Close Article | Forward in Tax Path | <<< Grand Tour >>> Escape || Turn Page (Later)
V a l p a r a i s o U n i v e r s i t y L a w R e v i e w
Volume 22 Winter 1988 Number 2
DID YOUR LAW PROFESSOR TELL YOU BASIS MEANS COST? THE RECOGNITION THEORY OF BASIS
This article advances a new theory of basis in United States federal income taxation law in the context of a primer on basis as a system. This theory will more readily be grasped by viewing basis in its natural environment - a dynamic conceptual system possessed at its ultimate core of a unifying coherency. Examples chosen will be simple, but will build, for pur-
* Professor of Law, Valparaiso University School of Law. B.A., University of New Mexico, 1969; J.D., Boston College Law School, 1974; M.S., Northeastern University, 1975. Member of the New Mexico Bar; C.P.A., New Mexico. I am indebted to my colleagues, Professor Richard T. Stith, 111, of Valparaiso University School of Law, Professor Alex Y. Seita, of Albany Law School, Union University, and Professor Martha S. Hanley, of Mount Mercy College, for commenting on a draft. I am also indebted to Mr. Thomas W. Hanley, C.P.A., of the accounting firm McGladrey & Pullen in Cedar Rapids, Iowa, for commenting on a draft. I am indebted to the following research assistants for work done in connection with this article: Charlotte Rosenberg, Tallam I. Nguti, Bernard Carter, Robert J. Brown, W. Joseph Beatty, G. Allen Keiser, Mark T. VanSlooten, and Clark W. Holesinger. I did not discover the theory of basis described herein until after beginning my teaching of federal income taxation. I am therefore indebted to the students in the individual tax courses who provided the occasion for the spontaneous development of this theory of basis while I questioned them during the summer and fall of 1982. The theory of basis described herein was the subject of a lecture I delivered to the faculty of the Notre Dame Law School in February, 1985.
233
poses which transcend particulars.
This new recognition theory addresses the theoretical underpinning of basis in situations where measuring income and taxing it are goals. The theory accommodates all income situations, whether recognition is current or deferred. It is not addressed to those features of the tax expenditure system,' a vast spending rather than taxing apparatus, whose purpose is to prevent certain income from ever being recognized. When provisions are directed toward preventing income taxation, one would not expect events to fit a coherent theory of income taxation. Initially, the general statutory framework provided by the Internal Revenue Code for measurement of income from particular transactions will be presented, for this is the basic structure of which the mechanism of basis is an integral part. Then, the historical background of the entrance of the terms "basis" and "cost" into the statutory scheme in the years following passage of the sixteenth amendment will be examined. This examination will show that the word "basis" was originally intended to be used in its ordinary sense and that its use came about by accident, with no intention that the word become a special tax term of art. The historical analysis of the words "basis" and "cost" will further show that interpreting "basis" in light of its plain meaning is an insightful way of viewing the term when used today. Thereafter, recognition alone will be shown to be the only rule of basis that explains why the basis amount should be subtracted in all situations in which income measurement and taxation are intended. In the course of this analysis, the rule that basis means cost, even sometimes, will be shown to be a myth. Viewing basis as cost will be shown to represent a fundamental misunderstanding of this foundational building block of income taxation. Cost and its various exceptions will be shown to be a maze of rules that vary from situation to situation and therefore lack conceptual integrity. This lack of coherency will be illustrated by a series of six examples: 1) a purchase; 2) a taxable property exchange; 3) a taxable property exchange in which the properties are not equal in value; 4) a like- kind exchange, which is called non-taxable but is really tax-deferred; 5) a mixed like-kind exchange; and 6) a sale. The manner in which realized gain is calculated in each of these situations will be explained. The exact operation of basis in each instance will be explored as well. The applicable rules will be given for each situation and will be tested for system-wide applicability in other situations. The purpose of this entire analysis is to find a unifying theme which
1. See generally EXECUTIVE OFFICE OF MANAGEMENT AND BUDGET, SPECIAL ANALYSIS G, BUDGET OF THE UNITED STATES GOVERNMENT (FY 1986) (hereinafter SPECIAL ANALYSIS G1. The tax expenditure system is a spending system, not a taxing system, notwithstanding its disharmonious grafting onto the income tax system.
1988 RECOGNITION THEORY OF BASIS 235 applies across the field of basis, thus representing a coherent theory of the meaning of the term. Recognition is this unifying theme. Ultimately, basis as amount recognized, exclusively, will be discussed in the context of the system as a whole. Finally, the article will include a discussion of the purview of the system of basis.
II. STRUCTURAL MECHANISMS FOR GAIN MEASUREMENT To be true to its name, income taxation law must involve the measurement of income and its taxation, once and only once.' Although efforts have been made frequently and successfully to use income tax systems for additional purposes 3 a system ceases to be an income tax system to the extent that public policy objectives are embedded in the law to prevent achievement of these inherent purposes. When this happens, the system loses its conceptual integrity.
2. United California Bank v. United States, 439 U.S. 180, 194 n.14 (1978).3. Tax expenditures were expected to total $456,895,000,000 for fiscal year 1986. See generally SPECIAL ANALYSIS G, supra note 1. This sum of indirect spending is well over double the then projected annual deficit for 1986 of $180,000,000,000. BUDGET TOTALS BY FUND GROUP, BUDGET OF THE UNITED STATES GOVERNMENT, 6-25 (FY 1986). Objection to the idea of using the taxing power to accomplish social policy objectives is not new:
The financial history of the United States points with peculiar emphasis to one fact, and that is the danger of employing a power granted for one purpose for a purpose entirely different. In the discussions upon the first revenue law, Mr. Clymer of Pennsylvania, one of the few men who saw the tendency of the language employed, desired a separation of the bill into two parts; one of which should contemplate revenue alone and be shaped entirely by revenue principles. This suggestion was not, however, favorably accepted; and as a consequence, there was included in the first finance bill, in addition to provisions for securing a revenue, part of the country's navigation laws and the major part of its formulated foreign policy. Although, as has been shown, the distinctively protective character of revenue acts does not make its appearance till much later, it yet remains true that a precedent for using revenue machinery in a loose manner was then established, and out of this precedent have grown many of the abuses which subsequent history discloses. Looked at from this point of view, one may hold the first Congress responsible for the dangers that threatened the country in 183 1, for the disasters that followed the distribution scheme of 1836, and for the absurd position in which the people of the United States now find themselves, - with an overflowing treasury and yet unable to shut down the floodgates of revenue. The financial reform which this day requires is more than a modification in tariff-rates; it consists rather in such a revolution of public sentiment that finance laws may be judged on the basis of financial principles, and revenue-machinery be employed primarily, if not solely, for revenue- purposes. If the disturbing element of protection can in this manner be separated from questions of finance, the injustice and expense of paying a subsidy out of public funds for the support of losing industries will clearly manifest itself. Tariff-Reform means tariff for revenue only.
HENRY C. ADAMS, TAXATION IN THE UNITED STATES 1789-1816, at 78-79 (Burt Franklin 1970). "Unyielding resistance should be offered to any endeavor to make the income tax law the means of forcing amelioration of social conditions." JOSEPH J. KLEIN, FEDERAL INCOME TAXATION, at xvii (1929).
236 VALPARAISO UNIVERSITY LAW REVIEW Vol.22 The verbal formulation that an income tax system measures income and taxes it once seems obvious. However, carrying out these objectives in any pure sense has proved vexing. Aside from policy roadblocks, numerous conceptual and technical problems exist in any comprehensive income tax system.
Identification of what is income presents its own challenges. The United States statutory scheme does not define income, but does give guidance. Sections 61, 62, and 63 of the Internal Revenue Code (I.R.C.) define gross income, adjusted gross income, and taxable income, respectively. These legal concepts are all to be distinguished from the concept of income, which is an economic concept. By defining gross income as "all income from whatever source derived,"" the statutory scheme presupposes knowledge of the meaning of the word "income."
The Code is more helpful in explaining income derived from particular transactions. When property is sold, for instance, I.R.C. 61(a)(3) tells us that the "[g]ains derived from dealings in property" are included in gross income.' I.R.C. 1001(a) further helps to interpret the meaning: gain "from the sale or other disposition of property" is the excess of the "amount realized" over the property's "basis," properly adjusted for well-recognized changes in basis. In adding that "the loss shall be the excess of the adjusted basis . . . over the amount realized,"' the subsection merely re-orders its first statement with negative signs in front of each component.
True to its general writing style and penchant for certainty of meaning, the Code goes on to define the significant new terms - "amount realized" and "basis." The phrase "amount realized" has the meaning one would expect, but is expressed rather oddly in section 1001(b) as "the sum of any money received plus the fair market value of the property (other than money) received."' The final element in the definition of "gain" is the concept of "basis." Aside from adjustments to basis, the statement that basis means cost is commonplace.8 This reflects the statutory language in I.R.C. 1012 which states that the "basis of property shall be the cost of such property." An analysis of the historical development of this terminology will shed light on the usefulness of this legal maxim.
4. I.R.C. 61(a) (Supp. 111 1985).5. I.R.C. 61(a)(3) (1982).
6. I.R.C. 1001(a) (1982).
7. I.R.C. 1001(b) (1982), and see infra note 39.
8. See citations infra note 10.
9. I.R.C. 1012 (1982).
Close Article | Forward in Tax Path | <<< Grand Tour >>> Escape || Turn Page (Later)