Definitions of Taxable Income:
· Generally: § 63(a)
o “gross income minus the deductions allowed by this chapter (other than standard deduction)”
§ Read: Gross Income minus Above-the-line Deductions, Personal Exemptions, and Itemized Deductions
· Alternative Definition of Taxable Income: § 63(b)
o “adjusted gross income, minus the standard deduction and the deduction for personal exemptions.”
Definition of Gross Income:
§ 61(a) – defines gross income as “all income from whatever source derived.”
Note: This parallels the language used in the Sixteenth Amendment and Congress clearly intends to exert full measure of its authority to tax.
§ 161 – only deductions specifically authorized by the Code can be used to compute taxable income. YOU MUST HAVE STATUTORY AUTHORITY FOR EVERY DEDUCTION YOU TAKE.
Adjusted Gross Income:
§ 62(a) – Adjusted Gross Income is gross income minus 18 specifically identified deductions which are the Above-the-Line Deductions.
***All taxpayers may claim § 62(a) (above-the-line)deductions***
Even if you choose standard deduction, certain additional deductions are allowed.
§ 151 – “personal exemptions” available to all taxpayers, even those who do not itemize. However, they are not listed in § 62(a), so they are Below-the-Line. These exist because a certain amount of income must be used to meet basic subsistence needs.
Note: Personal Exemptions can only be taken into account AFTER you have calculated Adjusted Gross Income.
§ 63(c) – Standard Deduction
Comprised of a “basic standard deduction” and “additional standard deduction.”
§ 63(d) – Itemized Deductions
All deductions other than above-the-line deductions and personal exemptions.
Limits on Itemized Deductions
**GO BACK AND RE-LEARN THE HAIRCUT AND PHASE OUT**
§ 67(a) – “miscellaneous itemized deductions” can only be taken to the extent that the deductions exceed 2% of the taxpayer’s adjusted gross income
§ 67(b) – defines “miscellaneous itemized deductions” – all items NOT LISTED.
§ 68(a) – affluent taxpayers with taxable incomes in excess of an “applicable amount” will lose up to 80% of their total itemized deductions. (phase out)
§ 68(b)(1) – amount is $100,000 / married filing separately is $50,000
§ 68(b)(2) – amounts adjusted for inflation
If you have an adjusted gross income in excess of the applicable amount, you must reduce the amount of your itemized deductions by 3% of the excess. This reduction shall never exceed 80% of the total itemized deductions.
§ 68(c) – Four exceptions to the phase-out (“Fantastic Four”)
Section B. Personal Exemptions
Two sources within § 151
§ 151(b) – exemption for the taxpayer
§ 151(c) – exemptions for dependents
Also exemption for taxpayer’s spouse if they file separately and spouse has no gross income.
Section C. Overview of Credits
After computing taxable income and determining tax liability, taxpayers claim various credits against the tentative tax liability.
***Prefer Credits to Deductions***
§ 21(c) – Household and Dependent Care Credit
Non-refundable credit—can only reduce tax liability to zero but cannot create a refund.
Two-earner households are eligible for this credit to recoup for expenses related to the care of a dependent.
§ 25A – Hope Scholarship and Lifetime Learning Credit
§ 31(a) – Money withheld from wages and credited against tax liability
Withholding reduces taxpayers spending power. People seek to invest and earn interest – accelerate deductions and avoid payment.
§ 32 – Earned Income Tax Credit
Targeted to low-income taxpayers and phased-out as the adjusted gross income exceeds $5,280. Percentage is a function of the number of “qualifying children.” The credit normally generates a refund.
The law is too complicated for low income individuals who cannot afford profession
aid for with something other than money, the fair market value of services or property taken in payment must be included in income.
Note: It doesn’t matter if the barter is uneven, you must include the fair market value of the service received.
Prizes and Awards
§74(a)—prizes must be included into income. (i.e. when Oprah gives you a car, you have to include that into income and pay taxes on it.)
§208(g)—When renting out your home for less than 15 days, you do not need to pay tax on anything received for payment.
This is like the “extreme home makeover” provision in the tax code.
James v. United States “Illegal Income Case”
Union official embezzles over half million in union funds.
Rule: If a taxpayer receives income—legally or illegally—without consensual recognition to repay that money (i.e. loan note), that income is included into income and is taxable.
Rationale: The 16th Amendment suggests that unlawful, as well as lawful, gains are included in “gross income.”
Congress does not intend to treat law-breaking tax-payers more differently than law abiding tax-payers.
Ways IRS handles illegally earned income:
Brings a civil case against you—requests that you pay what you owe
Brings a criminal case—pay what you owe or go to jail.
Things Excluded from Income:
Free Samples (targeted as part of an advertising campaign)
Gifts §102 (a)
Imputed Income—Imputed income is benefits resulting from a taxpayer’s personal efforts (ex. Growing your own vegetables in your garden).