PORTFOLIO

Gross Income: Tax Benefit, Claim of Right and Assignment of Income (Portfolio 502)

Tax Management Portfolio, Gross Income: Tax Benefit, Claim of Right and Assignment of Income, No. 502-4th, addresses three areas of gross income that are substantially judicial in origin and nature. It analyzes in depth the nature, concept, scope, and application of the tax benefit doctrine, the claim of right doctrine, and the assignment of income doctrine.

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DESCRIPTION

Tax Management Portfolio, Gross Income: Tax Benefit, Claim of Right and Assignment of Income, No. 502-4th, addresses three areas of gross income that are substantially judicial in origin and nature. It analyzes in depth the nature, concept, scope, and application of the tax benefit doctrine, the claim of right doctrine, and the assignment of income doctrine.

The tax benefit doctrine excludes from a taxpayer's gross income any recovery or refund of an amount deducted in a prior taxable year to the extent the deduction did not reduce tax liability.
Under the claim of right doctrine, a taxpayer must include in gross income for the year of receipt any income received under a claim of right free of restrictions.

Under the assignment of income doctrine, gross income from personal services must be included in the gross income of the person who rendered the services. In addition, under that doctrine, gross income from property must be included in the gross income of the person who beneficially owns the property.

The Worksheets include relevant legislative history for provisions discussed in detail and for which regulations have not yet been issued.


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AUTHORS

JAMES EDWARD MAULE
James Edward Maule, B.S., University of Pennsylvania (1973); J.D., Villanova University (1976); LL.M. (Taxation), George Washington University (1979); lecturer, Villanova University Graduate Tax Program and Tax Forum CLE Programs; lecturer, Philadelphia Bar Association Tax Section; member, U.S. Income Advisory Board, Tax Management Inc.; former attorney-advisor, United States Tax Court, Judge Herbert L. Chabot; former attorney-advisor, Chief Counsel to the Internal Revenue Service; former Editorial Advisory Board member and Columnist, Journal of Limited Liability Companies; former lecturer, ALI-ABA; former lecturer, Tax Management, Inc. & Continuing Legal Education Satellite Network; former lecturer, Pennsylvania Bar Institute; former lecturer, Georgetown University Law Center Institute on State and Local Taxation; former lecturer, The Dickinson School of Law CLE Programs; member, American Bar Association, Section of Taxation, Committee on S Corporations (Consultant and former Chair, Subcommittee on Subchapter S and State Law; former Chair, Subcommittee on Comparison of Partnerships and S Corporations); member, American Bar Association, Section of Taxation, Committee on Teaching Taxation (Chair, Subcommittee on Manuscripts and Unpublished Teaching Materials; member, Subcommittee on Important Developments); member, American Bar Association, Section of Taxation, Tax Practice Management Committee; member, American Bar Association, Section of Taxation, Formation of Tax Policy Committee; member, American Bar Association, Section of Taxation, Committee on Tax Structure and Simplification; former Chair, American Bar Association, Section of Taxation, Phaseout Tax Elimination Project; former member, American Bar Association, Section of Taxation, Task Force on Pass-Through Entities; former member, American Bar Association, Section of Taxation, Task Force on Legislative Recommendation No. 86-1; former member, Philadelphia Bar Association Tax Section; author and owner, TaxJEM Inc., publisher of computer assisted legal instruction programs; owner, JEMBook Publishing Company, publisher of law and genealogy books; author of numerous books, monographs, and book chapters; contributor to various tax periodicals.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. Tax Benefit Doctrine

A. In General

1. Deductions for Prior Taxable Years

2. Credits for Prior Taxable Years

3. Limitations

a. No Elimination of Deduction Through Amended Return

b. No Reverse Benefit Doctrine

c. No Recharacterization of Net Operating Losses

4. Burden of Proof

5. Inclusions Not Requiring Tax Benefit

6. Alternative Minimum Tax

B. Scope of Tax Benefit Doctrine

1. Items Subject to the Doctrine

a. In General

b. Professional Fees

c. Insurance Premiums

(1) Automobile Insurance

(2) Compensation Insurance

(3) Mortgage Insurance

(4) Life Insurance

d. Employee Benefit Plan Contributions

e. Rent

f. Employee Business Expenses

g. Miscellaneous Business Expenses

h. Taxes

(1) Refunds of Invalid Taxes

(2) Overpaid, Overwithheld, and Rebated Income Taxes

(3) Rebated Real Property Taxes

(4) Personal Property Tax Refunds

(5) Estate Taxes

(6) Sales Taxes

i. Losses

j. Charitable Contributions

k. Expenses in Connection with Mortgaged Property

2. Exclusions from the Tax Benefit Doctrine

a. Depreciation, Depletion, Amortization, and Amortizable Bond Premiums

b. Other Exclusions

c. Recovery Occurring in Taxable Year of Deduction

d. Income Not Previously Reported

e. Repossession of Amounts Always Owned by Taxpayer

f. Cooperatives' Qualified Written Notices of Allocation

3. Propriety of Deduction Claimed for Prior Taxable Year

4. Recovery for Which No Deduction Claimed in Earlier Taxable Year

5. Other Deductions Not Claimed for Prior Taxable Year

C. Definition of Recovery

1. In General

2. Form of Recovery

3. Relationship of Recovery to Prior Deduction

4. Amount Received Greater Than Prior Deduction

5. Amount Received If No Prior Deduction

6. Application to Bad Debt and Other Reserves

D. Computation of Amounts Included and Excluded

1. Determination of Tax Benefit

2. Treatment of Carryforwards

3. Recovery of Item Deducted in More Than One Earlier Taxable Year

4. Value At Which Recovery Included in Gross Income

a. In General

b. Recovery of Property Contributed to Charity

5. Recovery of Capital Loss Deductions

6. Character of Recovery

E. Persons Within Scope of Tax Benefit Doctrine

1. In General

2. Transfers of Right to Receive Recovery

3. Partnerships

4. Consolidated Returns

5. Transfer and Reacquisition of Deducted Item

F. Accumulated Earnings Tax and Personal Holding Company Tax

1. Recoveries of Amounts Deducted in Prior Taxable Year

2. Recoveries of Amounts Not Deducted in Prior Taxable Years

G. Restoration in Value of Certain Securities

1. In General

2. Applicable Securities

3. Limitations

4. Characterization

III. Claim of Right Doctrine

A. Nature and Origin of the Doctrine

1. In General

2. Origin of the Doctrine

3. Relationship to Annual Accounting Period Concept

4. Effect of the Doctrine

B. General Rules

1. Elements of the Doctrine

2. Receipt of Income

a. Income

(1) In General

(2) Uncertainty with Respect to Income Status

(3) Conflict Over Nature of Transaction

(4) Relationship with Prepaid Income Issues

b. Receipt

(1) Cash Method Taxpayer

(2) Accrual Method Taxpayer

(3) Denial of Access

3. Under a Claim of Right

a. Bona Fide Nature of Claim

(1) In General

(2) Acts Inconsistent with Bona Fide Claim

(3) Agency

(4) Renouncement

b. Pending Dispute

c. Illegitimate Claims

(1) Violation of Law

(2) Embezzlement and False Pretenses

(3) Breach of Fiduciary Duty

(4) Breach of Contract

4. Without Restriction

a. In General

b. Trust and Stakeholder Situations

(1) In General

(2) Amounts Received for Services

(3) Limited Rights and Voluntary Trusts

(4) Lack of Express Trust

(5) Constructive Trust

(6) Stakeholders

c. Posting Bond

d. Placement of Income into Separate Account

e. Contingent Repayment Obligations

C. Repayment of Amounts Received Under Claim of Right

1. In General

a. Right to Deduction

b. Existence of Right to Deduction

(1) Statutory Grounds

(2) Actual Payment

(3) Voluntary Repayment

c. Bar on Reopening Year of Inclusion

2. Statutory Mitigation

a. Introduction

b. Requirements To Be Met

(1) In General

(2) Item Previously Included in Gross Income

(3) Appearance of Unrestricted Right to Income

(4) Entitlement to Deduction

(a) In General

(b) Relationship Between Deduction and Inclusion

(c) Impact on Cost of Goods Sold

(5) Repayment Because Lack of Unrestricted Right Established

(a) Lack of Unrestricted Right

(b) When Lack of Unrestricted Right Must Be Determined

(6) Limitation to Deductions Exceeding $3,000

c. Transactions Excluded from § 1341

(1) Inventory

(2) Bad Debts

(3) Dealers' Reserve Credits

(4) Legal Fees and Expenses Resisting Repayment

(5) Amounts Not Previously Reported as Income

d. Application of § 1341

(1) In General

(2) Section 1341(a)(4)

(3) Section 1341(a)(5)

(a) In General

(b) Repayment in Excess of Income Amount

(c) Decrease in Tax Not Limited by Tax Liability

(d) Adjustments to Tax Liability for Previous Year

(e) Alternative Minimum Tax

e. Special Rules

(1) Inclusions in More Than One Previous Year

(2) Net Operating Losses Arising in Year of Repayment

(3) Net Operating Loss Arising in Previous Year of Inclusion

(4) Impact on Unrelated Net Operating Losses

f. Taxpayers Entitled to Use § 1341

IV. Assignment of Income

A. Introduction

B. Nonstatutory Assignment of Income

1. Factors Relevant to Application of Doctrine

a. Valid Transfer of Property

(1) In General

(2) Delivery of Property

(3) Transfers by Gift

(4) Transfers to Minors

b. Retention of Benefits and Burdens of Ownership

(1) Retention of Control

(a) In General

(b) Imposition of Conditions

(c) Intent to Convey in Future

(d) Control of Professional Corporation

(e) Insufficient Consideration

(f) Retention of Burdens

(2) Satisfaction of Transferor's Obligations

(a) In General

(b) Stock and Dividends

(c) Rent and Other Lease Obligations

(d) Taxes and Penalties

(e) Purchaser's Obligations

(f) Employee's Obligations

(3) Retention of Possession

(4) Retention of Income

c. Privity of Contract

2. Scope of Doctrine

a. In General

b. Income from Services

(1) In General

(2) Assignment Pursuant to Employees' Consent

(3) Prizes

(4) Assignment of Rights Under Contract for Services

(5) Assignment to Partnership

c. Income from Property

(1) Businesses

(a) Taxpayer Control

(b) Taxpayer Participation

(c) Formation and Financing of Business

(d) Transfer of Business Assets

(e) Income Generated by Capital

(2) Jointly Held Property

(a) In General

(b) Financing of Property

(c) Tenancy by the Entirety and Community Property

(3) Corporate Stock

(a) In General

(b) Discharge of Obligations

(c) Transfer After Declaration

(d) Transfer After Authorization

(e) Reserved Dividends

(f) Controlled Corporation

(g) Liquidating Dividends

(4) Interest-Bearing Property

(a) In General

(b) Co-Owned Property

(c) Assignment of Interest Only

(d) Accrued Interest

(5) Rental Property

(a) Assignment of Rent

(b) Assignment of Lease

(c) Lease Cancellation

(d) Assignments for Life

(e) Lease Stripping Transactions

(6) Contract Rights

(a) Patent Royalties

(b) Copyrights

(c) Business Contracts

(d) Litigated Contract Claims

(7) Oil, Gas and Mineral Properties

(a) Oil Payments

(b) Oil, Gas and Mineral Royalties

(8) Partnership Interest

(a) In General

(b) Assignments of Interests

(c) Ascertaining Transferee's Partnership Status

(d) Transfer for Value

(9) S Corporation Stock

(10) Beneficiary's Trust Interest

(a) In General

(b) Assignment for Less Than Full Life Term

(c) Restrictions on Assigned Interest

(d) Restrictions on Assignment

(e) Effect of State Law

(f) Assignments to Satisfy Taxpayer's Obligations

(11) Proceeds of Disposition to Third Party

(a) Assignment of Proceeds

(b) Transfer of Property Followed by Sale

(c) Transfer of Option

d. Anticipatory Assignment

(1) As Part of Contract

(2) Of Contract

(3) Of Right to Receive Income for Past Services

(4) Services Subject to Vow of Poverty

e. Application to Gratuitous Transfers

(1) Gifts

(2) Charitable Contributions

3. Exceptions

a. Agency

(1) In General

(2) Partial Agency

(3) Agency Arising from Agreement to Share Income

(4) Proof of Agency

(5) Lack of Agency

(6) Transactions Benefitting Alleged Agent

(7) Acts Beyond Scope of Agency

(8) Breach of Agency

(9) Agency for Specific Transaction

(a) Limited Transaction

(b) Funds Pooled for Limited Purpose

(c) Effect on Burden of Proof

(10) Amounts Remitted to Employer

(11) Amounts Used for Principal's Benefit

(a) Treatment of Agent

(b) Treatment of Principal

(12) Buyers and Sellers

(a) Income Attributable to Periods After Sale

(b) Income Attributable to Periods Before Sale

(13) Corporations and Shareholders

(a) Corporation as Agent

(i) In General

(ii) Property Transactions

(iii) Services

(b) Shareholder as Agent

(c) Other Arrangements

(d) Subsidiary as Agent

(e) Officer as Agent

(14) Corporate Reorganizations

(15) Corporate Liquidations

b. Trustees

(1) In General

(2) Family Transactions

(3) Pooled Funds

(a) In General

(b) Cemetery and Similar Associations

(c) Environmental Credits

c. Nominees

(1) In General

(2) Beneficial Owner

(3) Proof of Nominee Status

(4) Factors

(a) Provision of Acquisition Funds

(b) Risk of Loss

(c) Restrictions on Ownership Rights

(d) Control of Property

(e) Control and Disposition of Income

(f) Property Held as Collateral

d. Constructive Trustee

(1) In General

(2) Erroneous Possession

(3) Governmental Compulsion

(4) Voluntary Actions

(5) Escrow

(a) In General

(b) Exchange Funds

(c) Pre-Closing Escrows

(d) Contingent At-Closing Escrows

(e) Disputed Ownership Funds

e. Restricted Ownership

(1) Possession Without Ownership

(2) Restricted Income Rights

(3) Property Subject to Spousal Rights

(4) Property Received for Designated Purposes

f. Contingent Income Rights

g. Waiver

C. Statutory Incorporation of Assignment of Income Doctrine

1. In General

2. Trusts

a. In General

b. Conditions Under Which Grantor Trust Rules Apply

3. Partnerships

a. In General

b. Substantial Economic Effect

c. Contributed Property

d. Potentially Abusive Partnerships

(1) In General

(2) Recognition as Partner

(3) Allocation of Income

(4) Purchase of Partnership Interest by Family Members

e. Retroactive Allocations

4. S Corporations

5. Personal Service Corporations

6. Related Party Reallocation

7. Income of a Minor Child

a. Inclusion in Child's Gross Income

b. Tax Computation


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Legislative History of Code § 111 As Amended by the Tax Reform Act of 1984 (P.L. 98-369)

Worksheet 2 Legislative History of Code § 111 as Amended by the Tax Reform Act of 1986 (P.L. 99-514)

Bibliography

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Public Laws:

Regulations:

Legislative History:

Treasury Rulings:

Cases:

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