Class: Federal Income Taxation
Professor Coverdale
Spring 2013
Introduction
· Gross Income: all income from whatever source derived except as otherwise provided by the statute
o For most individuals: wages & salaries, dividends, interest and rents, and gains from the sale of investments such as securities and real estate
· Exclusions to GI: statutory exceptions to reach of 61
o 103(a): Interest on state and municipal bonds
o Effect of an exclusion: tax excluded item at a rate of zero
o Benefit: depends on applicable tax bracket
· After determining gross income, taxpayer subtracts all outlays and expenditures that are allowed by the Code as deductions
o Deductibles include: business expenses, charitable contributions
o Dollar value of a deduction from GI is same as that of an exclusion
· Effect is the same whether the amount of charitable gift is excluded from GI first or included and then accounted as a deduction
· Long-term capital gains
o Sale of property: taxpayer subtracts cost (basis) for property sold from amount realized on transaction
· Gain is recognized and included in gross income
· If property is capital asset (ie: real estate acquired for an investment) and held for one year, it will generally be taxed at a lower rate than that which applies to ordinary income
· Taxable income: residual or net amount on which taxpayer's tax liability is based
· Tax credits are subtracted directly from the tax due
o Credit has same dollar-value for all taxpayers entitled to use it
· Most individuals use cash method of accounting while businesses use accrual method
· Pay now or pay later?
· Progressive Tax Rates
· Marginal rate of tax: applicable rate of tax at each bracket level
· Average or effective rate of tax: rate that is applicable to the taxpayer's income as a whole
· Additional earnings will always involve some increase in a taxpayer's after-tax income as long as the highest marginal rate of tax is less than 100%
· Code 1(f) provides that the brackets used in the individual rate schedules shall be adjusted or indexed each year to reflect the percentage by which the CPI exceeds the CPI for base year of 1993
· Corporations are subject to a 4 step tax schedule which distinguishes between small companies and others
o Taxable income is computed mush the same
Sources of Tax Law
· Trial Courts
o If Commissioner of IRS asserts deficiency in income tax, taxpayer may:
· Refuse to pay and petition Tax court for redetermination of deficiency
· Pay deficiency, file administrative claim for refund, and upon denial of claim sue for refund in federal district court of US Court of Federal Claims
o Three courts have original jurisdiction in federal tax cases: Tax Court, US District Courts, US Court of Federal Claims
· Tax Courts
o Poor persons court
o 19 members
o Cases tried without a jury by one judge who submits an opinion to the chief judge for consideration
· Chief judge either allows decision to stand or refer it to full court for review
· Federal District Courts
o Jurisdiction in any tax case against US seeking a refund of tax, regardless of amount involved
o May be tried before juries
o Taxpayer must bring tax actions against US in district is which taxpayer resides (corporations = principal place of business)
o Must first pay amount in dispute and commence refund action
· US Court of Federal Claims
o Jurisdiction over all tax suits against US regardless of their amount
o Jury trial unavailable
o Where one resides makes no difference
o No jurisdiction to hear deficiency cases
· Appellate Courts
o Jurisdiction is in the court for circuit in which taxpayer resides
o Decisions are reviewable by Supreme Court
· Selection of Forum
o Taxpayer has choice
o Tax Court often favored because do not have to pay before bring action
o Other factors: desire for jury trial, expertise of Tax Court judges, past record of particular court on a given issue
Researching the Tax Law
· Internal Revenue Code
o Primary source of federal tax law
· Legislative History
· Illuminate Congressional intent
· Regulations
o Issued by the Treasury
o Provide flesh to the skeletal structure of IRC and have force of law
o Courts typically give deference to the Treasury and seldom find regulations to be invalid
o Older = more likely to be upheld (long-standing administrative interpretations and procedures apparently have the blessing of Congress)
· Revenue Rulings and Procedures
o Interpretative pronouncements designed to indicate the Service's position regarding the application of the tax law to a certain set of facts
o Rulings are not published in proposed form, no opportunity for comment, not approved by the Secretary of Treasury
o Revenue Rulings
· Rulings which IRS determines are of general interest, found in weekly IRB
· Result of a taxpayer's request for advice on position that Service would take with respect to a proposed course of conduct or may simply represent the Service's position on issues arising on audit of a taxpayer's return or on issues which have been decided by various federal courts
· Unless superseded, modified, or revoked, revenue rulings can be relied upon by any taxpayer whose circumstances are substantially the same as those set out in the ruling
· May be cited as precedent supporting a particular position
o Revenue Procedure
· Statements of the Service regarding its internal management operations
· General effect upon taxpayer's rights and duties = represent interpretations of the statutory language and cannot be overlooked as one represents a client
o Letter Rulings
· Responsive to a particular taxpayer's request for advice on tax consequences of a specific transaction
· IRS does not consider itself bound by letter rulings in dealings with other taxpayers
· Case Law
o Two types of Tax Court Decisions
· Regular Decisions
§ Officially reported in Tax Count Reports and in 47 volumes of its predecessor
§ Generally involve important issues in tax which may not have previously been resolved
· Memorandum Decisions
§ Generally involve the application of settled points of tax law to particular facts
§ Not officially published
o When Tax Court rules against Commissioner, Commissioner will commonly issue a notice of acquiescence or of nonacquiescence
· Acquiescence: IRS accepts conclusion of Tax Court on issues
· Nonacquiescence: IRS does not accept Tax Court conclusion and intends to continue challenging taxpayers with respect to the issue or issues before the court
· Updating Research
o Must reference to a citator to determine current status of that authority
First Class
· Base * Rate = Tax
o Taxable Income * Progressive Rates = Tax
· To raise the base
o Can eliminate deductions (usually used)
o Can include more things in taxable income (not commonly used)
· Better to have broad base and narrow rates
o Individual taxpayer doesn't really care about which method is used, only care about the end result (higher taxes)
· Income tax system is way too complicated
o None of this complication comes from progressive tax rates
o Complications arise from what is included and what is deducted (aka the calculation of taxable income)
· Rates
o Flat:
· Proportional
· Single rate applicable to all
o Progressive:
· Income goes up, tax rate goes up *at the margin*
· Not all income is taxed at highest rate
· Tax is lower than people think because the lower income gradients are taxed accordingly
o Regressive:
· Rate you pay decreases with the amount of income that you have
· Social Security tax: nominally a flat tax (7.5% but capped at certain amount of income)
· Bill Gates & I pay the same amount of social security tax (not necessarily true)
· Criteria Used to Judge a Particular Tax System
o Will it raise the required amount of money
· Head tax: everyone pays the same amount of money
o Economically Efficient
o Should be simple, easy, and relatively cheap to administer
· How does the income tax fair under this criteria
§ It does not cost a huge amount to collect if you look at the direct cost of the IRS
§ Fairly economic to administer
§ Not a simple system
· For the majority of taxpayers it is simple
· Why?
· Base (taxable income) is artificial and complicated
· Complex because Congress has chosen to use the tax code for all types of activities other than taxing income for several reasons
· Low income tax credit
· Congress wants to dis those are highly taxed
· Congress says A is taxable and B is not taxable
· Manipulating the system: same economic effect of A but in the form of C
· Congress would then tax C and the company would go to option D
o Politically it is a difficult process
Effici
· President of a company that had invoked a policy to pay the income taxes of all officers of the company
· Issue: does the payment of income taxes by employer constitute additional taxable income to such employee?
· Court
o Payment of the tax by employer was in consideration of the services rendered by the employee and was a gain derived by the employee from his labor
o Payment = income
o Payment of the tax was not a gift
· Argument: never-ending cycle
o Congress could not have contemplated or intended this
o We will not answer this question now
· Notes:
o Courts will uphold the pyramiding of tax liability in appropriate cases
McCann v. US
· Plaintiffs sue for refunds of income taxes which the plaintiffs were required to pay pursuant to deficiency notices issued by IRS
· Husband and wife made a round trip to Las Vegas to attend a seminar that was conducted by Mrs. McCann's employer
o All traveling and other expenses were paid by employer
· McCann did not include this amount on tax return
· Employees not required to attend
· Court
o Value of the reward must be regarded as income to the employee
o Reward was compensation for her services rendered
Pellar v. Commissioner
· Petitioners entered into an agreement with a construction company for the erection of a dwelling on land previously purchased by petitioners
o Actual cost of construction was substantially in excess of price fixed in agreement, with the excess being due to extras requested by petitioners and increased labor costs
o Contractor had never expected to make a profit on the construction work and was satisfied to take a small loss
· Father of Pellar had an interest in several corporations which had employed the contractor for construction work in amounts totaling in excess of a million dollars
· Issue: did petitioners receive income by virtue of the construction of a residence for them where the cost of construction and the fair market value of the residence materially exceeded the agreed price paid to contractor
· Court
o Fair market value = $70,000
o Agreed price = $40,000
o In total Pellars paid $55,000 for house worth $70,000
o Purchase of property for less than its value does not give rise to realization of taxable income
· Realization arises and is taxed upon sale or other disposition
o Fail to find any circumstances on the basis of which we may determine that petitioners realized taxable income upon the principles announced by the authorities cited above
· Non employer-employee relationship to find it to be compensatory
o Actions were akin to lavish expenditures for presents or entertaining
· No more was intended
Roco v. Commissioner
· Deficiency found in Roco's income tax of $610,446 and an accuracy related penalty under section 6662(a) of $122,093
· Petitioner sued NYU Medical Center in a qui tam action under False Claims Act
o Petitioner claimed that NYUMC had submitted false information to the US which resulted in a substantial overpayment of Federal funds to NYUMC
o NYUMC agreed to pay $15,500,000 to US to settle
o US paid petitioner $1,568,087 as his share of settlement proceeds
· Issues:
o Whether payment to petitioner received from US is includable as gross income = YES
Whether petitioner liable for accuracy-related penalty = YES
· Petitioner attempted to determine tax treatment of the qui tam payment
o Found that no authorities discussed these payments
· Court
o Payment is equitable to a reward paid to petitioner for his efforts to obtain repayment to the US of overcharges
