Federal Income Tax Outline

Identifying the Taxpayer:
1.       General:
a.       Identification of the proper taxpayer to report income and claim deductions is crucial in maintaining a tax system that fairly allocates income along various taxpayers.
2.       Person’s Subject to Tax:
a.       Adult individuals:
                                                               i.      Adults are subject to tax at rates described in § 1 ranging from 10 percent to 35 percent.
                                                              ii.      Single Adults:
1.       Files a tax return reporting their own taxable income (§ 1(b))
                                                            iii.      Married individuals:
1.       Can file joint tax returns, reporting heir income and deductions together (§ 1(a)). They have the option to file separately, but it is usually a less desirable option.
b.       Children:
                                                               i.      If children have sufficient taxable income to generate a tax, they must file their own tax return separately from their parents. Occurs when parents transfer income-producing property to children. 
                                                              ii.      “Kiddie tax”: (§ 1(g))
1.       A child’s, less than 14, investment income in excess of $1600 is subject to tax at the parental rate and parents may elect to report child’s investment income on the parent’s tax return.
3.       Assignment of Income: General rule
a.       In a progressive tax system, an incentive exists for those in high tax brackets to direct income to related persons in lower tax brackets to reduce the overall tax imposed on the group.
b.       Personal services income cannot be shifted except by the performance of gratuitous services. Income from property can be shifted provided there is a complete transfer of the income-producing property and the donee does not receive a carved-out or vertical interest
c.        Exception:
                                                               i.      Transfer of tangible self-created property is seen as the transfer of property rather than services and is effective to shift income from the property to the transferee.
d.       Income for Services:
                                                               i.      General:
1.       Income is taxed to the person who earns it regardless of arrangements made to channel it to another person. 
                                                              ii.      Private Agreement: (Lucas v. Earl)
1.       If taxpayer who performs services attempts to direct the compensation to another person by private agreement, the taxpayer will be required to include the amount in gross income;
                                                            iii.      Operation of law: (Poe v. Seaborn)
1.       Outdated due to joint filing for married individuals
                                                            iv.      Armantrout v. Commissioner:
1.       Held that parents were required to include in their gross income amount paid by the trust for the children’s tuition. Trust arrangement constituted a device by which the parents attempted to divert compensation income they had earned to their children. 
e.        Income from Property:
                                                               i.      General:
1.       Attempts to transfer income of property independently of the property itself generally will be respected only if the income interest is transferred for its entire duration. Otherwise donor will be taxed on the income and will be deemed to have made a nontaxable gift to the donee.
2.       Blair v. Commissioner: (trust)
a.       Held that taxpayer was not required to include trust in gross income because he transferred to his children the property interest he owned, not just the income.
f.        Transfers of Property:
                                                               i.      General rule:
1.       The owner of property is defined as the person who enjoys the economic benefit. If the donor transfers the property itself, the donee will properly report the income from the property.
                                                              ii.      Helvering v. Horst: (interest coupons)
1.       Held that taxpayer (dad) should have reported the interest income in gross income because dad’s gift of the coupon constituted enjoyment of the income. Courts hold that the person who enjoys property should be taxed. (rationale not favored today)
2.       Dad gave away only the income from the property, not the property itself (carved out interest)
g.        Services Transformed into Property:
                                                               i.      General rule:
1.       The transfer of the income producing property results in the donee being taxed on the income. In order to qualify as property, the transfer must include some bundle of legally enforceable rights, other than the right to collect income, given to the donee.
                                                              ii.      Helvering v. Eubank:
1.       Held that the insurance agent was taxable on the commissions when he assigned renewal commissions to others who collected.
4.       Trusts:
a.       General rules:
                                                               i.      Income of a simple or complex trust is taxed only once
                                                              ii.      Income is taxed to the beneficiaries in the year earned
                                                            iii.      Complex trusts that accumulate income, income is taxed to the trust in the year it is earned and then taxed again to the beneficiaries when distributed
1.       Tax owed by the beneficiaries is offset by the prior tax paid by the trust
b.       Simple trust:
                                                               i.      Trust that is required to annually distribute current income and only current income to the beneficiaries and that does not distribute or set aside any amounts to charity
                                                              ii.      Nominally taxed on its income but receives deduction for distribution of that income (trust itself does not generally pay tax)
1.       Income from a simple trust is taxed directly to the beneficiaries
c.        Complex trust:
                                                               i.      Any trust that is not a simple trust
                                                              ii.      Able to deduct current income that is distributed to the beneficiaries and beneficiaries are then taxed on that income
                                                            iii.      Trust is taxed on the undistributed current income under the rate schedule set forth in § 1(e)
1.       Rate schedule has the same maximum marginal rate as the rate schedule that applies to individuals
                                                            iv.      Throwback rule:
1.       Tax paid in prior years by the trust on that income is credited to the beneficiaries
d.       Grantor Trusts:
                                                               i.      Revocable trusts:
1.       Corliss v. bowers:
a.       Held that taxpayer who had established a trust to pay the income from property to his wife and at her death to his children, but who had retained the power to revoke the trust at any time, was taxable on the income as if he had made no gift
                                                              ii.      Totten trusts and similar arrangements: General rule
1.       Income from funds deposited in a savings account tin the depositors name as trustee for another person is taxable income of depositor if under local law the transaction creates only a revocable trust
2.       Income of custodial accounts under state custodial and uniform gifts to minors act however is taxed to the child and not to the parent-custodian
                                                            iii.      Obligations of Support:
1.       Braun v. Commissioner:
a.       Held that under NJ law the taxpayer had an obligation to provide his children with college educations and that consequently the amounts of trust income used for that purpose were includable in his income under § 677;
e.        § 671: General rule
                                                               i.      If grantor is treated as owner of the trust, grantor will be taxed;
f.        § 672: Definitions and Rules
                                                               i.      Adverse party:
1.       One having a substantial beneficial interest in the trust which would be adversely affected by the exercise or non-exercise of the power which he possesses respecting the trust
                                                              ii.      Non-adverse party:
1.       One who is not an adverse party
                                                            iii.      Related or Subordinate party
g.        § 673: Reversionary Interests
                                                               i.      If the value of the reversionary interest to the grantor exceeds 5 percent of the value of the property, income from the property is taxed to the grantor. (valued at the time of contribution)
h.       § 674: Power to Control Beneficial Enjoyment
                                                               i.      Grantor is to be treated as owner of any portion of a trust if after the initial transfer of the property to a trust, the grantor or his spouse retains the right to change the mix of income received by the trust beneficiaries or to add new beneficiaries.
                                                              ii.      Escape taxation liability by vesting such power in an independent trustee (not spouse)
1.       Provided that the exercise of that power is limited by a reasonably definite external standard
                                                            iii.      Exceptions:
1.       List of powers that can be retained by anyone, including grantor:
a.       Power to withhold income temporarily
b.       Distribute corpus
c.        Grantor may best in an independent person an unfettered sprinkle or spray power as to both income and corpus
d.       Any person other than the grantor or the grantor’s spouse may have the sprinkle power over income if the power is limited by a reasonably definite external standard
i.         § 675: Administrative Powers
                                                               i.      Treats the grantor as the owner of any property in respect to which he retains certain prohibited administrative powers such as the power to purchase the property at less than full consideration
                                                              ii.      Taxes the grantor on any amounts he has borrowed from the trust unless the loan carries adequate security and interest and meets certain other requirements
j.         § 676: Power to Revoke
                                                               i.      Provides that a grantor who transfers property to a trust but retains the right to revoke the transfer and regain title of the property is taxed on the income from the property;
1.       Same result if a third party is given the power to re-vest title to property in the grantor unless third party has a substantial interest in the trust as beneficiary or power of appointment.
k.       § 677: Income for Benefit of Grantor
                                                               i.      Treats the grantor as the owner of any portion of a trust property the income of which may be distributed or accumulated for the benefit of the grantor’s spouse or used to pay life insurance premiums on the life of the grantor or the grantor’s spouse
l.         § 678:
                                                               i.      The income of a trust in which the grantor or trustee have the power to direct the disposition of the trust income will be taxed to the person with control over the trust. (Mallinckrodt/demand trust)
 
Identifying Taxable Year: (timing issues)
 
1.       Annual Accounting: (§§ 61, 111, 172, 441, 1341)
a.       A taxpayer reports all of his income, deductions, and allowable credits on an annual basis, reporting these items based on the facts as they exist as of he close of the taxable year in question. (Burnett v. Sanford and Brooks)
                                                               i.      Rationale:
1.       Only by such a system is practicable to produce a regular flow of income and apply methods of accounting, assessment, and collection capable of practical operation
b.       Exceptions:
                                                               i.      While annual accounting is administratively easy, it can inaccurately measure a taxpayer’s ability to pay, particularly for transactions that span more than one taxable year. Several code provisions have evolved as a method of mitigating the impact of annual accounting.
c.        §172: Net Operating Loss Deduction (ordinary loss)
                                                               i.      Net operating loss suffered in any year can be c