And the winner is . . . you (and the IRS)

Some taxpayers have tried to get around this problem by selling to someone to whom they're not related. That person turns around and sells to your relative. I don't advise this idea. If there's any prearranged agreement, the IRS will collapse the two transactions, deem the first sale to be a sham and successfully establish the true nature of the gift to your relative.

Sticky questions

The courts have defined income to include all accession to wealth, clearly realized, over which you have dominion. Essentially, what that means is that income is anything of value that you receive to do with as you please, for which you do work or because it is obligated by contract. And, unless it's excluded as income by the constitution or by statute (like municipal bond interest), it's taxable.

Where defining what's income gets complicated and confusing involves the issue of making whole or return of capital.

The idea is this: If the dollars you receive are only to bring you back to your original position, those dollars aren't really income.

The simplest example of this comes with a stock investment. When you sell your stock, you're not taxed on the whole amount you receive, just on the amount in excess of what that stock cost you. Since you didn't get a deduction when you bought the stock, only the gain should be taxable. That's only reasonable.

However, I must warn you: Anyone who lives in expectation of our tax system being reasonable is going to be sorely disappointed.

Here's a taste of what I mean. Sometimes, damages awarded in suits for wrongful termination, sexual or age discrimination, or personal injuries are taxable income; sometimes they're not. It depends on what kind of lawsuit is filed and the exact language of the award.

• Video: Are you a victim of the alternative minimum tax?

A suit involving physical damage or physical sickness (personal or otherwise) generally produces damages that are nontaxable. Are the damages punitive (normally taxable) or compensatory (potentially nontaxable)? A judgment in a contract dispute can be taxable. It all depends on the specific facts in the case.

Updated Dec. 18, 2008

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