§ Introduction (Chapter 1)
o Outline
§ Federal Income Tax
§ Sources of Federal Tax Law
· Internal Revenue Code (“Code”) – The law – look at the index
· Treasury Regulations – Treasury’s interpretation of the law.
· Internal Revenue Service Rulings, etc. – Service’s interpretation of the law and regulations.
· Court Decisions (Tax Court, Federal District Courts, Court of Federal Claim)
§ Functions of Federal Income Tax System
· Raise revenue – Through payment of taxes
· Tool of Social Policy – Encourage personal behavior (home ownership, business investment)
· Implements Economic Policy – Stimulate economy/behavior (American Recovery & Reinvestment Act of 2009 and its $819 billion in stimulus payments)
§ Questions Addressed by Income Tax System
· What items of economic income or gain are included in gross income?
· What items of expense will be allowable as a deduction?
o Business/investment/personal
· When is an amount included in income?
· Who is the taxpayer?
o The appropriate taxing unit.
· What is the character of items of income or deductions?
o Ordinary or capital?
§ General Structure of Code
· Gross Income Inclusions – §§ 61 and 71 – 86
· Gross Income Exclusions – §§ 101 – 139
· Deductions from Gross Income – §§ 161 – 249 (some business, some personal)
· Items Not Deductible from Gross Income – §§ 261 – 280G
· Items Credited to Tax Due – §§ 21 – 53
§ Gross Income
· Under Code Section 61, “gross income” is defined as “all income from whatever source derived, including (but not limited to) the following items.”
§ Adjusted Gross Income
· Under Code Section 62, “adjusted gross income” is defined as gross income less certain deductions listed under Code Section 62.
· What is meant by “above-the-line” deductions?
o Alimony? – Subtracted from gross income
o Child support? – Not subtracted from gross income
§ Deductions
· Originate from expenditures incurred in producing income and from economic and social policies.
· Some expenditures are currently deductible (§ 162), others are deductible over time (§ 168), while others are never deductible (§ 262) (most personal expenses and some capital expenditures).
· To be deductible, a deduction must be authorized by a specific Code provision/section.
· Authorized deductions are either above the line deductions or below the line deductions.
§ Taxable Income
· Under § 63, the definition of “taxable income” depends on whether the TP itemizes or takes the standard deduction.
· Non-Itemizing TP – TI defined as adjusted gross income minus (standard deduction + personal exemptions).
· Itemizing TP – TI defined as adjusted gross income minus (itemized deductions plus personal exemptions).
§ Standard Deduction
· Taken in lieu of itemizing deductions.
· Under § 63, the standard deduction is identified with regard to filing status and indexed each year. §§ 63(b)(2) & (c)(2).
· Standard deduction is taken when SD > itemized deductions allowed.
§ Personal Exemptions
· § 151 provides personal exemptions for filing taxpayers and their dependents.
o § 152 defines dependents
§ Credits
· After preliminary tax due is calculated, then it must be determined whether TPs qualify for any tax credits.
· Credits are dollar-for-dollar offsets against the tax calculation.
o Compare to deductions, which just reduce taxable income.
§ Tax Rates
· Our income tax is a progressive income tax with a marginal tax rate and an effective tax rate.
· The 2001 Tax Act reduced individual tax rates over a 6-yr period, from 28% to 25%, from 31% to 28%, from 36% to 33%, and from 39.6% to 35%. § 1(i)(2).
§ Judicial Process and the Tax Court
· If the IRS decides that you owe tax, then there is a deficiency
· Two choices for challenging a deficiency (choice determines the court):
· Choose not to pay the taxàgo to the tax court
o Centered in D.C.
o 19 judges that travel around the country to hear cases
· If you choose to pay the tax firstàgo to Federal District Court or Federal Claims Court
§ Decisions by an individual tax judge are reviewed by the Chief Judge and he decides whether or not all 19 judges should review the decision
§ Reviewed decisions carry more weight for precedential purposes
§ Appeals from tax court decisions are in the Court of Appeals in the state in which you live
§ Golson v. Commissioner: announced that the tax court would follow precedent on appeal of the circuit in which the appeal is taken
§ Other reasons to go to tax court or district court:
§ Tax court has the expertise in the tax arena
§ Sympathetic facts, but adverse lawàyou probably want to go to district court so you can have a trial by jury
§ Miscellaneous
· Management fee would not be a deduction because of §62. However, individual could deduct it through §212
o Code
§ § 1 – Tax Imposed
· Provides tax rates and brackets
§ §24 – Child Tax Credit
§ §31 – Tax withheld on wages
§ §61 – Gross Income Defined
· (a) General definition – “all income from whatever source derived”
§ §62 – Adjusted Gross Income Defined
· (a) – General rule – adjusted gross income means gross income minus the following deductions
o Trade and business deductions, certain trade an business deductions of employees (artists, teachers, officials, reimbursed expenses), losses on sale or exchange of property, deductions of rents or royalties, certain deductions of life tenants and income beneficiaries, pension, retirement savings as allowed, alimony, moving expenses, interest on education loans, higher education expenses, health savings accounts, costs involving discrimination suits.
§ §63 – Taxable Income defined – (2 definitions)
· (a) – In general, taxable income means adjusted gross income minus deductions allowable
· (b) – For individuals who do not itemize, taxable income means adjusted gross income minus standard deduction minus personal deductions in § 151
§ §67 – 2% floor on miscellaneous itemized deductions
· (a) – 2% only deductible to t
taxed
o Evident in self help
§ Performing services for family or self
· Bargain Purchases
o Transfer of property for less than fair market value
§ Needs to be an arms length transaction and
§ Not for compensation for services
· When in doubt, exclude the bargain element, within limits, from income
o Do not misapply Realization Requirement from Bargain Purchases – ER transfers to EE 500k of stock for 100k. There is no realization. However, it is gross income for 400k. §1.61-2(d)(1) – Compensation paid other than cash.
§ Early Attempts at Defining “Gross Income”
· 1913 Tax Act – “the net income of a taxable person shall include gains, profits, and income . . . derived from any source whatsoever.”
· Eisner v. Macomber – “gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets.”
§ “Clearly Realized” Requirement
· Treas. Reg. Sec. 1.61-1(a) “realized in any form, whether in money, property, or services.”
§ McCann v. United States
· ER, that ran an insurance company in Louisiana, and EE/spouse who received all expenses paid trip to Vegas.
· What is the relationship b/t payor and payee?
· Criteria for agent attending seminar?
· Arguments for including in gross income?
· Arguments for excluding from gross income?
· Business purpose/convenience of the employer.
· What about Mr. Ourso? Should he be treated differently?
§ Bargain Purchases
· A bargain purchase is where the price paid is less than the FMV of the item/asset.
o Going out of business sale/fire sale resulting from divorce (Angela Basset).
· Two rules:
o In arm’s length transactions, the bargain element is not taxable income (any eventual gain realized will be taxed at sale or other disposition of property).
o In other than arm’s length transaction, look at the reason for the bargain element.
§ See Treas. Reg. § 1.61-2(d)(2) – is it compensation paid other than cash for other services?
§ Example
· Ted, Paula’s EE, purchases Paula’s home for $80,000. Paula had been asking $100,000.
o Bargain purchase (Pellar) or income ?
o Does it make a difference whether the home had been on the market for over a year?
· What is Ted’s cost of the home?
§ Example
· Alice received a $50 rebate on a lawnmower that she purchased.
o Is the rebate includable in income?
Purchase price adju
