Realization (tax)

Realization is a requirement in determining what must be included as income subject to taxation. It should not be confused with the separate concept of Recognition (tax).

Background: What is Income?

Determining what is subject to Income tax in the United States can be a tricky undertaking. The Tax ladder is a useful formula for calculating a taxpayer’s tax liability, with gross income at the top of the ladder. What is gross income? The Internal Revenue Code gives a somewhat unhelpful definition of income in §61 as “all income from whatever source derived,” and includes an un-exhaustive list of 15 items that should be included in gross income.

Although the most common definition of income in economic theory is the Haig-Simons income calculation of consumption plus savings, practical limitations forced courts to find some kind of more suitable definition of income. [Samuel A. Donaldson, "Federal Income Taxation Of Individuals: Cases, Problems and Materials", 2d. edition (St. Paul: Thompson-West 2007, 2d edition, 44-5.]

Eisner v. Macomber held that income includes gain derived from capital, labor, or both. However, it is the US Supreme court case of Commissioner v. Glenshaw Glass Co. which gives the most preferred test for determining what is income: gross income is an undeniable accession to wealth, clearly realized, over which the taxpayer has complete dominion.

Problems in Line-Drawing

Figuring out what this realization requirement "actually" requires is also a tricky undertaking, and unfortunately no clear answers emerge from the swamp of Case law that exists about this question. For example, Cesarini v. United States held that a couple who found money in an old piano "realized" that money as income when they found it. It is also not entirely clear whether realization means a taxpayer must realize the "actual item" in question (e.g., money in a piano), or realize the "value of the item" (e.g., buying something and later discovering it is worth a lot more than was originally paid: the taxpayer has an income inclusion when the property is sold or exchanged, and the gain is realized).

An example of a tricky realization situation without answers- but which has given rise to substantial debate among tax professors - is the 62nd home run ball hit by Mark McGwire. It was retrieved by a grounds crewman, Tim Forneris. Forneris gave McGwuire the ball immediately after the game, amidst speculation that the ball could fetch at least $1 million in an auction. Do either McGwire or Forneris have gross income? Did Forneris realize income when he caught the ball? Tax professor Allison Christians argues it could be income to Forneris when he caught it, similar to the Treasure trove type of theory used in "Cesarini".

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