The famous Amos incident

The income tax treatment of damages is a lot looser than it ought to be. You would think that when a claimant or plaintiff recovers money from a bad guy on a claim or lawsuit, the tax consequences would be clear. But often they are not.

One notorious case on this subject involves a tawdry incident that took place on a professional basketball court in front of a worldwide audience. The taxpayer was a photographer named Eugene Amos, who had an unpleasant interaction in Minneapolis with a fellow named Dennis Rodman. Yes, that Dennis Rodman. Amos got six figures from Rodman to shut up. Was it taxable income? The judge in the tax case wound up splitting the baby between Amos and the IRS.

Anyway, more than you ever wanted to see in connection with the events in question can be found here:

First-in, still-here

Hard to believe that it's been six years since I last posted on this blog. I'm still teaching an introductory Income Tax course to law students, but I've also been doing a lot of professional writing that has limited my blogging time. And there was a sabbatical in there – spent stuck in my home office as the pandemic raged on.

During the intervening years, I've switched the casebook that I use in the course, and as a result, a fair number of the cases that used to be central to my spiel have been swept into the dustbin of tax history. I suppose I'll always be reliving Duberstein and Benaglia, for example, but Drescher and LoBue, the people, are now out of the picture that the students are getting from me.

There's always some tax story to follow up on, though, and I hope to resume doing some of that over the next few months here. (Photo: Markus Winkler.)

Ladies and gentlemen, Ted Drescher

Another school year, another telling of the tale of Ted Drescher, the Bausch & Lomb executive whose retirement annuity became the topic of conversation among such notables as Judges Learned Hand and Charles Clark. I had dug up some stuff on Ted before, and posted it here. But when I showed that material to my class yesterday, I lamented the fact that I had never come up with a photo of Ted himself.

Not half a day later, not one but two students had located the image I was missing. It seems there's a photo history book of Bausch & Lomb, and the all-knowing eye of Google Books has captured some of it -- including this shot of the taxpayer in No. 111, Docket 21427:

Thanks to Brad Crittenden and Christine Bushnell for the excellent sleuthing. Chris Huettemeyer was close behind with the same find.

Here we go again

Another school year is just around the corner -- time for some more spins through the Internal Revenue Code.  Congress may be gridlocked on taxes, but that hasn't stopped some of the authors whose casebooks I use from putting out new editions.  That shakes things up considerably, but hey, we all need something to keep us on our toes.

The day they argued Duberstein

Commissioner v. Duberstein and its companion case, Stanton v. United States, are two of my favorite cases to talk about in class. The Supreme Court turned aside the government's theory of what constitutes a tax-free gift for income tax purposes, leaving open the possibility that a gift can be made in a business setting, even by a corporation. Congress has since changed the rules quite a bit, essentially vindicating the government's theory, but Congress had to -- the High Court wasn't going to refine the statute.

It never occurred to me that there might have been a tape recorder going during the oral arguments in the Supreme Court in those days -- but as I just found out, there was.  And if anyone wants to hear what was said, on one chilly, blustery Wednesday in March, 1960, it's here.  My old tax professor in law school, Wayne G. Barnett, can be heard making the IRS's pitch in the Stanton case.  As students of income tax history know, he lost.

The most colorful moments on the tapes come when Duberstein's lawyer is speaking.  He really had everyone going, until he decided to skip a lot of his prepared remarks and simply read out loud what the Sixth Circuit had written.  Not only was that a totally boring ending to his argument, but he lost his place and made everyone wait nearly a minute before he found it.  He wound up losing, too.

Happy 100th birthday, federal income tax

It's a big day for us tax mavens. It's the 100th anniversary of the effective date of the U.S. individual income tax. To celebrate the occasion, we've ordered up some custom refreshments. Many happy returns!
 

 

A tax on the tax on the tax

What if the IRS had won the Clark case (page 122 of our casebook)?  What if the receipt of the malpractice settlement from the Clarks' attorney had been treated as gross income to them for tax purposes?  Well then, the Clarks would have needed more money from the attorney in order to be made truly whole.  They would have needed the attorney to pay them the tax owed on the base settlement amount.  And if the attorney paid them that additional amount, that would have been gross income, too, triggering additional tax.  And if the attorney paid them that additional tax, that payment would have been more gross income, triggering more tax.

Would this result send us into an endless feedback loop?  Not really, because the tax is only a percentage of one's taxable income, and so the additional amount of tax triggered by any receipt will be smaller than the receipt itself.  The additional amounts become smaller and smaller and eventually drop to just tiny fractions of a penny; at that point we can stop counting them.

For example, assume that the taxpayer is in the 35% marginal bracket, and she receives $10,000 of gross income (with no offsetting deductions) in a transaction in which the other party agrees to pick up the tax on the $10,000 receipt.  That tax would be $3,500, and if the payor reimbursed the taxpayer for that amount, the additional $3,500 of income would trigger another $1,225 of tax -- 35% of $3,500.  The tax on that $1,225 would be $428.75, the tax on that $428.75 would be $150.06, etc.

In the end, the total payout needed to allow the taxpayer to keep $10,000 after tax would be $15,384.62, calculated as follows:

$10,000.00
$3,500.00
$1,225.00
$428.75
$150.06
$52.52
$18.38
$6.43
$2.25
$0.79
$0.28
$0.10
$0.03
$0.01
$0.0041
$0.0014
+  $0.0005
$15,384.62

Another way of looking at it is this: If this taxpayer gets $15,384.62 of additional gross income, the tax at 35% is $5,384.62 -- leaving the taxpayer with the $10,000 base payment to keep.

And so if the Clarks' receipt had been gross income, the attorney would have had to pay them more --  probably a substantial amount more -- to make them whole.  That wasn't the result in Clark, but it would be the result if, say, one's employer agreed to pay one's income taxes.  (See Reg. sec. 1.61-14.)  If your employer agreed to pay $10,000 of income tax for you, then assuming a 35% tax, she'd have to pay you an additional $5,384.62 to pay the tax on the tax, the tax on the tax on the tax, and so on.

You math majors out there are way ahead of me -- you've already figured out the formula for finding the total payout (or PT).  It is: 

PT = PB + (.35 * PT)

where PB is the base payment (the amount that the taxpayer would like to keep).  If PB is $10,000, the algebra goes like this:

PT = $10,000 + (.35 * PT)

.65 * PT = $10,000

PT = $10,000 / .65

PT = $15,384.62