Federal Income Taxation -RYAN
Fall 2011
__________________________I. Tax Rates ___________________________
Marginal tax rate: rate at which our “next” or “last” dollar of income is taxed.
– at present the rates are:
o 10%
o 15%
o 25%
o 28%
o 33%
o 35%
Effective Tax rates: the amount of tax paid divided by total income
– total income
Standard Deductions: always function as a “zero rate bracket” because 0-6k is 0%
Computing Tax and Effective Rate
Gross Income
– Above the line Deductions
= ADJ GROSS Income
– Standard or Itemized Deductions
– Personal Exemptions
= TAXABLE INCOME
X Tax Rates (progressive scale)
= TENTATIVE TAX
– Credits
= TAX DUE
Tax Due / AGI = Effective Rate
Deduction v. Credit
– Credits and deductions are both subtractions but get subtracted in different places
– Deductions are subtracted BEFORE we apply the tax rate, so the value of the deduction is the amount of the deduction multiple by the tax rate.
– Credits are subtracted at the end: the value of a credit is a dollar for dollar reduction in your tax liability.
o Deductions are worth more to people with lots of money because they get the most bang for the buck
o Low income tax payers do better with credits.
o Note that exclusions function the same as deductions
_________________________II. Principles in Creating Tax Laws _________________
1. Equity / Fairness
– Horizontal: similar tax burdens on similarly situated taxpayers
– Vertical: appropriate differential in tax burdens for people in different circumstances
o Progressivity is a form of vertical equity
2. Efficiency (aka neutrality)
– avoiding the distortion of normal economic incentives
3. Administrability
– fair and efficient administration
___________________________________Income______________________________
Economic Definition: Schanz-Haig -Simons Definition of Income
– Income = consumption + savings
o Consumption is the market value of rights exercised in consumption and
o Savings is the change in the value of the store of property rights.
§ Savings can be investment: putting cash in bank account or buying stock
o Economic definition NOT concerned about source of income only cares about USE – what you do with it!
o Note that if M withdraws $100 from her bank savings account and spends it on food which she eats: positive income – negative income = NO economic income bc offsetting things in the equation above.
o Psychic feeling – aka good feeling does not give rise to economic income
Tax Definition of Income
– § 61(a) Gross income defined: Except as otherwise provided in this subtitle, GI means all income from whatever source derived, including (but not limited to): compensation, business, gains from dealings in property, interest….
o This is tautological definition not very helpful
o Note Section 7806(b): code is helpful but not determinative
– Tax definition is different from economic definition of income because USE does not make any difference under tax def.
o Tax definition is worried primarily about the SOURCE of the money – where did it come from.
o What you do with it is of relevance when we talk about deductions but for income alone the USE is not relevant.
o Source is also highly relevant with capital gains
– Are there situations in which something might fall in the definition of section 61 but not be included as income?
o Note the words in Section 61 “except as otherwise provided” so things in the code may create exceptions
o Note 7806(a) says cross references are not legally binding?
– Commissioner v. Glenshaw Glass (p. 31)
o T did not report punitive damages from a lawsuit as income.
o Rule: Punitive damages are income and subject to tax
o Definition of Income: accessions to wealth, clearly realized, over which Taxpayer has complete dominion.
o Clearly Congress does not intend some things to be counted as income even tho you won’t find the explicit exceptions in the code
§ For example: imputed income (painting your own house, washing your own clothes, cooking your own food, etc) is not included as gross income and there is no express exclusion in the code.
o Glenshaw Glass is helpful BUT there is NO all encompassing definition of income – take it case by case.
– § 102 Gifts and inheritances (a) GI does not include value of property acquired by gift, devise, bequest, or inheritance.
o (b) Not excluded from GI: income from property described in (a), or income where the gift, bequest, etc. is income from property. (c) Not excluded from GI: any amount transferred by or for an employer to, or for the benefit of, an employee.
o Note “detached and disinterested generosity” infra”
– Interest: yes always included in GI
– Taking money out of your savings: Not a taxable event – you are usuing after tax money
– Borrowing Money: No not income bc you have to give it back, it is an equal and offsetting liability. Usually borrwing not subject to income tax
– Found 100 dollars / treasure trove: yes this counts as income
– Psychic Income: Not included in income, feeling good etc is not included as income
– RELEVANT QUESTIONS
o (a) what constitutes a gain? Because income can be received as “kind” as well as cash this is difficult.
o (b)When is income clearly “realized?”
o (c) Consider the source of specific exclusions. Such a gifts.
Calculating Gain or Loss
– What is the purpose of Section 1001?
o Gives us a formula tha
or other basis allocated to such part.”
– “The sale of each part is treated as a separate transaction and gain or loss shall be computed separately on each part.
– “Thus, gain or loss shall be determined at the time of sale of each part and not deferred until the entire property has been disposed of.”
Property not of uniform value: Treas. Reg. § 1.61-6(a), ex. 2:
– B purchases for 25K property consisting of a used care lot and adjoining filling station
o So cost basis for WHOLE property is 25K
– At the time of purchase the fmv of the filling station is 15K and the fmv of the used car lot is 10k
– Five years later B sells the filling station for 20k at a time when 2k has been property allowed as depreciation
– B’s gain on this sale is $7,000, since $7,000 is the amount by which the selling price of the filling station exceeds the portion of the cost equitably allocable to the filling station at the time of purchase reduced by the depreciation properly allowed.
– So a larger piece of property the basis is allocated base on the relative fmv of these parts at the time of purchase
When it is not feasible to allocate basis to different parts of a property
– Backload Approach:
o First Northwest Industries of America Inc. v. Commissioner
o If you can prove your basis subtract from AR but if you can’t then your basis is ZERO bc you cannot prove that you have one
– Frontload Approach
o Injaha Land Company Ltd. v. Commissioner
o Instead of making you wait til the end if you can’t prove you could get your basis up front
o Note that in easement situations IRS will follow Inaja Land but outside will likely not follow this approach
– This is all about timing, when do you report gain and when do you get your tax free return of capital
Old Colony Trust Co. v. Commissioner
Facts: Corporation reimbursed T for income taxes he paid on his salary.
Court said Payment of tax was income to T. “ It was in consideration for services rendered.”
Discharge of T’s obligation by a 3d party is equivalent to receipt by T.
This would have been a tax break for people who could arrange what T did. He saw more of the company’s total payment on his behalf (salary + taxes they paid for him) than an employee who got that same sum as salary.
