What Is an Accession to Wealth for Tax Purposes?

The concept of an “accession to wealth” is a core principle in the U.S. system of taxation, serving as the primary measure for what constitutes “gross income” under federal law. An accession to wealth is any realized increase in an individual’s or entity’s net worth. This principle is the starting point for tax calculations, defining the pool of resources from which tax obligations are determined.

This concept has direct implications for every taxpayer, as it determines which financial gains must be reported to the Internal Revenue Service (IRS). A clear grasp of what constitutes an accession to wealth is necessary to accurately calculate tax liability.

The Core Principle of Gross Income

The modern understanding of what constitutes taxable income is largely shaped by the U.S. Supreme Court case, Commissioner v. Glenshaw Glass Co. This 1955 decision established a three-part test to determine if a taxpayer has received income. The court created a broader and more encompassing standard that remains the foundation of tax law today, moving away from earlier, more rigid definitions that tied income strictly to sources like labor or capital.

The first element of the Glenshaw Glass test is the existence of an “accession to wealth.” This means there must be a clear and measurable increase in the taxpayer’s net worth. The source of the wealth is less important than the fact of its existence; whether it comes from wages, investments, or a lawsuit settlement, the key is the demonstrable financial gain.

The second element is that the accession to wealth must be “clearly realized.” Realization requires a specific event, such as a sale or receipt of payment, which converts the increase in value into a tangible form. For instance, if you own stock that increases in value from $1,000 to $5,000, this appreciation is not income until you sell the stock. The sale is the “realization event” that triggers the tax consequence.

Finally, the taxpayer must have “complete dominion” over the wealth. This means the taxpayer has the freedom to use the funds or property without restriction. If money received is subject to a substantial limitation or an obligation to be used in a specific way dictated by another party, the taxpayer may not have complete dominion.

Common Examples of Taxable Income

Many financial receipts meet the three-part test and constitute gross income that must be reported on a tax return. The most familiar example is compensation for services, which includes wages, salaries, and bonuses. When an employer pays an employee, the employee has an increase in wealth that is realized upon receipt and is available for their unrestricted use.

Profits generated from a business are another primary example. The net income of a business represents an accession to wealth for its owners. Unearned income such as interest from bank accounts, dividends from stock ownership, and rents received from leasing property are also taxable.

The principle extends to less common gains. Prizes and awards, such as lottery winnings, are taxable income based on the fair market value of the prize. Even found property, like discovering a sum of cash, is considered income in the year it is found.

Royalties from intellectual property, such as books or patents, also fall into this category. The same logic applies to income from canceled debt. If a lender forgives a portion of a loan, the amount forgiven is generally considered taxable income to the borrower because their net worth has increased.

Statutory Exclusions from Gross Income

While the Glenshaw Glass definition of income is expansive, Congress has specifically carved out certain items from taxation through the Internal Revenue Code. These “statutory exclusions” are items that are accessions to wealth but are not included in gross income for tax purposes due to specific policy decisions. It is important to understand that these items are not inherently non-income; they are income that federal law explicitly exempts.

One of the most well-known exclusions is for gifts and inheritances. When an individual receives property from another person as a gift or from a decedent’s estate, its value is not included in the recipient’s gross income. This policy helps prevent double taxation, as the transfer may have already been subject to federal gift or estate taxes.

Proceeds from a life insurance contract paid due to the death of the insured are another significant exclusion. When a beneficiary receives a life insurance payout, that amount is generally not taxable income. This policy is intended to provide financial relief to beneficiaries during a difficult time.

Certain scholarships and fellowship grants are also excluded from gross income. A scholarship for tuition, fees, books, and required supplies is not taxable. However, any portion of the scholarship covering other expenses, like room and board, is generally considered taxable income.

Items Not Considered Accessions to Wealth

Separate from statutory exclusions are receipts that are not considered accessions to wealth because they do not result in a net increase in the taxpayer’s wealth. The primary concept in this category is the return of capital. When you sell an asset, you are only taxed on the gain, which is the amount you receive that exceeds your original investment, or “basis.”

For example, if you purchase a stock for $1,000 and later sell it for $1,500, your accession to wealth is only $500. The initial $1,000 you receive is simply a return of your capital and is not income. This principle ensures that you are not taxed on the recovery of your own money, as only proceeds in excess of your basis are considered a taxable gain.

Loan proceeds are another example of a receipt that is not income. When you borrow money, you receive cash but also have an equal obligation to repay the debt. Because your assets increase by the same amount as your liabilities, your net worth does not change, and there is no accession to wealth to tax.

Finally, unrealized appreciation in an asset’s value is not income. The realization requirement means that an increase in the value of your home or stock portfolio is not taxed until you sell or otherwise dispose of the asset. Until that event, the increase in value is not considered a realized accession to wealth.