Professional Documents
Culture Documents
Ames v Commissioner
Petitioner Ames was charged in the U.S. District Court, Eastern Virginia on charges of
conspiracy to commit espionage and conspiracy to defraud the U.S. Internal Revenue Service.
YES
A taxpayer reporting income on the cash method of accounting, such as petitioner, must include
an item in income for the taxable year in which the item is actually or constructively received.
The concept of constructive receipt is well established in tax law.
Income although not actually reduced to a taxpayer's possession is constructively received by
him in the taxable year during which it is credited to his account or made available to him.
Evidenced by the facts of the case, petitioner did not constructively receive the income in 1985.
It was made physically and/or practically available to him during years 1989-1992.
Raytheon sued Radio Corporation of America (RCA) for an anti-trust issue related to some
patent claims. They won a $410k settlement.
The IRS claimed that the $350k that Raytheon received for the settlement of the suit was also
taxable as gross income.
Raytheon argued that it wasn't gross income at all, but a replacement of capital, which was not
taxable.
The Appellate Court found for the Raytheon.
WON the awarded damages be considered a taxable income in this case.
YES.
The Court suggested that the question to ask was, "in lieu of what were the damages awarded."
If the damages were for loss of profits due to an injury on your business (like say someone
breaks your finger and you can't perform in that concert so you don't get paid for playing), then the
damages are a substitute for lost profit and are taxable as gross income.
On the other hand, if the damages were for loss of a capital item (like say someone burns
down your house and pays to build you a new house), then the damages are to replace what you
lost (aka replacement capital), and are not taxable as gross income.
This is now known as the Substitution Theory.
However, the Court found that when RCA reimbursed Raytheon for the loss of a business unit,
that was basically the equivalent of RCA buying the business unit from Raytheon.
The Court found that the payment made to Raytheon is taxable because it was made in excess of
reimbursement.
Tax law does not exempt compensatory damages just because they are a return of capital
exemption applies only to the portion that recovers the cost basis of that capital.
Any excess damages serve to realize prior appreciation, and should be taxed as income.