FEDERAL INCOME TAX COVERDALE FALL 2014
REMINDERS: *No “Bargains” in tax class- you would only give someone something at FMV for the services.
*Anything that is a town, municipalities, girl scouts, SHU, universities are all tax exempt
INTRODUCTION
I. Definitions
a. “Cash flow” Consumption tax: inc tax w/ a ded for savings- tax based on amts drawn down f/ savings & used for consumption
b. Tax incidence: who bears the burden of paying corporate tax
i. Tax has been shifted & the incidence is on the consumers rather than on the manufacturers, or employees, or shareholders
c. Inflation: §1(f) individual rate schedules adj each year to reflect increases in consumer price index
d. Realized gain: change in circumstances & a gain or loss might be taken into account
i. Just b/c it is realized does not have to mean that it is recognized if there is a provision to exclude
ii. Ex. gain f/ sale of securities for cash
e. Recognized Gain: taxable (when there is recognized then it must have been realized)
f. Present Value:
i. Table on 505: Right side- yrs til $ is due; Top interest % = $ is worth at PV
ii. Table on 506: is the amt w/ invested growth
II. Types of Taxes
i. Avg rate: avg tax paid on inc (across all tax bracket, weighted)
1. Taxes (due to pay) / TI (taxable inc)
ii. Effective Tax rate: taxes (due to pay) /AGI
1. Measuring your real INC- what you are paying on every $ of your total economic inc
iii. Marriage Tax Penalty: married couples who file jointly & have 1 primary earner pay less tax.
1. Married couples w/ 2 inc earners pay more b/c they are denied f/ benefitting f/ ↓ levels of the progressive rate structure twice, individually.
b. Proportional tax: uniform percentage of inc regardless of base amt
c. Regressive tax rate: percentage of tax rate declines as base inc increases Ex. social security
III. Importance of Inc Tax
a. Filing options for individuals subject to U.S. inc tax return (Form 1040)
i. Joint returns filed by married couples
ii. Single individuals
iii. Heads of house-holds (single w/ at least one dependent w/ you)
iv. Surviving spouses
v. Married persons filing separate returns
b. Economic consequences
i. Inc effects: changes in behavior induced by fact that tax reduces the money available to TP
1. Some tax provisions favor particular type of activity or investment (INCENTIVES)
ii. Substitution effects: change in what consumer’s buy b/c of attractiveness of dif commodities
c. Ability to pay
i. Wealthier you are the less each dollar lost to tax diminishes your well-being (should pay more)
d. Global v. Scheduler tax approach
i. Global- INC f/all sources combined & taxed under rate schedule that applies to TP’s total inc
ii. Schedule- separate rate schedule applies to several different categories of inc & losses
e. Compliance & administration
i. IRS is a branch of the Treasury department & headed by the commissioner of Internal Revenue
ii. Our inc tax relies on self-assessment
1. IRS has 3 yrs statute of limitations to assert a “deficiency”
2. Person who fails to file an inc tax return may be subjected to both civil & crim penalties
IV. History–1861: US’s 1st inc tax, 1894: 2% tax those making >$4,000, Pollack, 1980: proportionate taxation
V. Rate Structure, Compliance, & Tax Terminology
a. §62 Adj Gross Inc–AtL ded’s get you f/GI to AGI. These are exclusions f/ inc
1. Most fall into the category of cost of making gross inc (biz expenses)
2. Or things that are targeted at people who do not itemize (stu loan int, tuition & fees ded)
b. Economist Approach–Haig-Simmons: Inc = Consumption + Change in wealth (beginning→ yr end)
1. Used by economists not by the tax code–Issues: (1) you do not have the $ to pay for that unrealized amt right now (2) difficult administrative feasibility (3) valuation issues
c. CG (& Dividend Inc)–gain or loss f/ the “sale or exchange of a capital asset”
1. Capital asset: prop held f/inventory or f/sale to custs in ord course of trade or biz
a. Think stocks & bonds, [LTCG > 1 yr, STCG < 1 yr]
d. Tax Accounting
i. Cash Method--Amts are treated as inc when received in cash/equivalent & deductible when paid
ii. Accrual Method--Items included in GI when earned & items of expense are deductible when the obligation to pay is incurred, regardless of when pymt is made
VI. Tax Policy Goals
a. Economic effect--Is the tax causing any unintended perverse effects? Ex. free parking .:. ↑ pollution
b. Vertical equityà fairness--Should pay taxes according to ability to pay
c. Horizontal equityà fairness--TPs w/ similar inc/similarly situation should pay similarly
d. Administrative Feasibility→Valuation- does it make it easier for TPs to comply?
VII. Sources of Tax Law--Taxes are imposed only by statuteà if vague look to other sources
a. Internal Revenue Code
b. Congressional Record --Committee Reports
i. Common for courts to rely heavily on them
ii. Reports prepared by technicians on the staff of the Joint Committee on tax; this committee is composed of reps of the House Ways & Means Committee & the Senate Finance Committee
iii. Reprinted in the Internal Revenue Bulletin
c. Blue Book—Pub’d by Joint committee on tax- advises both Senate & House committees – non-partisan
i. Explains the act, the kinks are brought to their attn & they can iron them out (given wt in Cts)
d. Hearings before the Senate & House Committees--Occasionally Cts refer to these to aid construction
e. Treasury Regulations
i. The Code authorizes Sec of Treasury to prescribe all rules & regs for enforcement of the code
ii. Authorized to issue regs to cover more specific areasà interprets the statutes giving more detail
1. Interpretative type: explains the statute
2. Legislative type: delegate authority to treasury to regulate
3. Procedural type: deals w. matters that tell you time, place. Etc. “how to”
iii. “Chevron deference” – when Congressional intent is unclear – admin. Agency responsible for interpreting the statute has broad discretion to adopt whichever interpretation it prefers
f. Revenue Rulings (rev. rul.)--Reprinted in the Internal Revenue Bulletin
i. Opinions on matters of law arising in particular fact settings; often they are based on requests by TPs for advice about a specific legal issue w/ which they are confronted
ii. No binding effectà can influence the argument
g. Revenue Procedures--Reprinted in the Internal Revenue Bulletin
i. Statements describing procedures affecting the rights or duties of TP’s à Administrative Rules
h. Private Letter Rulings--Issued to TPs in response to requests f/advice @ their own specific situation
i. These ruling do not become Revenue rulings, the gov is not bound to follow the legal position that it adopts except as it is applied to the individual TP to whom the advice is directed
i. Decisions of the Tax Court- CASE law
VIII. How a Tax Bill Becomes a L
An owner cannot deduct as a biz expense gifts to individuals (in excess of $25). If biz wants to deduct the full amt of the “gift” then the recipient must treat it as inc.
2. Payor deduct biz expense if MOTIVE was compensation for services; payee must include
Proposed amendment to regulation–For purposes of §102 (c), extraord transfers to the natural objects of an employer’s bounty (employer’s kids) will not be considered transfers to, or for the benefit of, an employee if the employee can show that the transfer was not made in recognition of the employee’s employment. Accordingly, §102 (c) shall not apply to amts transferred between related parties (e.g. father & son) if the purpose of the transfer can be substantially attributed to the familial relationship of the parties & not to the circumstances of their employment
e. TP, President of real-estate investment subsidiary of a church of NY was awarded “gratuity” of $20,000 on his resignation after many yrs of svc. Pymt was excluded f/inc due to the SC motivation test
f. Welfare & various other gov’t pymts, like disaster relief, are excludable
g. Always remember-
i. One can turn down a prize if you do not want to pay taxes on it!
II. Inheritance Rule: §1.102-1 (EXCLUDED) up to 5.25M per person dying. Inheriting party can get unlim’d
a. Gr&son receives inheritance pursuant to a compromise agreement rather than judgment. Prop received as a gift, whether under a will or compromise agreement or under statutes of decent & distribution are EXCLUDED f/ GI, although the inc f/ such prop is includible in GI.
b. Attorney performs lifetime legal services for client in exchange for client bequeathing substantial sum in will to lawyer in lieu of pymt of fees during the client’s lifetime. Holding: Taxable INC
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FOR DUDUCTIONS: Genly Personal Deds are NOT deductible
i. Exceptions:
1. Medical expenses
2. Casualty losses
3. Contributions to charity
4. Interest on home-mortgage loans
5. State & local inc & prop taxes
III. EMPLOYEE BENEFITS (EXCLUSION)
Exclusions for Fringe Benefits§132
a. A fringe benefit is a non-cash benefit provided by employer for free or below market price to employees
i. Benefits are a cash substitute –they relieve the employees of expenses they would otherwise incur & are intended as compensation
ii. Fringe benefits made excludable by sections other than §132:
1. §79 allows employer to give $50,000 in life insurance tax free
2. §129 dependent childcare services (up to $5,000 child care tax free)
b. Who qualifies as an employee:
i. §132(h) Certain individuals treated as employees
1. retired, disabled employees & surviving spouse of employee treated as employee.
2. Why spouses can benefit f/ ONLY No Add’l Cost Svcs & Qual Employee Discounts
3. (h)(2) Any use by his spouse & dependent children shall be treated as use by employee
4. (h)(3) Special rule for parents in case of air transport: Parents treated as employee
Policy issues: valuation & enforcement (administrative feasibility)
c. §132 coverage of fringe benefits excluded f/ inc
i. Codifying no tax on fringe benefits that are relatively small in value & which were available to ↑ & ↓ paid employees alike
