 1980 tax year. The U.S. Supreme Courtthen granted certiorari.

Issue: whether the exchange was a "disposition of property."

Held:Material difference is a requirement for a disposition under 1001 . Marshall citedTreasury Regulation 1.1001-1 (26 C.F.R. 1.1001-1), which required that an exchange ofmaterially different properties constitutes a realization under the Tax Code. Congressdelegated to the Commissioner the authority to make rules and regulations to enforce theInternal Revenue Code. Because Title 26 of the Code of Federal Regulations represents theCommissioner's interpretation of the Code, the Court deferred to the Commissioner's

judgment, holding that the regulation was a reasonable interpretation of the Code andconsonant with prior case law.Material difference defined . Marshall defined what constituted a "material difference" inproperty under 1001 by examination at what point "realization" had been found in pastcase law. He started with Eisner v. Macomber, which dealt with exchange of stock incorporations. In several cases after Eisner, the court held that an exchange of stock whichoccurred when a corporation reorganized in another state was a realization, becausecorporations have different rights and power in different states. Marshall reasoned thatproperties materially differ for tax purposes when their respective possessors enjoy differentlegal entitlements from each. As long as the properties being exchanged were not identical,a realization had taken place. This was a simpler, black letter rule, as compared to what theCommissioner was arguing for, which would have examined not just the underlyingsubstance of the transaction, but also the market and other non-tax regulations.

The properties exchanged were "materially different." Marshall held that theparticipation interests exchanged by Cottage Savings and the other S&Ls were "materiallydifferent" because the loans involved were made to different obligors and secured bydifferent properties. Even though the interests were "substantially identical" for the FHLBB'spurposes, that did not mean they were not materially different for taxation purposes.Therefore, the exchange was a "disposition of property," Cottage Savings had realized aloss, and their deduction was appropriate.The Court agreed that "material difference" is the applicable test of realization under Code 1001(a), but it did not agree that that test had been flunked merely because the propertiesexchanged were economic substitutes or equivalents. While the test for regulatory purposesmight indeed be one of economic substance, for tax purposes the question was one of

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administrative convenience only. As the mortgages exchanged were secured by differenthomes and involved different mortgage borrowers, the banks on either side emerged with"legally distinct entitlements". More important, the swap itself sufficed to meet theadministrative aims that underlie the realization requirement. The transaction was an arms-length deal between unrelated parties. As such, it "put both Cottage Savings and theCommissioner in a position to determine the change in the value of Cottage Savings'mortgages relative to their tax bases" and thus to reckon up gain or loss under 1001(a).

Justice Blackmun dissented, joined by Justice White.First, Blackmun wanted to define "material difference" with reference to how the term"materiality" was defined. In TSC Industries, Inc. v. Northway, Inc., Justice Marshall himselfhad stated, in the context of securities fraud, that an omitted fact is material if there is asubstantial likelihood that a reasonable shareholder would consider it important in decidinghow to vote. By implication, a material difference is a difference capable of influencing thedecision made by the parties to the transaction.Second, Blackmun pointed out that the majority created something of an anomaly byallowing the property interests exchanged here to be "identical" for accounting purposes but"different" for tax purposes.Finally, he explained the he felt the substance of the transactions, including the fact thatCottage Savings retained a 10% interest in loans it traded away so it could continueservicing them, did not point to any real difference that should permit the allowance of adeduction.

C. OTHER RELEVANT CONCEPTS

1. Tax-Free Imputed Income v. Taxable Barter

Sec. 41, Rev. Regs. 2.Compensation paid other than in cash . Where services are paid for with somethingother than money, the fair market value of the thing taken in payment is the amountto be included as income. If the services were rendered at a stipulated price, in theabsence of evidence to the contrary, such price will be presumed to be the fair valueof the compensation received. Compensation paid an employee of a corporation in itsstock is to be treated as if the corporation sold the stock for its market value and paidthe employee in cash. When living quarters are furnished in addition to cash salary,the rental value of such quarters should be reported as income .

CIR v. Minzer279 F.2d 338 (5th Cir. 1960)

Rev. Rul. 79-241979-1 C.B. 60

2. Tax-Free Return of Capital

Sec. 36, Rev. Regs. 2.Meaning of net income . The tax imposed by law is upon income. In the

computation of the tax, various classes of income must be considered:(a) Income, in the broad sense, meaning all wealth which flows into the tax-

payer other than as a mere return of capital. It includes the forms of incomespecifically described as gains and profits, including gains derived from thesale or other disposition of capital assets. Income cannot be determinedmerely by reckoning cash receipts, for the statute recognizes as incomedetermining factor other items, among which are inventories, accountsreceivable, property exhaustion, and accounts payable for expensesincurred.

(b) Gross income, meaning income (in the broad sense) less income which isby statutory provision or otherwise exempt from the tax imposed by law.

(c) Net income, meaning gross income less statutory deductions. The statutorydeductions are, in general, though not exclusively, expenditures other thancapital expenditures, connected with production of income.

(d) In the case of a taxpayer other than a corporation as defined in Section 84(b) of the Code, net income means gross income less exemptions. Ordinarilythe net income is to be computed in accordance with the method ofaccounting regularly employed in keeping the books of the taxpayer.

EDWARD CLARK V. CIR40 B.T.A. 333 1939)

This is a proceeding to redetermine a deficiency in income tax for the calendar year 1934 inthe amount of $10,618.87.

Facts: The petitioner was required to file a Federal ITR for 1932. Petitioner retainedexperienced tax counsel to prepare the necessary return for him and his wife. Such taxcounsel prepared a joint return for petitioner and his wife and advised petitioner to file itinstead of two separate returns. In 1934, a duly appointed revenue agent audited the1932return and recommended an $32,820.14 additional assessment against petitioner. This sumwas paid by petitioner. The deficiency of $32,820.14 arose from an error on the part of taxcounsel who prepared petitioner's 1932 return. The tax counsel improperly deducted fromincome the total amount of losses sustained on the sale of capital assets held for a period ofmore than two years instead of applying the statutory limitation required by Section 101(b)of the Revenue Act of 1932. Recomputations were then made which disclosed that ifpetitioner and his wife had filed separate returns for the year 1932 their combined taxliability would have been $19,941.10 less than that which was finally assessed against andpaid by petitioner.

The tax counsel admitted the error in computing the tax liability and tendered to petitionerthe sum of $19,941.10 which the petitioner then accepted. In his final determination ofpetitioner's 1934 tax liability, the respondent included the aforesaid $19,941.10 in income.Respondent contends that the sum $19,941.10 be included as petitioner's gross income (astaxes paid for petitioner by a third party for 1934. Petitioner contends that this paymentconstituted compensation for damages or loss caused by the error of tax counsel, and thathe therefore realized no income from its receipt in 1934.

Issue: Whether petitioner derived income by the payment to him of an amount of$19,941.10, by his tax counsel, to compensate him for a loss suffered on account of

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P then contracted with a 3 rd party to finish construction of the plant to satisfy the standardswith an additional cost of 50x dollars.

ISSUE: WON payment by a contractor of a sum of money to a buyer in exchange for arelease of the buyer's claims against the contractor for failure to fulfill a contract result inincome to the buyer or a return of capital?

HELD: NO! The 40x dollars payment from M to P represents a return of capital and is notincome to P. The basis of the plants cost in P's hands should be adjusted downward to210x to reflect the 40x dollar payment of M, and adjusted upward to 260x dollars when Pincurs expenses of 50x dollars to finish construction of the plant.

RATIO:Section 61 of the Internal Revenue Code provides that gross income means all incomefrom whatever source derived, including income realized in any form. Inherent in section 61of the Code is the concept of economic gain. For a taxpayer to have income under section61, there must be an economic gain that benefits the taxpayer personally.

The determination of whether the proceeds received in a lawsuit or received in settlement ofa lawsuit constitute income under section 61 of the Code depends on the nature of the claimand the actual basis for recovery. If the recovery represents damages for lost profits, it istaxed as ordinary income. If, however, the recovery is treated as a replacement of capital,the damages received from the lawsuit are treated as a return of capital and are not taxableas income. Payments by the one causing a loss that do not more than restore a taxpayer tothe position he or she was in before the loss was incurred are not includible in gross incomebecause there is no economic gain.

In the present situation, the effect of the settlement agreement was that M wouldcompensate P for M's failure to provide a fully operational and licensable plant for 250xdollars as agreed upon under the contract. The payment from M to P of 40x dollarsrepresents the estimated present damages P has incurred because of the breach ofcontract, determined under the settlement agreement as the estimated additional costsneeded to satisfy new regulatory standards that were necessary to deliver a complete, safe,licensable, fully operational plant as required under the contract. P has received noeconomic gain as a result of the 40x dollars payment and is merely being made whole underthe contract. P is being restored to the position that it would have been in if M had fulfilledthe terms of the contract.

LAWS:

Section 1012 of the Code provides that the basis of property is usually its cost .Section 1.1012-1(a) of the Income Tax Regulations provides that cost is the amount paidfor property in cash or other property.Section 1016(a) provides that adjustments are made to the basis of property forexpenditures, receipts, losses, or other items properly chargeable to the capital account.

2. WINDFALL RECEIPTS

Sec 32. Gross Income

(A) General Definition. - Except when otherwise provided in this Title, gross income

means all income derived from whatever source, including (but not limited to) thefollowing items: (9) Prizes and winnings

(B) Exclusions from Gross Income. The following items shall not be included in grossincome and shall be exempt from taxation under this title:

(7) Miscellaneous Items(c) Prizes and Awards. - Prizes and awards made primarily in

recognition of religious, charitable, scientific, educational, artistic,literary, or civic achievement but only if: (i) The recipient was selected without any action on his part to enterthe contest or proceeding; and (ii) The recipient is not required to render substantial future servicesas a condition to receiving the prize or award.

CESARINI V. U.S.296 F. SUPP. 3 (ND OHIO 1969)

Facts:In 1957, the plaintiffs purchased a used piano at an auction sale for $15. In 1964, whilecleaning the piano, they discovered the sum of $4,467 in old currency. Plaintiffs exchangedthe old currency for new at a bank, and reported the sum of $4,467 on their 1964 jointincome tax return as ordinary income from other sources.

In 1965, plaintiffs filed an amended return eliminating the sum of $4,467.00 from the grossincome computation, and requesting a refund in the amount of $836.51 , the amountallegedly overpaid as a result of the former inclusion of $4,467.00 in the original return forthe calendar year of 1964. In1966, the CIR rejected taxpayers' refund claim in its entirety,hence this case.

Issue: WON plaintiffs errouneously overpaid tax in the amount of $836.51 ;WON plaintiffs are entitled to refund

Held: No. Windfalls, including found monies, were properly includable in gross income. Thearguments of the taxpayers which attempt to avoid the application of Rev. Rul. 61, 1953-1are not well taken.

"The finder of treasure trove is in receipt of taxable income, for Federal income taxpurposes, to the extent of its value in United States currency, for the taxable year inwhich it is reduced to undisputed possession." ( Rev. Rul. 61, 1953-1, Cum. Bull. 17.)

Plaintiffs Contention #1: There are inconsistencies between the code, rules and regulationsand court decisions.Court: Plaintiffs in the instant case have been unable to point to any inconsistency betweenthe gross income sections of the code, the interpretation of them by the regulations and thecourts, and the revenue ruling which they herein attack as inapplicable. On the other hand,the United States has shown a consistency in letter and spirit between the code, rulings andregulations, and court decisions.

Plaintiffs Contention #2: If any tax was due, it was in 1957 when the piano was purchased,

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and by 1964 the Government was blocked from collecting it by reason of the statute oflimitations.Court: The $4,467.00 in old currency was not "reduced to undisputed possession" until itsactual discovery in 1964, and thus the United States was not barred by the statute oflimitations from collecting the $836.51 in tax during that year.

HORNUNG V. CIR47 TC 428 (1967)

Flo: This case is long (LUCKY ME!) and has 3 issues. I believe the most important is the 1 st ,because it discusses prizes and winnings, nevertheless, I included the other 2.

FACTS:In 1961, Paul Hornung (plaintiff) was a football player for the Green Bay Packers. OnDecember 31, 1961, Sunday, Hornung played in the National Football League (NFL)championship game and won. Sport Magazine (Sport) named him the outstanding player ofthe game. Sport is a New York publication that annually awards a new Corvette to athletesfor outstanding performance. It announced the award to Hornung immediately after thegame but did not make the car available to Hornung on the same day. Hornung did notreceive a key or title to the car, and no arrangements were made for Hornung to receive thecar prior to the luncheon. ( Hornung was not required to attend this luncheon or perform anyother services in order to receive the vehicle.)

At the time, the car was held at a New York dealership that was closed on Sundays. Although in previous years, Sport made the car available for pick up in New York on the dayof the game, Sport did not believe the winner of the car would choose to travel from GreenBay to New York City immediately after the game.

The fair market value of the Corvette was $3,331.04. Hornung sold the vehicle and reportedthis sale on his 1962 Federal income tax return. However, he did not include the fair marketvalue of the car (when he received it) in his tax return for 1962 or any other year. TheCommissioner (defendant) determined the value of the car should have been included inHornungs gross income for 1962.

ISSUE: WON the value of a 1962 Chevrolet Corvette won by Paul Hornung (taxpayer) forhis performance in the 1961 NFL championship game should be included in his grossincome for the taxable year 1962.

HELD: YES! The value of the car should have been included in Hornung!

s gross incomefor 1962 because the Corvette was received in 1962, and not excludable from taxableincome as a gift or applicable award or prize.

RATIO:

Hornung did not, for income tax purposes, constructively receive the Corvette in 1961,but rather received it in 1962.

Hornungs arguments:(1) that the Corvette was a gift and therefore exempt from federal income tax;

(2) that it was constructively received by him in 1961, and therefore was not subject tofederal income tax in the year of 1962.

On the 1 st argument:The court determined that the Corvette was not given as a gift because Sport Magazine hada motive for giving it beyond a 'detached and disinterested generosity' (a requisite for a

judicial finding of a 'gift'). The court dismissed Hornung's claims that the championshipfootball game constitutes an educational, artistic, scientific, or civic achievement. The courtreaffirmed the principle that words in the revenue acts should be interpreted in theirordinary, everyday sense. The court believed the exceptions articulated in 74(b) refer to"activities enhancing in one way or another the public good."

On the 2 nd argument:Under the Internal Revenue Code ,

"the amount of any item of gross income shall be included in the gross income forthe taxable year in which received by the taxpayer ..."

Under the cash receipts method , which Hornung had appropriately utilized, itemsconstituting gross income are to be included for the taxable year in which they are actuallyor constructively received. The court noted that an item is constructively received when ithas been set apart for the taxpayer or otherwise made available for him to draw upon, if theintention to do so is known. But "income is not constructively received if the taxpayer'scontrol of its receipt is subject to substantial limitations or restrictions."

The court found that on Sunday, December 31, 1961, there were substantial limitations orrestrictions on Hornungs control over the Corvette. At that time, the car was physically inthe state of New York, and the editor in chief of Sport Magazine had neither keys nor title tothe vehicle to give to Hornung to establish his possession. Additionally, because December31, 1961 was a Sunday, the dealership where the car was kept was closed, and Hornungcould not have accessed it on that date even if he wanted to.

Based on the above, the Tax Court held that the constructive receipt doctrine wasinapplicable and the Corvette was received by Hornung for income tax purposes in 1962.

Pertaining to the 1962 Thunderbirds Pertaining to the Fur StoleIn July 1962, Hornung asked a friend to

arrange for a car to be available for him to drivewhile in Green Bay. A local Ford dealershipfurnished Hornung with a 1962 Thunderbird, laterexchanging the original for a second 1962Thunderbird. The title to the cars remained withFord, though Hornung paid the insurance and alloperating costs while driving the Thunderbirds.

Hornung was not asked to make anypersonal appearances or special efforts for thedealership, except that he was asked to "come inand say hi" during a Ford-sponsored children'sfootball event. Ford had also furnished otherGreen Bay Packers with vehicles for their usearound Green Bay.

Hornung did not recognize or report anyincome associated with this use. The value of thisuse was determined to be $600.

After winning the Western Division title ofthe National Football League in 1961, VinceLombardi bought and distributed fur stoles to thewives, friends, and mothers of each player on theteam. Hornung's mother received the stole in1961. The stoles were reported by the Packers as"Other Unallowable Deductions" and weredescribed as "Awards to players' wives, etc." Thestoles were valued at $395 per stole, less an 8-percent bulk discount.

Hornung did not report any gross incomewith respect to the stole given to his mother.

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Whether the value of the use of the1962 Thunderbird automobiles furnished toHornung by Ford should be included in grossincome for the taxable year 1962;

Whether Hornung's gross income for 1962 shouldinclude the value of a fur stole received by hismother from his employer.

The court found that Hornung had not met theburden of proving his use of the Thunderbirds wasa gift. Therefore, the economic benefit hereceived was taxable gross income.

The stole was not income to Hornung in 1962, asit was actually received in 1961.

Hornung argued that the use of theThunderbirds was a gift under section 102, sincehe was not obligated to perform any services touse the cars.

The court focused on the dealership'sintentions in making the loan, and determined thatHornung had not sufficiently proven that theloaned cars were given as a result of 'detachedand disinterested generosity.

The court then considered whether theeconomic benefit to Hornung was gross income.Relying on the test provided in Commissioner v.Glenshaw Glass Co. , the court found that thebenefit was an undeniable accession to wealth,clearly realized, and over which Hornung hadcomplete dominion; and therefore was taxablegross income under section 61 of the tax code.

The court dispensed of this issue easily by notingthat the stole was actually received by Hornung'smother in 1961. Therefore, it did not constituteincome in 1962.

3. Tax Benefit Principle Recovery Of Deducted Items

SEC. 34. Deductions from Gross Income.Except for taxpayers earning compensation income arising from personal services

rendered under an employeremployee relationship where no deductions shall be allowed under this Section other thanunder subsection (M) hereof, in computing taxable income subject to income tax underSections 24 (A); 25 (A); 26; 27 (A), (B) and (C); and 28 (A) (1), there shall be allowed thefollowing deductions from gross income;

(E) Bad Debts.(1) In General .Debts due to the taxpayer actually ascertained to be worthless and charged off

within the taxable year except those not connected with profession, trade orbusiness and those sustained in a transaction entered into between parties

mentioned under Section 36 (B) of this Code: Provided, That recovery of baddebts previously allowed as deduction in the preceding years shall be includedas part of the gross income in the year of recovery to the extent of the incometax benefit of said deduction.

BIR Rul. 102-95(July 7, 1995)

4. Indirect Receipts Cancellation Of Indebtedness And Discharge By 3 r Parties

Sec. 50, Rev. Regs. 2SECTION 50. Forgiveness of indebtedness. The cancellation andforgiveness of indebtedness may amount to a payment of income, to a gift, or to acapital transaction, dependent upon the circumstances. If, for example, an individualperforms services for a creditor, who, in consideration thereof cancels the debt,income to that amount is realized by the debtor as compensation for his services. If,however, a creditor merely desires to benefit a debtor and without any considerationtherefor cancels the debt, the amount of the debt is a gift from the creditor to thedebtor and need not be included in the latter's gross income. If a corporation towhich a stockholder is indebted forgives the debt, the transaction has the effect ofthe payment of a dividend.

BIR RUL. 76-89(APRIL 17, 1989)

Doctrine: When a creditor cancels a debt as part of a business transaction, the debtor isenriched or its net assets has been increased and, therefore, he realized taxable income.However, a transaction whereby nothing of exchangeable value comes to or is received bya taxpayer does not give rise to or create taxable income.

FACTS:General Motors Pilipinas, Inc. (GMPI) is a joint venture corporation owned 60% by GeneralMotors Overseas Distribution Corporation (GM-US) and 40% by Isuzu Motors Limited ofJapan (ISUZU). GMPI was engaged in the manufacture of transmissions and componentsas well as in the assembly of cars and trucks (largely Isuzu).

September 1985, due to economic recession in the Phil. and the depressed automotivemarket, plus the non-availability of foreign exchange for the importation of parts for car andtruck assemblies, GMPI ceased its operations. GMPI, from that time, was insolvent and hassince remained as such.

December 1985, the SH and the BOD of GMPI recommended its dissolution approved aresolution to shorten GMPI's corporate life to October 1986. Pursuant to the resolution,GMPI filed with the SEC an application to amend its Articles of Incorporation.

Based on the December 31, 1988 unaudited financial statements of GMPI, it hasoutstanding liabilities/indebtedness to banks and affiliates in the following amounts:

Bank DebtNon-Trade Related Principal P280,150

Interest 54,522

Trade Related Principal 246,942Interest 48,093

Due to Affiliated CompaniesIsuzu Motors Limited P113,240

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General Motors Corp. (GMC) 19,334 132,574

TOTAL P762,281=======

Total outstanding liabilities to banks and GMC plus accrued interest = P649,041,0001987 GMPI capital deficiency = P664,522,0001988 capital deficiency = P739,057,000Value of property, plant and equipment = P20,450,000

Since GM-US has no further interest to continue its ownership in the defunct GMPI, itassigned its 60% shares in GMPI to Isuzu. It was agreed that GMPI would "clean-up" itscurrent outstanding liabilities except the liability to Isuzu, to be accomplished when theshares are transferred in three steps, as follows:(1) By having GMPI's creditor banks waive accrued interest on the non-trade and traderelated debt;(2) By having these banks assign to GM-US, its GMPI non-trade related receivables.

At that time GM-US will condone the total GMPI indebtedness due to it amounting toP299,484,000 including the aforementioned non-trade debt as well as other non-trade liabilities due GMC;

(3) By having the banks grant a participation to GM-US in GMPI trade related receivables,GM-US would then assign these receivables to Isuzu.

Later, Isuzu, as the new 100% parent company, considered infusing additional capital torestore the business into a viable operation and eliminate the capital deficiency so that thecompany will resume its "going concern" status. And that as a going concern, its assets

previously adjusted to liquidation values, shall be restored to its valuation prior to liquidation.

ISSUE: WON the bank's waiver (of accrued interest on the non-trade and trade relatedindebtedness of GMPI) and GM-US condonation (of GMPI's non-trade related indebtedness) aresubject to income tax or to gift tax.

HELD: NO! Banks waiver and GM-US condonation are NOT subject to income or gift tax.

RATIO:GM-USs condonation of GMPI's indebtedness is NOT subject to income tax since beforeand after the condonation GMPI remains insolvent, i.e., in a capital deficiency position. Thecondonation is likewise NOT subject to gift tax since there is no donative interest on the partof GM-US but solely for business consideration since Isuzu will only acquire the GMPIshares from GM-US if GMPI has a "clean" balance sheet with no outstanding liabilities

except those to Isuzu.Moreover, a return to solvency due to a possible future additional capital infusion by Isuzuand/or subsequent profitability in a different taxable year will not affect the non-taxability ofthe condonation.

Cancellation and forgiveness of indebtedness may amount to a payment of income / to a gift/ or to a capital transaction, dependent upon the circumstances.

Examples:If an individual performs services for a Then income to that amount is

creditor who, in consideration thereofcancels the debt

realized by the debtor ascompensation for his services

If a creditor merely desires to benefit adebtor and without any considerationtherefor cancels the debt

Then amount of the debt is a giftfrom the creditor to the debtor andneed not be included in the latter'sgross income

If a corporation to which a stockholder isindebted forgives the debt, the transactionhas the effect of the payment of adividend

(Sec. 50 Revenue Regulations No. 2)

The waiver of interest by the bankson non-trade and trade relatedindebtedness of GMPI is not subjectto income tax considering that the

deduction of said interest as expensein prior years did not offset norreduce the taxable income of GMPIsince it was in a financial lossposition even without the deduction.

Old Colony Trust Co. v. CIR 279 U.S. 716 (1929)

Facts:

In 1916, the American Woolen Company adopted a resolution which provided that thecompany would pay all taxes due on the salaries of the company's officers. It calculated theemployees' tax liabilities based on a gross income that omitted, or excluded, the amount ofthe income taxes themselves.

In 1925, the Bureau of Internal Revenue assessed a deficiency for the amount of taxes paidon behalf of the company's president, William Madison Wood, arguing that his $681,169.88tax payment had wrongly been excluded from his gross income in 1919, and that his$351,179.27 tax payment had wrongly been excluded from his gross income in 1920. OldColony Trust Co., as the executors of Wood's estate, filed suit in the District Court for arefund, then appealed to the Board of Tax Appeals (the predecessor to the United StatesTax Court). The petitioners then appealed the Board's decision to the United States Court of

Appeals for the First Circuit.

Issue: Were the taxes paid by the company additional income of Wood?

Held:YES. Taft held that payment of Mr. Wood's taxes by his employer constituted additionaltaxable income to him for the years in question. The fact that a person induced or permitteda third party from paying income taxes on his behalf does not excuse him from filing a taxreturn. Furthermore, Taft added, "The discharge by a third person of an obligation to him isequivalent to receipt by the person taxed."

Thus, the company's payment of Wood's tax bill was the same as giving him extra income,regardless of the mode of payment. Nor could the payment of taxes of Wood's behalfconstitute a gift in the legal sense, because it was made in consideration of his services tothe company, thus making it part of his compensation package. (This case did not change

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the general rule that gifts are not includable in gross income for the purposes of U.S.Federal income taxation, while some gifts but not all gifts from an employer to an employeeare taxable to the employee

The Supreme Court notes that Wood and other employees received a direct benefit whenthe company discharged their tax obligation. Wood received a benefit in exchange for hisservices to the company. This was clearly a taxable gain.

Notes:The payment of the tax by the employers was in consideration of the

services rendered by the employee, and was again derived by the employee from hislabor . The form of the payment is expressly declared to make no difference. It is thereforeimmaterial that the taxes were directly paid over to the government. The discharge by athird person of an obligation to him is equivalent to receipt by the person taxed . Thecertificate shows that the taxes were imposed upon the employee, that the taxes wereactually paid by the employer, and that the employee entered upon his duties in the years inquestion under the express agreement that his income taxes would be paid by his employer.This is evidenced by the terms of the resolution passed August 3, 1916, more than one yearprior to the year in which the taxes were imposed. The taxes were paid upon a valuableconsideration, namely, the services rendered by the employee and as part of thecompensation therefor. We think, therefore, that the payment constituted income to theemployee.

'In no view of the evidence, therefore, can the $35,000 be regarded as a gift. It waseither compensation for services rendered or a gain or profit derived from the sale of thestock of the corporation, or both; and, in any view, it was taxable as income.'

BIR Rul. 85-95 (June 13, 1995)

Facts:Subic Power Corporation (SPC) is registered with the Subic Bay Metropolitan Authority(SBMA) to engage in the business of generation and sale of electric power. SPC has acontract with the National Power Corporation to develop, construct and operate a 108megawatt power station in the Subic Bay Freeport, Olongapo City and the estimated cost ofthe power station project is about U.S. $143.0 million

To finance the project, SPC has undertaken a "Rule 144 A" offering in the U.S. and hasissued notes under an Indenture Agreement; that the notes are direct obligation of SPC andare floated in the U.S.; that under the Indenture Agreement, SPC will pay interest to the

holders of the notes without any withholding or deduction for any taxes imposed orlevied by the Philippine Government ; that the said tax assumption is not only inconformity with the international banking practice on foreign loans, but also primarily as aconsideration for the credit and in lieu of additional interest that would have beenimposed had SPC not agreed to assume the Philippine withholding tax ; that therefore,the Philippine withholding tax on the interest is passed on to SPC and it assumes thepayment of the tax; that SPC bears the burden of and becomes directly liable to thetax otherwise due from the noteholders ; that the Philippine withholding tax on the interestbecomes SPC's additional tax liability, and an addition to its financing chargesassociated in the construction of the power plant.

Issue/Query:

W/N The withholding tax base for purposes of applying the 5% final withholding tax is thetotal amount of income to be remitted without grossing up the 5% final withholding tax duethereon.

Held:

YES. The assumption of the tax constitutes an additional income of the non-residentcreditor-bondholders, which in turn should be subject to tax. (Old Colony Trust Co. vs.Commissioner, 279 U.S. 716). Thus, the tax base should be grossed-up by adding to theinterest income payments the amount of tax assumed.

III. GROSS INCOME

A. Inclusions

SEC. 32. Gross Income. -(A) General Definition. - Except when otherwise provided in this Title, grossincome means all income derived from whatever source, including (but notlimited to) the following items:

(1) Compensation for services in whatever form paid, including, but notlimited to fees, salaries, wages, commissions, and similar items;(2) Gross income derived from the conduct of trade or business or theexercise of a profession;(3) Gains derived from dealings in property;(4) Interests;(5) Rents;(6) Royalties;(7) Dividends;(8) Annuities;(9) Prizes and winnings;(10) Pensions; and(11) Partner's distributive share from the net income of the generalprofessional partnership.

1. Compensation: Special Problems on In-Kind Compensation

Sec. 2.78.1(A) and (1), Rev. Regs. 2-98 (April 17, 1998)

(A) Compensation Income Defined . In general, the term "compensation" means allremuneration for services performed by an employee for his employer under anemployer-employee relationship, unless specifically excluded by the Code.

The name by which the remuneration for services is designated is immaterial. Thus,

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salaries, wages, emoluments and honoraria, allowances, commissions (e.g.transportation, representation, entertainment and the like); fees including director'sfees, if the director is, at the same time, an employee of the employer/corporation;taxable bonuses and fringe benefits except those which are subject to the fringebenefits tax under Sec. 33 of the Code; taxable pensions and retirement pay; andother income of a similar nature constitute compensation income.

The basis upon which the remuneration is paid is immaterial in determining whetherthe remuneration constitutes compensation. Thus, it may be paid on the basis ofpiece-work, or a percentage of profits; and may be paid hourly, daily, weekly, monthlyor annually.

Remuneration for services constitutes compensation even if the relationship ofemployer and employee does not exist any longer at the time when payment is madebetween the person in whose employ the services had been performed and theindividual who performed them.

(1) Compensation paid in kind . Compensation may be paid in money or insome medium other than money, as for example, stocks, bonds or other forms ofproperty. If services are paid for in a medium other than money, the fair market valueof the thing taken in payment is the amount to be included as compensation subjectto withholding. If the services are rendered at a stipulated price, in the absence ofevidence to the contrary, such price will be presumed to be the fair market value ofthe remuneration received. If a corporation transfers to its employees its own stockas remuneration for services rendered by the employee, the amount of such

remuneration is the fair market value of the stock at the time the services wererendered.

a. Limited Choice and Restricted Property

U.S. v. Drescher179 F.2d 863 (2nd Cir. 1950)

Facts:Drescher was an employee of Bausch and Lomb who was given voluntary

retirement before he reached 65. He was given in recognition of prior services rendered anon-transferable annuity that would begin to pay when he reached 65 in 1958 )or to hisdesignated beneficiary if he died), for which the company paid a premium of $5,000 anddeducted as compensation to Drescher. The policy had no cash surrender value. It was onlya guaranteed future income stream for himself or his beneficiary.

Issue:What is the includable income value of the annuity in the present tax year? Is it the

price of the premium paid by the company ($5,000), or is it zero because the annuity givesthe taxpayer no present income?

Held:

YES. Taxable. The present value of an annuity which is non-transferable is equalto the cost to the taxpayer of acquiring identical rights. An annuity is deferred compensation.Sec. 22(b) (2) "Annuities, etc; Amounts received (other than amounts paid by reason of thedeath of the insured and interest payments on such amounts and other than amountsreceived as annuities) under a life insurance or endowment contract, but if such amounts(when added to amounts received before the taxable year under such contract) exceed theaggregate premiums or consideration paid (whether or not paid during the taxable year)then the excess shall be included in gross income.

The court reasoned that the value lie somewhere between the premium price paidand zero. Even though the taxpayer might die before the annuity started paying, he hadsome present rights to a future income stream, which he could designate to a beneficiary.Furthermore, the taxpayer could realize present cash payment from a third party who hecould designate as a trustee to hold the future payments in trust for him. However, thiswould probably be worth less than the premium paid by the company based on the risk ofthe taxpayer dying before the annuity began paying, and thus the payments going to thebeneficiary. However, the burden of proof was on Drescher to show that the present valuewas less than $5,000.Dissent (CLARK)

The dissent reasoned that the value was the amount paid by the companybecause it represented the present value of the future payments, and was consideration forthe contract between the taxpayer and the company. The amount of the policy premiumrepresented what the market expected the present value of the aggregate payments overDreschers life to be, which was greater than $5,000.

BIR Rul. 9-04(Sept. 13, 2004)

Facts: ANZ (Australia and New Zealand) Bank was organized under the laws of Australia;

that its shares are listed and traded in the Australian Stock exchange; that in order toincrease employee motivation and to create a stronger link between increasing shareholdervalue and its employee reward system ANZ Bank has established the ANZ Employee Share

Acquisition Plan (ESAP) to provide employees with the opportunity to participate in thegrowth of the Bank.

Under the ESAP, all employees, including executive officers, with at least one yearof service with the Bank will be offered Australian registered shares in ANZ Bank free of

charge. There are two schemes under the plan: (1) the general scheme and (2) theincentive scheme. Under both schemes, a trading lock of three years from the date ofaward or from the termination of employment from ANZ in case of general scheme shall beimplemented. During the trading lock, a Trustee will hold the shares on behalf of theemployees . Dividends accruing to the employees during the trading lock are required to bereinvested in ANZ shares under the compulsory participation requirement of theDividend Reinvestment Plan (DRP). As such, employees cannot receive cash dividends;the cash dividends will be received in the form of additional ANZ shares . Theadditional shares will be released from restriction at the same time the participant's planshares are released.

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The main distinction between the two scheme is that in general scheme, sharesare not forfeitable under any circumstance whereas in the incentive scheme the shares andany accumulated DRP shares will be forfeited if the employee resigns or is dismissed beforethe end of the three year restriction period; that however, if the employee retires or is maderedundant, the shares will not be forfeited; that they will be transferred to him followingtermination of employment.

Issue/Query:1. W/N shares granted under the ANZ ESAP Plan which are subject to disposal

restriction and forfeiture clause (the latter applies to ESAP shares under incentive scheme)at the time of grant shall not be taxed until the disposal restriction is lifted.

2. W/N dividends from ANZ ESAP shares which are mandatorily reinvestedthrough the ANZ Dividend Reinvestment Plan (DRP), with the same disposal restrictionsand/or forfeiture clauses as the original shares, shall not also be taxed until the disposalrestriction is lifted.

HELD:In both instances NOT TAXABLE until disposal restriction of three years is

lifted.

1. Section 32(A)(l) of the Tax Code