Exclusions from Gross Income

• Author: William Kratzke
• Pages: 136-194

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Chapter 3: Exclusions from Gross Income

In this chapter, we take up exclusions from gross income. Congress has chosen –

for various reasons – to permit taxpayers not to “count” certain accessions to wealth

in their gross income. An exclusion is not the same as a deduction. A deduction is

a reduction (subtraction) from what would otherwise be “taxable income.” An

exclusion does not even count as “gross income,” and so cannot become “taxable

income” – even though it usually is quite clearly an “accession to wealth.” We are

still focusing on the first line of the “tax formula” – only now we are examining

accessions to wealth that are not included in gross income as opposed to those that

are. Deductions come later.

The availability of exclusions may

have several consequences:

•Taxpayers may feel

encouragement to seek

wealth in forms that the Code

excludes from their gross

income. They might do this

in preference to procuring

wealth in a form subject to

income tax.

•The fact that a taxpayer may

acquire a particular form of

wealth without bearing any

tax burden does not mean

that the taxpayer necessarily

enjoys the full benefit of the exclusion. Others may “capture” some or all

of the benefit.

•The fact that many taxpayers find a particular benefit to be attractive will

most certainly affect the market for that benefit, e.g., health care. Taxpayers

acting as consumers will bid up the price of the benefit and so must spend

more to acquire such forms of wealth (benefits) than they would if all

taxpayers had to purchase the benefit with after-tax dollars. The price of

acquiring the tax-favored benefit will change. Entrepreneurs may be

encouraged to enter fields in which their customers can purchase their goods

and services with untaxed dollars. Such entrepreneurs might have created

more societal value by selling other goods and services.

The Tax Formula:

 (g ro ss inco m e )

MINUS deductions named in § 62

EQUALS (adjusted gross income (AGI))

MINUS (standard

deduction or itemized

deductions)

MINUS (personal exemptions)

EQUALS (taxable income)

Compute income tax liability from tables

in § 1 (indexed for inflation)

MINUS (credits against tax)

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•The Treasury obviously must forego tax revenues simply because these

accessions to wealth are not subject to income tax.

In light of these points, you should consider the net effectiveness of exclusions from

gross income as a means of congressional pursuit of policy. Consider also whether

there are better ways to accomplish these objectives. We will consider the

parameters of some exclusions and note others. This text groups excluded benefits

very roughly into three overlapping categories: those that encourage the

development of the society and government that we want, those that encourage the

creation of social benefits – perhaps of a sort that the government might otherwise

feel obliged to provide, and those that are employment-based.

I. The Society and Government that We Want

The Code excludes from a taxpayer’s gross income certain benefits that (seem to)

encourage taxpayers to make certain decisions that foster development of a certain

type of society and government. You might see in such provisions as §§ 102, 103,

107, and 121 the policies of generosity, federalism, spiritual growth, and home

ownership. Consider:

•Whether these are policies that the government should pursue;

•Whether tax benefits are the appropriate means of pursuing these policies.

After all, those who choose to avail themselves of the benefits of these tax

benefits do so at the expense of taxpayers who do not;

•Whether the tax provisions by which Congress pursues these policies lead

to unintended consequences and/or capture by those other than those

Congress intended to benefit.

A. Gifts and Inheritances, § 102, and Related Basis Rules, §§ 1014, 1015

Read § 102. There has always been an exclusion for gifts and inheritances from

the federal income tax in the Code. Perhaps Congress has always felt that it would

be inappropriate to assess a t ax on the generosity of relatives who give birthday and

Christmas gifts – sometimes very expensive ones. But:

•Is it possible that this may lead to a culture of gift-giving in contexts other

than the family – whose effects may not reflect generosity or affection?

•If so, is it possible that the costs of such gifts will escalate, and is it not

certain that the donor will (at least try to) deduct the escalating costs of such

gifts?

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

MR. JUSTICE BRENNAN delivered the opinion of the Court.

These two cases concern the provision of the Internal Revenue Code which

excludes from the gross income of an income taxpayer “the value of property

acquired by gift.” [footnote omitted] ... The importance to decision of the facts of

the cases requires that we state them in some detail.

No. 376, Commissioner v. Duberstein. The taxpayer, Duberstein, [footnote

omitted] was president of the Duberstein Iron & Metal Company, a corporation

with headquarters in Dayton, Ohio. For some years, the taxpayer’s company had

done business with Mohawk Metal Corporation, whose headquarters were in New

York City. The president of Mohawk was one Berman. The taxpayer and Berman

had generally used the telephone to transact their companies’ business with each

other, which consisted of buying and selling metals. The taxpayer testified, without

elaboration, that he knew Berman “personally,” and had known him for about seven

years. From time to time in their telephone conversations, Berman would ask

Duberstein whether the latter knew of potential customers for some of Mohawk’s

products in which Duberstein’s company itself was not interested. Duberstein

provided the names of potential customers for these items.

One day in 1951, Berman telephoned Duberstein and said that the information

Duberstein had given him had proved so helpful that he wanted to give the latter a

present. Duberstein stated that Berman owed him nothing. Berman said that he had

a Cadillac as a gift for Duberstein, and that the latter should send to New York for

it; Berman insisted that Duberstein accept the car, and the latter finally did so,

protesting, however, that he had not intended to be compensated for the

information. At the time, Duberstein already had a Cadillac and an Oldsmobile, and

felt that he did not need another car. Duberstein testified that he did not think

Berman would have sent him the Cadillac if he had not furnished him with

information about the customers. It appeared that Mohawk later deducted the value

of the Cadillac as a business expense on its corporate income tax return.

Duberstein did not include the value of the Cadillac in gross income for 1951,

deeming it a gift. The Commissioner asserted a deficiency for the car’s value

against him ... [T]he Tax Court affirmed the Commissioner’s determination. It said

that “The record is significantly barren of evidence revealing any intention on the