A small set of court decisions built the rules that every U.S. taxpayer files under, and the famous tax cases that shaped U.S. tax law are almost all Supreme Court rulings that started as fights over a single line on a single return. They set what counts as income, who owes tax on it, which expenses can be deducted, when the IRS can look past the paperwork of a transaction, and how a private business is valued at death. The principles below are still the ones auditors, planners, and courts apply today.
What Counts as Taxable Income
The Internal Revenue Code defines gross income as “all income from whatever source derived.”1Office of the Law Revision Counsel. 26 USC 61 Gross Income Defined Three cases show how broad that language really is.
Commissioner v. Glenshaw Glass Co.
Glenshaw Glass received punitive damages in an antitrust and fraud settlement and left the money off its return, arguing that punitive damages weren’t the kind of “income” Congress meant to tax. In 1955 the Supreme Court disagreed and gave the modern test for taxable income: any accession to wealth that is clearly realized and over which the taxpayer has complete dominion. Punitive damages met it. So do prize money, gambling winnings, and virtually every other financial benefit that lands in your hands, unless the Code contains a specific exclusion.
United States v. Kirby Lumber Co.
In 1931, Kirby Lumber issued bonds at face value and later repurchased some on the open market for less than it had received. The Supreme Court held that the difference was taxable income, because the company freed up assets that had been locked up by the debt.2Justia U.S. Supreme Court Center. United States v. Kirby Lumber Co., 284 U.S. 1 (1931) This is the doctrine of discharge-of-indebtedness income, and it reaches everyday debt settlements. If a credit card issuer forgives $5,000 of what you owe, that $5,000 is generally taxable in the year of forgiveness.
Cesarini v. United States
An Ohio couple bought a used piano and, years later, found $4,467 in cash inside it. A federal court ruled the money was taxable in the year they discovered it, applying the Treasury regulation that treats treasure trove as gross income when the finder takes undisputed possession.3Justia Law. Cesarini v. United States, 296 F. Supp. 3 (N.D. Ohio 1969) The case is now the standard citation for any found-property income question, from cash in furniture to a valuable painting at a yard sale.
Who Pays the Tax on Income
Taxpayers have tried for a century to shift income to relatives in lower brackets. The Supreme Court shut that door early.
Lucas v. Earl
Guy Earl, a California attorney, had an agreement with his wife to split all their earnings equally, and he reported only half his salary on his own return. In 1930 the Supreme Court ruled that income is taxed to the person who earns it, and Justice Holmes wrote that the tax could not be escaped “by anticipatory arrangements and contracts however skilfully devised” to keep the salary from vesting in the person who earned it.4Justia U.S. Supreme Court Center. Lucas v. Earl, 281 U.S. 111 (1930) The metaphor that stuck: you can’t attribute the fruit to a different tree from the one on which it grew.
Helvering v. Horst
Ten years later the Court extended the rule to investment income. Horst owned negotiable bonds, detached the interest coupons before they came due, and gave them to his son, who collected the interest. The Supreme Court held that the power to dispose of income is the equivalent of owning it, so Horst owed the tax.5Justia U.S. Supreme Court Center. Helvering v. Horst, 311 U.S. 112 (1940) Direct a consulting fee to your daughter instead of yourself, and the outcome is the same.
Business Expenses Versus Personal Spending
The Code allows a deduction for ordinary and necessary expenses of running a business,6Office of the Law Revision Counsel. 26 USC 162 Trade or Business Expenses and flatly prohibits deductions for personal spending.7Office of the Law Revision Counsel. 26 U.S. Code 262 – Personal, Living, and Family Expenses Two cases mark the boundary.
Pevsner v. Commissioner
A boutique manager had to wear expensive Yves Saint Laurent clothing at work to project the store’s image. She testified she never wore it off the clock and deducted the cost. The Fifth Circuit denied the deduction using an objective test: clothing is deductible only if it is required for the job, is not suitable for everyday wear, and is not actually worn as everyday clothing.8Justia. Pevsner v. Commissioner, 628 F.2d 467 (5th Cir. 1980) What matters is whether the clothes could function as ordinary attire, not whether the taxpayer chooses to wear them that way. Scrubs, hard hats, and stage costumes pass. A nice blazer does not.
Commissioner v. Flowers
Travel expenses are deductible only when you’re away from your “tax home” on business, and your tax home is generally the area where your principal place of business sits, not where your house is. The Supreme Court in Flowers set a three-part test: the expense must be ordinary and necessary, incurred in pursuit of business, and incurred while away from the taxpayer’s tax home. If you choose to live two hours from the office, your daily commute isn’t deductible, no matter what it costs you.
When the IRS Can Ignore a Transaction
Two Supreme Court decisions gave the IRS the power to look past the paperwork and ask whether a transaction had any real purpose beyond dodging tax. Congress eventually wrote the answer into the Code.
Gregory v. Helvering
In 1935 the Court reviewed a corporate reorganization that satisfied every statutory requirement but existed only to convert dividend income into a lower-taxed capital gain. The taxpayer had formed a new corporation, transferred appreciated stock into it, dissolved it, and distributed the stock to herself. The Court disregarded the entire arrangement, holding that a reorganization must be more than “a disguise for concealing its real character.”9Justia U.S. Supreme Court Center. Gregory v. Helvering, 293 U.S. 465 (1935) Following the letter of the statute wasn’t enough; the transaction had to be the thing the statute intended.
Knetsch v. United States
Twenty-five years later, Knetsch borrowed millions from an insurance company to buy annuity bonds from the same company and deducted the interest. Each year he borrowed slightly more than the prior year’s interest, netting a tiny cash increase while generating large deductions. The Supreme Court found the arrangement had “no commercial economic substance” and disallowed the deductions.10Justia U.S. Supreme Court Center. Knetsch v. United States, 364 U.S. 361 (1960)
The Doctrine in the Code Today
A transaction now has economic substance only if it meaningfully changes the taxpayer’s economic position apart from tax effects, and the taxpayer has a real business purpose for entering it.11Office of the Law Revision Counsel. 26 U.S. Code 7701 – Definitions – Section: Clarification of Economic Substance Doctrine Failing that test triggers a 20% accuracy-related penalty on the underpayment, or 40% if the taxpayer didn’t disclose the transaction.12Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments
Illegal Income, Evasion, and Legal Fees
Three cases in this area show that the reporting obligation survives even when the money is dirty, and they mark the line between a filing mistake and a felony.
James v. United States
A union official embezzled money and argued it wasn’t taxable because he was legally obligated to return it. The Supreme Court rejected that in 1961: embezzled funds are taxable in the year the embezzler takes control of them.13Justia U.S. Supreme Court Center. James v. United States, 366 U.S. 213 (1961) What matters is dominion and control. Theft proceeds, fraud proceeds, and bribes all follow the same rule. Repaying the money later can produce a deduction in the year of repayment, but the original income has to be reported.
Spies v. United States
Failing to file or failing to pay is a misdemeanor. Felony evasion requires an affirmative act meant to mislead the IRS. In Spies the Supreme Court listed examples: keeping a double set of books, creating false invoices, destroying records, hiding assets, and concealing sources of income.14Justia U.S. Supreme Court Center. Spies v. United States, 317 U.S. 492 (1943) Felony evasion carries up to five years in prison and fines up to $100,000 for individuals or $500,000 for corporations.15Office of the Law Revision Counsel. 26 USC 7201 Attempt to Evade or Defeat Tax
Commissioner v. Tellier
A securities dealer convicted of fraud and mail fraud connected to his business deducted his legal fees. The IRS conceded the fees met the statutory test for a business expense but argued public policy blocked the deduction. The Supreme Court reversed, holding that the income tax is a tax on net income, not a penalty for wrongdoing.16Justia U.S. Supreme Court Center. Commissioner v. Tellier, 383 U.S. 687 (1966) The deduction applies whether the defense wins or loses.
Gifts and the Value of a Family Business
The Code excludes gifts from a recipient’s gross income,17Office of the Law Revision Counsel. 26 U.S. Code 102 – Gifts and Inheritances but what qualifies as a gift, and how to value transferred property, have produced some of the most consequential decisions in tax law.
Commissioner v. Duberstein
Duberstein passed valuable customer referrals to an associate, who thanked him with a Cadillac. The associate deducted the car as a business expense; Duberstein called it a gift and excluded it. The Supreme Court held that a tax-free gift must come from “detached and disinterested generosity,” or from feelings like affection, respect, or charity.18Justia U.S. Supreme Court Center. Commissioner v. Duberstein, 363 U.S. 278 (1960) The critical question is the transferor’s real motive. The Cadillac was compensation. Employer “gifts” to employees are almost always taxable for the same reason, and so are holiday payments from clients and bonuses labeled as gifts.
Crummey v. Commissioner
The annual gift tax exclusion, $19,000 per recipient for 2026, applies only to gifts of a “present interest,” meaning the recipient must have an immediate right to enjoy the property.19IRS. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Gifts into a trust normally fail that test because the beneficiary can’t touch the money right away. In Crummey the Ninth Circuit approved a workaround: give each beneficiary a temporary right to withdraw their share shortly after the gift is made. If the withdrawal right is legally enforceable and the beneficiary is notified, the gift qualifies for the annual exclusion even when everyone expects the withdrawal will not be exercised. These “Crummey powers” now appear in most irrevocable life insurance trusts and similar planning vehicles.
Connelly v. United States
The most recent landmark in this area came in 2024. Two brothers owned a building supply company and agreed that the corporation would buy back a deceased brother’s shares. The company held $3.5 million in life insurance on each brother to fund the buyout. When one brother died, the estate valued his shares at $3 million on the theory that the insurance proceeds were offset by the redemption obligation. The IRS assessed the company at $6.86 million and valued the shares at $5.3 million.
The Supreme Court sided with the IRS. A corporation’s obligation to redeem shares does not reduce their value, because the transaction is circular: the company pays the estate with its own assets, and life insurance proceeds are a corporate asset any willing buyer would include in the price.20Justia U.S. Supreme Court Center. Connelly v. United States, 602 U.S. (2024) The practical effect is that corporate-owned life insurance funding a stock buyback increases the taxable estate, the opposite of what many plans were built to do. Business owners with buy-sell agreements funded that way should revisit them.
What Getting It Wrong Costs
The cases above set the rules. The price of breaking them ranges from a percentage penalty to prison, and the IRS has more time to come looking than most people expect. An underpayment caused by carelessness or disregard of the rules generally carries a 20% accuracy-related penalty on the amount underpaid.12Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments The IRS normally has three years from the filing date to assess additional tax, but a fraudulent return or a willful attempt to evade removes the deadline entirely. The IRS can audit that return decades later and assess the full amount plus penalties.21IRS. Overview of Statute of Limitations on the Assessment of Tax Combined with the felony exposure under Spies, that no-limit rule creates a long tail of risk for anyone hoping the clock will simply run out.