Exclusions from Gross Income

AuthorWilliam Kratzke
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
MINUS (personal exemptions)
EQUALS (taxable income)
Compute income tax liability from tables
in § 1 (indexed for inflation)
MINUS (credits against tax)
•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
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

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