MICHAEL SIMKOVIC
FEDERAL INCOME TAXATION FALL 2010
1. Why Tax
a. Because government spends money
b. Areas like military and SS are non discretionary so Congress has little say in how much it wants to spend
2. Who pays taxes?
a. Pretty much everyone and everything
b. Corporations pay less tax as they can hire lobbyists
c. The taxable unit
i. Means that individual or group of individuals who are treated as a taxpaying unit in the sense that they must aggregate their income for purposes of calculating tax payable.
ii. Married people are permitted to file a joint return which means a return on which they aggregate their income and deductions so that it does no matter who earned what. Defined in §143
1. The rate schedule for such returns provides the lowest rates of the four schedules provided in the IRC. Defined in §2(a)
2. This rate schedule is also available to surviving spouses but not to single sex couples
3. Married single earner couples are better off than they would be under a system with one schedule for all since they have the advantage of the most favorable rate. Called Marriage Bonus
4. On the other head, two earned married couple may be worse off than if they had remained single because of the requirement that they file jointly or use the unfavorable MFS schedule. Called Marriage penalty.
iii. Another rate schedule is heads of households and is somewhat less favorable than the one for married couples
1. Generally head of households = unmarried person with a dependent living. Defined in §2(b)
iv. Next “unmarried individuals” commonly single people. Defined in §1(c)
v. Finally married people filing separate returns
1. Rarely financially beneficial to the taxpayer
2. Results in increased aggregate taxes
d. Standard of favorability
i. Married people > Head of household > unmarried individuals > married filing separately
ii.
3. How does the government tax?
a. Income tax forms a major part of the tax system
i. We have a system of progressive marginal tax rates
b. Effects of income tax
i. Income effects are changes in behavior induced by the fact that the tax reduces the money available to the tax payer
ii. Substitution effects are changes in behavior that arise from a change in the relative attractiveness of different commodities or activities
c. Stealth tax
i. The tax system doesn’t factor in inflation it happens automatically
ii. Seigniorage as a tax
1. Some economists regarded seigniorage as a form of inflation tax, redistributing real resources to the currency issuer. Issuing new currency, rather than collecting taxes paid out of the existing money stock, is then considered in effect a tax that falls on those who hold the existing currency. The expansion of the money supply may cause inflation in the long run.
2. Banks or governments relying heavily on seigniorage and fractional reserve sources of revenue can find it counterproductive. Rational expectations of inflation take into account a bank's seigniorage strategy, and inflationary expectations can maintain high inflation. Instead of accruing seigniorage from fiat money and credit most governments opt to raise revenue primarily through taxation and other means.
4. Progressive tax system
a. The system if progressive because we want to encourage people to keep working towards higher income
i. Leads to greater revenue for government
ii. Lookup more Policy Wiki
Progressive Rates: as the amount of income goes up, the rate also goes up
i. Marginal rates: what your last dollar of income is taxed at
1. The rate you pay on the last dollar you make goes up as your income goes up, but you don’t increase the rate on every dollar you make
2. Lowest rate = 15%; highest rate = 35%
3. Ex: $1-$9,999 = 10%; $10,000 = 20% – Therefore, you will pay 10% of the $9,999, and then 20% of every dollar after that until you hit the next bracket
c. Collection costs are less than .5% or minimal
i. The IRS relies on initial self assessment which means that once each year each individual or entity subject to the tax makes a calculation of the amount of tax owed.
ii. Failure to file could mean civil as well as criminal penalties
d. Sometimes the IRS can find a mistake and they will take steps
i. There are three choices about where to litigate the controversies
1. Choice of Forum
Tax Court
District court
United states court of federal claims
Time of payment of tax
Only after filing
Before filing
Before filing
1. Interest payment
US Short term + 3% (Sec 6621)
NA
NA
1. Tax expert
Yes
NO
NO
1. Jury trial
Bench Only
Jury or Bench
Bench
1. Appeals
a.
Federal Circuit Court of Appeals where tax payer resides
Federal Circuit Court of Appeals where tax payer resides
US Court of Appeals of Federal Circuit
Impact of taxpayer appellate victory
One Circuit only
One Circuit only
National Victory for all taxpayers
ii. Reasons for choosing one forum over another
i. Judge believes in law and society, and he is likely to not be in your favor.
ii. Jury probably don’t like taxes either, so this may be a better option
iii. The decision also depends on the client’s discount rate
Consider the 3% rate that is applied in tax court.
e. Sources of Tax Law
i. Tax Code, Court Decisions, Treasury Regulations, Congressional intent
ii. If Conflict
1. As long as the court and tax have not said anything the treasury can do a lot.
2. Congress is the most powerful as it has the power to make the laws but Treasury is the most active.
5. The basic income tax calculation
a. Gross income §61; §71-90; Glenshaw Glass
i. Minus exclusions §§101-137
ii. Minus above the line deduction §62(a)
b. AGI §62
i. Minus whichever is greater, either,
1. Standard deduction §63(c) OR
2. Itemized deductions §63(d)
ii. Minus Personal Exemptions
c. Taxable Income §63
i. Multiplied by applicable tax rates §1 (inflation adjusted tables)
1. Ordinary income brackets
2. Capital gains
ii. Minus Credits §§ 21-41 (so called below the line deduction)
d. Taxes due or refund
e. Unless AMT applies and is greater §§55
i. Alternative Minimum Tax
1. Limits the amount of deductions
6. Tax Strategy
a. The government wants more money in less amount of time the TP wants to give less money in more amount of time
i. Reasoning
1. Inflation
2. Opportunity cost
3. Alternative investments
4. Time is money aka time value of money
b. Time Value of money
i. Money now is better than money later (Look for reasons above)
ii. If a problem involves money that may be earned, transferred or paid at different points in time, it probably requires a present value calculation
1. Step 1: Break the problem down into components
a. Discount rate: This will likely be an interest rate or rate of return
b. Future Values: The nominal amounts of money in the future
c. Time: The number of years into the future of each future value
2. Step 2: Plug into the formula and calculate PVs
3. Step 3: Pick whichever choice maximizes present value (or minimizes PV of losses) for your client
iii. Formula
1. Present value = future value / (1+ Discount rate)^year
2. Future Value = present value * (1+ discount rate) ^year
3. Discount rate = year square root([future value]/[present value])-
payment of a student loan, provided the cancellation or repayment is contingent upon work for a charitable or educational institution.
e. Mortgage foreclosures & modifications up to $2million §108(h)
i. This section provides relief for TP who would otherwise recognize income from the discharge of indebtedness when mortgage lenders foreclose on the taxpayer’s principal residence.
ii. When the TP gets a break in the form of a mortgage modification, the taxpayer must reduce the basis in the principal residence (not below zero) by the amount excluded. Increases the likelihood that TP would recognize a gain on subsequent disposition.
iii. Enacted in Dec. 2007 to prevent a flood of foreclosures.
d. Exception of Housing or meals furnished for the convenience of the employer
i. §119(a) allows exclusion from gross income of an employee the value of any meals or lodging furnished to him, his spouse or any of his dependents by or on behalf of his employer for the convenience of the employer,
1. The meals are furnished on the business premises of the employer or
2. The employee is required to accept such lodging on the business premises of his employer as a condition of his employment
ii. However cash allowances are includible in gross income to the extent that such allowances constitute compensation. Meaning if the employee can decline the meal/lodging but cash instead then it counts as compensation.[H2]
iii. Requirements For lodging
1. The value of lodging furnished to an employee by the employee shall be excluded from the employee’s gross income if 3 requirements are met
a. The lodging is furnished on the business premises of the employer
b. The lodging is furnished for the convenience of the employer and
c. The employee is require to accept such lodging as a condition of employment
2. It doesn’t matter if the third requirement is in the employment contract §119(b) or not
3. If the employer furnishes the employee lodging for which the employee is charged an unvarying amount irrespective of whether he accepts the lodging the amount of the charge made by the employer for such lodging is not as such part of the compensation includible in the gross income of the employee[H3]
a. If the employer charges the employee a charge for furnishing the housing and the employee declines, the charge is not includible in gross income.
iv. Requirements for meal
1. The test
a. The meals are furnished for the convenience of the employee
i. Determined by analysis of all the facts and circumstances
b. The meal is furnished on the business premises
2. If the employer is required to pay for the meal periodically and such meals are for the convenience of the employers the employee can exclude from the gross income an amount equal to the charge of the meal.
a. It doesn’t matter if this charge comes out of pockets or compensation and even if the employee is required to pay regardless of the fact whether the accept or decline the meal.
[H1]Something here in the notes?!!
[H2]Check on this!
[H3]Huh? Does it mean that if the employee can turn down housing. .. . . .?
