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Federal Income Tax
SUNY Buffalo Law School
Forman, Heidi I.

I. Chapter 1: Introduction to Federal Income Taxation
A. A Brief History of Federal Income Tax: began w/ratification of 16th Amendment—set stage for 1913 Income Tax Act. Only small # of ppl paid income taxes. Increase in # of taxpayers after WWII. Modern w/holding system was created to alleviate some collection difficulties & assure taxpayer compliance. Employers w/hold according to a formulated schedule which approximates fed. income tax employee will owe. There is a progressive structure—changes in deductions/credits/exclusions tax rates & tax brackets effect progressivity. (§ 163 allows for mortgage interest deduction, §121—exclusion for gain on principle residence, §170—chartible deduction).—Social policy reasons for taxing. Also economic reasons–§168 (accelerated cost recovery system).
B. The Tax Practice: Advise clients regarding tax implications of actions they are about to undertake.
C. Resolution of Tax Issues Through the Judicial Process
1. Trial Cts.: If comm’r of IRS asserts a deficiency in income tax, a taxpayer may (a): refuse to pay & petition the Tax Ct. or (b) pay the deficiency, file an administrative claim for refund. 3 cts have original jurisdiction in fed. tax cases: TAX CT, US DISTRICT CT & US CT of FED. CLAIMS.
a) The Tax Ct: of the 3 cts. of original jurisdiction, Tax Ct. is the most important. “Poor person’s ct.” Taxpayer commences action w/o 1st paying the asserted deficiency. Tax Ct. has 19 members, it was established in 1924. 1969 Act renamed the ct. US Tax Ct & gave it “constitutional status” under Art. I, §8 cl. 9—now part of judicial branch. Cases are tried w/o a jury& by 1 judge and submits an opinion to the chief judge for consideration. Chief will allow decision or refer to full ct for review.
b) Federal District Cts: have jurisdiction in any tax case against US seeking a tax refund. Must be tried before juries. Taxpayer must bring tax actions against the US in the district in which the taxpayer resides. Must pay first.
c) The US Ct of Federal Claims: Created by the Fed. Cts improvement Act of 1982. Ct. has jurisdiction over all tax suits against US regardless of amt. No jury trial. Residency doesn’t matter. Taxpayer must pay 1st.
2. Appeals: appeals from Tax Ct. are heard as a matter of right by the Fed. Ct of Appeals. Jurisdiction is in the circuit in which the taxpayer resides. Decisions of the Ct of Appeals for the Fed. Circuit are reviewable by the SC.
3. Selection of Forum: Taxpayer as a choice regarding the forum in which resolution of the tax issue may be sought. One’s finances may prove controlling in choosing a ct.
D. Analysis of the Computation of Tax Liability of Tom & Caroline Taxpayer.
1. Basic Questions Addressed by Income Tax System
a) What items of economic income or gain will be includable in gross income?
b) What costs will be allowable as deductions?
c) When in an amt included in income?
d) Who is the taxpayer?
2. Evaluating the Taxpayers’ Tax Liability—must answer 2 questions
a) What is the applicable tax rate?
b) What is the tax rate applied to—that is, what is the tax base?
(1) The answer to the 1st question—IRC §1(a) provides rates for married individuals filing joint returns. §63(b)—individuals who do not itemize their deductions, the term “taxable income” means “adjusted gross income minus (1) standard deduction, & (2) deduction for personal exemptions provided in §151.” For all others “taxable income” means “gross income minus the deductions allowed.
(a) Gross income: in computing taxable income, must determine gross income. Gross income defn from §61 :Except as otherwise provided in this subtitle (26 USC , gross income means all income from whatever source derived, including a list of 15 items). Generally, cts have been expansive in their defn of income. Regulation §1.61-1(a) specifically says gross income includes income realized in any form whether in money, or services. Regulation §1.61-2(d)(1)—if services are pd for in exchange for other services, the fair market value in payment must be included as compensation. A cash method taxpayer includes income only when it is actually or constructively received. Appreciation must be realized by taxpayers (ex. the stock is sold).
(b) Adjusted Gross Income (AGI): Once gross income is calculated, now determine AGI. §62: gross income less deductions. There are 2 categories of deductions: (1) above-the-line deductions (deductions that a taxpayer may consider in determining AGI) and (2) below-the-line deductions (deductions a taxpayer may take into account only after the AGI has been determined). Taxpayers have the right to elect a standard deduction. Standard deduction would be a % of taxable income. AGI serves as a dividing line b/w deductions allowed by all taxpayers regardless of whether they itemize (above-the-line) and those deductions which may be taken only if taxpayer itemize (below-the-line).
(c) Deductions: Deduction provisions of the Code begin w/§161. Cts consider deductions as a matter of legislative grace, provisions are narrowly construed. Personal expenses are not generally deductable. Some expenditures are deductible—deducted over a period of time. Every time you have an expense that you believe is deductible you must find a specific Code section authorizing the deduction. Investing in stocks and bonds and managing one’s investments has been held not to constitute a trade or business w/in meaning of §162. Principle payments for mortgage are not deductible but interest is deductible. Property taxes are below-the-line deductions. Have the option to deduct state & local income taxes or state & local general sales taxes. No deduction for federal income taxes. §170(b)(1)(F) provides that “contribution case” means AGI. Limits taxpayers deduction to 50% of their contribution base. AGI=gross income-above the line deductions.
(d) Taxable income: Next determine the taxable inco

ional amount extracted as punishment for the same conduct that caused the injury. Punitive damages were not gifts, could not be considered a restoration of capital for taxation purposes, and did not fit under any exemption provision of the Internal Revenue Code.
5. Cesarini v. US
a) Facts: Plaintiffs purchased a used piano at an auction sale for approximately $15.00, and the piano was used by their daughter for piano lessons. In 1964, while cleaning the piano, plaintiffs discovered the sum of $4,467.00 in old currency. They reported the sum of $4,467.00 on their 1964 joint income tax return as ordinary income from other sources. On October 18, 1965, plaintiffs filed an amended return eliminating the sum of $4,467.00 from the gross income computation, and requesting a refund in the amount of $836.51.
b) Issue: Was the $4,467 properly included as gross inceome?
c) Holding: The $4,467 sum was properly included in gross income or 1964, and was not “reduced to undisputed” possession until its actual discovery in 1964. US is not barred by statute of limitations from collecting $836.51. The finder of treasure-trove is in receipt of taxable income.
6. Old Colony Trust Co. v. Commissioner
a) Facts: Petitioner corporation challenged the decision of the U.S. Circuit Court of Appeals for the First Circuit, which held that payment by the employer of the income taxes assessable against the employee constituted additional taxable income to such employee. Respondent, the Commissioner of Internal Revenue, assessed a deficiency against the employees. Petitioner paid the federal income taxed owed on salaries for some of its executives. The Commissioner assessed a deficiency against the employees, arguing that petitioner’s payment of their taxes constituted additional salaries, which was taxable.
b) Issue: Whether a taxpayer, having induced a third person to pay his income tax or having acquiesced in such payment as made in discharge of an obligation to him, may avoid the making of a return thereof and the payment of corresponding tax.
c) Holding: Taxpayer may not do so. The payment of the tax by the employers was in consideration of the services rendered by the employee and was a gain derived by the employee from his labor.
Revenue Ruling: Section 1.61-2(d)(1)—if services are paid for other than in money, the fair market value of the property or services