Old Colony Trust Co. v. Commissioner 279 U.S. 716 (1929) As a fringe benefit, the American Woolen Company started paying the income taxes for the officers of their company, including a guy named Wood. Wood's tax bill amounted to over $1M. Woolen paid Wood's taxes for a few years. Then Wood died. When Old Colony stepped in to execute the will, the IRS assessed a tax penalty. Old Colony appealed. The IRS found that the taxes paid by Woolen were gross income for Wood. The US Supreme Court found that the tax payments were themselves taxable as gross income. The US Supreme Court found that Woolen's payment of Wood's tax bill was the same as giving him extra income. "The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed." Old Colony argued that Woolen never gave the money to Wood, so how could it be considered to be Wood's income? However, the Court found that it was immaterial that the money was paid directly to the government, Wood benefited by the payments, so Wood had to pay the tax. The Court found that the tax payments could not be considered a gift, because they were made in exchange for Wood's work, so it was part of his overall compensation package. Technically, you could say this created an infinite loop. If Woolen paid all of Woods' taxes, and those payments were taxed, then Woolen would have to pay taxes on that tax, which would generate more income which would generate more taxes and so on and so on... In this case, the Court decided not to worry about this issue. This case said that when a taxpayer reduced a liability, their net worth has increased just as surely as it does when they receive a gain. Therefore, that reduction of liability is considered to be gross income for tax purposes.