FEDERAL INCOME TAXATION OUTLINE – McGOVERN
GENERAL TAX FORMULA:
1. GI (61) – A/L Deductions (62) = AGI
2. AGI – ID ( 63a) or SD ( 63b) = Deductions
3. Deductions – PE ( 151, stated in 63b) = TI
4. TI x Tax Table ( 1) = TL
a. Taxable Income x Applicable Tax Rate
5. TL – Credits = Taxes Due
SOURCES OF TAX LAW
· Internal Revenue Code—should always be the starting point for the analysis of a tax problem.
o If it answers the question, then you don’t have to look at anything else.
o Title 26 of the United States Code is the IRC.
o Current code is IRC of 1986, as amended.
· Legislative History
o Reports that give guidance on what Congress thought that it was doing when passing the legislation.
· Treasury Department
o Internal Revenue Service—a bureau w/in the Treasury Department
o Treasury Regulations—sets forth the Treasury Dep’t interpretation of the code
§ The code is always superior to a treasury regulation, and if it isn’t then it is invalid.
o Revenue Rulings—a ruling issued by the treasury dep’t on a specific set of facts.
§ The ruling will give a summary of the facts, legal analysis, and conclusion on that fact pattern.
§ They are publicly issued w/ the intent that the public will rely on them.
o Revenue Procedures—address procedural issues
o The Private Letter Ruling—similar to a revenue ruling; it looks at a particular set of facts and it gives an analysis, but the difference is that it is issued to an individual client and not the public at large.
§ The client is entitled to rely on it, but the rest of the world is not entitled to rely on it.
§ Individuals can request a private letter ruling; it does not have to be an attorney or other representative.
o United States Tax Court—most common court in which tax issues are litigated because:
§ The taxpayer doesn’t have to pay the tax bill until after the case has gone before the court and a decision made.
§ It hears only tax cases, and the judges on the court are tax experts.
o United States District Courts
§ Not the same level of expertise as the Tax Court b/c they hear all sorts of cases
§ Taxpayer has to pay the tax due before bringing suit in the district court.
o United States Court of Federal Claims
· Appeals from these courts go to the Federal Circuit Courts, and then on to the Supreme Court.
CONSIDERATIONS FOR DETERMINING TAXES OWED
a. Tax Base—how much income is taxed
i. Taxable Income.
1. 63(a) Definition—gross income minus the deductions allowed by this chapter (other than the standard deduction)
ii. Gross Income
1. 61(a) Definition—all income from whatever source derived, including (but not limited to) the following items:
a. Compensation for services, including fees, commissions, fringe benefits, and similar items;
b. Gross income derived from business;
b. Tax Rate—the rate at which the base is taxed
i. Our system is a progressive based system
c. Tax Liability—equals the tax base x the tax rate
d. There is a policy against permitting the assignment of income from one taxpayer to another to get into a lower tax bracket.
e. Cash method taxpayers: Under the cash method of accounting, items are recorded in gross income when they are actually received.
f. Accrual method taxpayers: Gross income is recorded in the year in which the services are rendered.
i. Costs associated with earning income are deductible under 167.
ii. Personal expenditures are not deductible.
1. Commuting costs are always personal expenditures.
iii. Investment services are deductible under 212.
iv. Mortgage interest payments are deductible under 163(a).
h. The Realization Principle—you are not taxed on your income until there is a realization event such as a sale of an asset.
i. 63(a) defines taxable income for those who itemize their deductions.
i. Taxable income = GI – itemized deductions
j. 63(b) defines taxable income for those who do not itemize their deductions.
i. Taxable income = AGI – standard deduction – deductions for personal exemptions
k. By itemized deductions, we are talking about below the line deductions.
l. Whether they take the standard amount or the itemized amount is depends on whatever gives them the most benefit.
m. 67 gives the 2-percent rule
i. The only miscellaneous itemized deduction is the 500 bank management fee.
ii. Take all of your miscellaneous deductions and they will only be allowed to the extent that they exceed (meaning the portion that exceeds) 2% of adjusted gross income, i.e. 4200. So for example if all of the miscellaneous deductions equaled 4250, then only the 50 would be deductible.
iii. This raises revenues by minimizing the amount of deductions a person can take. It is a way of raising revenue w/o raising the tax rate…i.e. it raised the tax base.
n. 68 gives the overall limitation on itemized deductions
p. Under our tax system, long term capital gains are entitled to a better rate of tax.
ue of the stock goes up to 1500, Mitch does not have income.
· There is no realization event in year 2.
· There is no realization event in year 3 b/c Mitch has an obligation to repay the loan which he used the stock certificate as collateral to obtain.
· There is no realization event in year 4 b/c he still owns the stock regardless of whether the stock certificate has been destroyed.
· There is realization in year 5 b/c he has disposed of the stock by using it to pay off a debt.
He bought the stock for 1K, so his gross income should be only 2500 even though the stock is worth 3500.
61 / 1.61 – All income from whatever source derived
· 61a1 / 1.61a1 – Employee bonuses
· 63a3 – Gains from property
· 1.61-2a1 – Compensation for services (including fees, commissions etc.)
· 1.16a1 – Bonuses
· 1.61-14 – Treasure trove
· 1.61-2d1 – Barter situation
o RR 79-24
· 1.61-8 – Rents and Royalties
· 74 – Prizes and awards
§ Prize was primarily recognition of rel, charitable, scientific, edu., artistic, literary, or civic achievement AND
· Recipient did nothing to be selected on their part AND
· Not required to reciprocate service AND
· Gives prize to govt.
§ 74c – Employee achievement awards AND
· Tangible personal property (Not ) AND
· Meaningful ceremony AND
· Not disguised as compensation
· Substantial tangible economic benefit (Cesarini)
o 6501 – 3 yr statute of limitation for IRS
· Fraud / Evade / No returns
· Substantial non-tangible economic benefit (Old Colony Trusts -Paying someonelses taxes)
o The d/c by third person debt
· Grenshaw – Punitive damages
o Qui Tam settlements
· Illegal funds – (James v. US)
o Illegal income + Obligation to repay = GI
NOT GROSS INCOME
· 1.61-2d2i / Peller – Bargain purchase
o Tax cost basis – anything over the price you paid is taxable (piano example)
· R Proc. 2002-18 Frequent flyer miles / meals in connection with producing income
· 102 – Gifts
o There is no AW / CR / CD
§ If tenant uses the sec. deposit as last month’s rent (as stipulated in the K) this is GI under 1.61 – 8