1. A Brief History of Federal Income Tax
a. The federal income tax had its beginning with the ratification of the 16th Amendment.
i. The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration.
b. This amendment set the stage for the 1913 Income Tax Act. Initially, very few Americans paid income taxes. During WWII the tax based increased.
c. The almost overnight movement from a system which taxed relatively few people to a mass tax system created serious administrative problems. To alleviate some of the collection difficulties and to assure taxpayer compliance, the modern tax withholding system was created. This has made our tax system successful.
d. The tax system serves a number of functions apart from raising revenues to operate the government. The tax system also allocates the cost of public goods and services among Americans on an ability-to-pay basis. It accomplishes this through a progressive rate structure.
e. In addition, Congress uses the federal income tax as a tool of social policy. For example. § 163 of the Code allows taxpayers to deduct home mortgage interest.
f. Congress also uses the federal income tax to implement economic policy. For example, the accelerated cost recovery system of § 168 stimulates the economy by allowing businesses to depreciate certain tangible property rapidly, thereby encouraging businesses to invest in new equipment.
2. The Tax Practice
a. Almost every practitioner will encounter clients with tax problems. As a result, attorneys must understand the general principles of the tax law so that they can assist their clients in making business and personal planning decisions.
b. Tax practice involves not only applying tax principles to past events but, more importantly, advising clients regarding the tax implications of actions they are about to undertake.
3. Resolution of Tax Issues Through the Judicial Process
a. Trial Courts
* If the Commissioner asserts a deficiency in income tax, the taxpayer may:
(a) refuse to pay the tax and petition the Tax Court for a redetermination of the deficiency.
(b) pay the deficiency, file an administrative claim for refund, and upon denial of the claim, sue for refund in federal district court or the United States Court of Federal Claims.
* Three courts have original jurisdiction in federal tax cases:
i. The Tax Court
Ø Taxpayer commences an action in Tax Court without first paying the asserted deficiency.
Ø Hears only tax cases. It is the most sophisticated trial court from the standpoint of tax expertise. The Tax Court has 19 members.
Ø Established in 1924 as an independent agency.
Ø 1969, Congress gave it “constitutional status” and it is now part of the judicial branch.
Ø Cases are tried without a jury by one judge, who submits an opinion to the chief judge for consideration. The chief judge will either allow the decision to stand
sed by an Income Tax System
a. What items of economic income or gain will be includable in gross income?
b. What items of expense will be allowable as deductions?
c. When is an amount included in income? When is the taxpayer entitled to claim a deduction for an amount that is clearly deductible?
d. Who is the taxpayer – who is going to be taxed on items of income?
e. What is the character of the items of income or the deductions?
2. Evaluating Mr. and Ms. Taxpayer’s Tax Liability
* To determine the tax liability for Mr. and Ms. Taxpayer, you will need to answer two questions:
(a) What is the applicable tax rate?
– § 1(a) provides rates
(b) What is the tax rate applied to – that is, what is the tax
– the more difficult question. § 1(a) states that the appropriate tax rate is applied to the “taxable income” of the taxpayer. In calculating the taxpayer’s taxable income, the five questions discussed above become important.
§ 63(b) provides that, for individuals who do not itemize their deductions, the term “taxable income” means “adjusted gross income minus (1) the standard deduction, and (2) the deduction for personal exemptions provided in § 151.”