Section 61(a) provides that, except as otherwise provided by law, gross
income means all income from whatever source derived. Under § 61,
Congress intends to tax all gains or undeniable accessions to wealth, clearly
realized, over which taxpayers have complete dominion. Commissioner
v. Glenshaw Glass Co., 348 U.S. 426 (1955), 1955-1 C.B. 207.
The Internal Revenue Service has consistently concluded that payments
to individuals by governmental units under legislatively provided social benefit
programs for the promotion of the general welfare are not included in a recipient’s
gross income (”general welfare exclusion”). See, e.g.,
Rev. Rul. 74-205, 1974-1 C.B. 20; Rev. Rul. 98-19, 1998-1 C.B. 840. To qualify
under the general welfare exclusion, payments must (i) be made from a governmental
fund, (ii) be for the promotion of the general welfare (i.e.,
generally based on individual or family needs), and (iii) not represent compensation
for services. Rev. Rul. 75-246, 1975-1 C.B. 24; Rev. Rul. 82-106, 1982-1 C.B.
16. Payments to businesses generally do not qualify under the general welfare
exclusion because the payments are not based on individual or family needs. See
Bailey v. Commissioner, 88 T.C. 1293, 1300-1301 (1987), acq.,
1989-2 C.B. 1; Rev. Rul. 76-131, 1976-1 C.B. 16; Notice 2003-18, 2003-1 C.B.
699.
Section 102(a) provides that the value of property acquired by gift
is excluded from gross income. Under § 102(a), a gift must proceed
”from a ‘detached and disinterested generosity,’ ... ‘out
of affection, respect, admiration, charity or like impulses.’” Commissioner
v. Duberstein, 363 U.S. 278, 285 (1960), 1960-2 C.B. 428. On the
other hand, payments that proceed ”primarily from the ‘constraining
force of any moral or legal duty’ or from ‘the incentive of anticipated
benefit’ of an economic nature” are not gifts. Duberstein at
285. Governmental grants in response to a disaster (whether to a business
or an individual) generally do not qualify as gifts because the government’s
intent in making the payments proceeds from a government’s duty to relieve
the hardship caused by the disaster. In addition, a government can expect
an economic benefit from programs that relieve business or individual hardships. See
Kroon v. United States, Civil No. A-90-71 (D. Alaska 1974), and
Rev. Rul. 2003-12, 2003-1 C.B. 283.
Section 139(a) excludes from gross income any amount received by an
individual as a qualified disaster relief payment. Section 139(b) provides,
in part, that the term ”qualified disaster relief payment” means
any amount paid to or for the benefit of an individual —
(1) to reimburse or pay reasonable and necessary personal, family, living,
or funeral expenses incurred as a result of a qualified disaster (§ 139(b)(1));
(2) to reimburse or pay reasonable and necessary expenses incurred for
the repair or rehabilitation of a personal residence, or repair or replacement
of its contents, to the extent that the need for such repair, rehabilitation,
or replacement is attributable to a qualified disaster (§ 139(b)(2));
or
(3) if such amount is paid by a federal, state, or local government,
or agency or instrumentality thereof, in connection with a qualified disaster
in order to promote the general welfare (§ 139(b)(4)). Thus, § 139(b)(4)
codifies (but does not supplant) the administrative general welfare exclusion
with respect to certain disaster relief payments to individuals.
Section 118(a) provides that, in the case of a corporation, gross income
does not include any contribution to the capital of the taxpayer. Section
1.118-1 of the Income Tax Regulations provides that § 118 also applies
to contributions to capital made by persons other than shareholders. For example,
the exclusion applies to the value of land or other property contributed to
a corporation by a governmental unit or by a civic group for the purpose of
inducing the corporation to locate its business in a particular community,
or for the purpose of enabling the corporation to expand its operating facilities.
However, the exclusion does not apply to any money or property transferred
to the corporation in consideration for goods or services rendered, or to
subsidies paid for the purpose of inducing the taxpayer to limit production.
The Supreme Court of the United States has considered the contribution
to capital concept. In Detroit Edison Co. v. Commissioner,
319 U.S. 98 (1943), 1943 C.B. 1019, the Court held that payments by prospective
customers to an electric utility company to cover the cost of extending the
utility’s facilities to their homes were part of the price of service
rather than contributions to capital. The case concerned customers’
payments to a utility company for the estimated cost of constructing service
facilities that the utility company otherwise was not obligated to provide.
Later, the Court held that payments to a corporation by community groups
to induce the location of a factory in their community represented a contribution
to capital. Brown Shoe Co. v. Commissioner, 339 U.S.
583 (1950), 1950-1 C.B. 38. The Court concluded that the contributions made
by the citizens were made without anticipation of any direct service or recompense,
but rather with the expectation that the contributions would prove advantageous
to the community at large. Brown Shoe Co. at 591. The
contract entered into by the community groups and the corporation provided
that in exchange for a contribution of land and cash, the corporation agreed
to construct a factory, operate it for at least 10 years, and meet a minimum
payroll. Brown Shoe Co. at 586.
Finally, in United States v. Chicago, B. & Q. R. Co.,
412 U.S. 401 (1973), 1973-2 C.B. 428, the Court, in determining whether a
taxpayer was entitled to depreciate the cost of certain facilities that had
been funded by the federal government, held that the governmental subsidies
were not contributions to the taxpayer’s capital. The Court recognized
that the holding in Detroit Edison Co. had been qualified
by its decision in Brown Shoe Co. The Court in Chicago,
B. & Q. R. Co. found that the distinguishing characteristic
between those two cases was the differing purposes motivating the respective
transfers. In Brown Shoe Co., the only expectation of
the contributors was that such contributions might prove advantageous to the
community at large. Thus, in Brown Shoe Co., because
the transfers were made with the purpose, not of receiving direct service
or recompense, but only of obtaining advantage for the general community,
the result was a contribution to capital.
The Court in Chicago, B. & Q. R. Co. also stated
that there were other characteristics of a nonshareholder contribution to
capital implicit in Detroit Edison Co. and Brown
Shoe Co. From these two cases, the Court distilled some of the
characteristics of a nonshareholder contribution to capital under both the
1939 and 1954 Codes —
1. It must become a permanent part of the transferee’s working
capital structure;
2. It may not be compensation, such as a direct payment for a specific,
quantifiable service provided for the transferor by the transferee;
3. It must be bargained for;
4. The asset transferred must foreseeably result in a benefit to the
transferee in an amount commensurate with its value; and
5. The asset ordinarily, if not always, will be employed in or contribute
to the production of additional income and its value will be assured in that
respect.
Under § 362(c)(2), if money is received by a corporation as
a contribution to capital, and is not contributed by a shareholder as such,
then the basis of any property acquired with such money during the 12-month
period beginning on the day the contribution is received shall be reduced
by the amount of such contribution. The excess (if any) of the amount of such
contribution over the amount of the reduction shall be applied to the reduction
of the basis of any other property held by the taxpayer.
Section 165(a) allows a deduction for any loss sustained during the
taxable year and not compensated for by insurance or otherwise. Section 165(b)
limits the amount of the deduction for the loss to the adjusted basis of the
property, as determined under § 1011. Section 1.165-1(d)(2)(iii)
provides that if a taxpayer has deducted a loss and in a subsequent taxable
year receives reimbursement for such loss, the amount of the reimbursement
must be included in gross income for the taxable year in which received, subject
to the provisions of § 111, relating to recovery of amounts previously
deducted.
Section 1033(a) provides that if property, as a result of its destruction
in whole or in part, is involuntarily converted into money, the gain, if any,
is recognized except to the extent that the electing taxpayer, within 2 years
after the close of the first taxable year in which any gain was realized (or
at the close of such later date as may be designated pursuant to an application
of the taxpayer under § 1033(a)(2)(B)(ii)), purchases other property
similar or related in service or use to the property so converted (”qualified
replacement property”). Under § 1033(a)(2), qualified replacement
property is treated as purchased only if, but for the provisions of § 1033(b),
its unadjusted basis would be determined under § 1012. In accordance
with § 1033(a), the gain is recognized only to the extent that the
amount realized upon such conversion exceeds the cost of the qualified replacement
property.
Under § 61, X must include in gross income ST’s
$90,000 grant payment unless another provision of the Code excludes it from
income or defers recognition of the income.
X may not exclude ST’s
$90,000 grant payment from gross income under the general welfare exclusion,
because that exclusion is limited to individuals who receive governmental
payments to help with their individual needs (e.g., housing,
education, and basic sustenance expenses).
X may not exclude the grant payment from gross
income under § 102 because ST’s intent
in making the grant payments proceeds, not from charity or detached or disinterested
generosity, but from the government’s duty to relieve the hardship resulting
from the disaster and the economic benefits it anticipates from a revitalized
economy in the area of ST affected by the disaster. See
Kroon. ST did not enact the legislation authorizing
the grant program for any donative purpose.
X may not exclude the grant payment from gross
income under § 139 because that exclusion applies only to individuals.
Even if X’s business were a sole proprietorship
or the disaster were a qualified disaster under § 139, the grant
payments would not qualify for exclusion from gross income under § 139
because the grant payments are not made for any of the specific purposes described
in § 139(b)(1), (2), and (4).
X may not exclude the $90,000 grant payment from
gross income under § 118. The ST grant program
compensates qualifying businesses for uncompensated eligible losses they incurred
as a result of the disaster. Accordingly, these payments are more akin to
insurance payments received for losses than contributions to capital of a
corporation within the definition of § 118 and the case law. Because
the $90,000 grant payment is not excludable from gross income under § 118,
the basis of the replacement equipment purchased by X is
not determined under § 362(c)(2).
Under § 61, X realizes gain of $80,000
($90,000 grant proceeds received less $10,000 adjusted basis in the destroyed
equipment). X must recognize the $80,000 gain unless X elects
to defer recognition of the gain under § 1033.
X may defer including in income the entire $80,000
gain because X meets all of the requirements to defer
the gain under § 1033. First, the grant payments are compensation
for the involuntarily converted property. Second, X made
the required election under § 1033 and, within 2 years after the
close of the taxable year in which X received the ST grant
payment, replaced the destroyed equipment with qualified replacement property,
the basis of which would be determined under § 1012 if § 1033(b)
did not apply. Third, the cost of the qualified replacement property ($150,000)
exceeds the gain realized on the conversion of the destroyed equipment into
money ($80,000). Amounts paid by X to repair damaged
or destroyed property, including amounts paid for debris removal and other
clean-up costs, are generally treated as amounts paid to purchase qualified
replacement property.
X’s basis in the replacement equipment is
$70,000 ($150,000 cost of qualified replacement property less $80,000 unrecognized
gain on the conversion of the destroyed equipment into money). See § 1033(b)(2).
The ST grant program reimburses uncompensated eligible
losses incurred by any qualifying business. Therefore, the grant payments
are treated as compensation received for such losses under § 165.
If X had properly deducted the $10,000 adjusted basis
of the equipment as a loss on a prior year federal income tax return, and
the loss reduced the amount of X’s tax in that
year, then X would be required by § 111 and
the tax benefit rule to include $10,000 of the $90,000 gain realized from
the receipt of the ST grant in gross income, as ordinary
income, on its federal income tax return for the year it received the grant. See § 1.165-1(d)(2)(iii).
Under § 1033, X could defer including in income
the remaining $80,000 of gain ($90,000 grant less $0 adjusted basis in the
converted property less $10,000 recovery of the prior year deduction). In
addition, X’s basis in the replacement equipment
would equal $70,000 (excess of $150,000 cost of replacement property over
$80,000 gain not recognized).
