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Federal Income Tax
SUNY Buffalo Law School
Wooten, James A.

CHAPTER 1: INTRODUCTION TO FEDERAL INCOME TAXATION                                     
 
Taxable income=
§61 Gross Income – §62 (above the line deduction)- §63 (below the line deductions)
 
·         Gross Income minus [§62] above the line deductions = adjusted gross income
o        Now to calculate taxable income [§63] taxpayer can take two below the line deductions
§         [§63(a)] Itemized personal exemptions
§         [§63(b)] Standardized personal exemptions
 
·         General rule: If something makes you better off, include in gross income unless you can find a statutory or judicial exclusion
o        Statutory authorization of deductions:
§         §151… personal
§         §161….business
§         §261…not deductible
 
Calculation of Mr. and Mrs. Taxpayer’s Tax Liability
 
I. Calculate Gross Income:
 
   $
SOURCE
INCLUDED OR EXCLUDED FROM GROSS INCOME
275K
Cash and checks representing gross receipts from business
INCLUDED per §61(a)(2)
10K
Value of landscaping services rendered to mother
INCLUDED
§         See Regulation §1.61-1(a): gross income includes income realized in any form whether in money, property, or services
§         Reg §1.61-1(d)(1) include FMV of services
§         Assignment of income- doctrine to prevent income shifting so that taxpayers in high brackets do not shift their income to related taxpayers in lower brackets
 
30K
Owed by clients for work performed that year
EXCLUDED
·         Cash Method Taxpayers; only include that $ which has been actually or constructively received. See §451(a), Reg §1.446-1(c)(1)(i)
19K
Interest income
INCLUDED in gross income per §61(a)(4)- interest
15K
Sale of stock
INCLUDED in gross income per §61(a)(3)- gain derived from dealing in property [will be treated as a capital gain] 1K
Dividend
INCLUDED in gross income per §61(a)(7)- dividends
10K
Stock appreciation
EXCLUDED: there has been no realization event
TOTAL GROSS INCOME = $320K
 
Now we must calculate Adjusted Gross Income [“AGI”]:
·         §62 Defines AGI as Gross Income- deductions
o        It is important to note that §62 is NOT a deduction granting provision: it only lists those deductions that should be taken into account when computing gross income
§         Two categories of deductions:
o        Above the line- deductions a taxpayer may consider in determining his adjusted gross income
o        Below the line- deductions a taxpayer may take into account after AGI has been determined.
Deductions Generally…
§         Provisions begin with § 161
§         Reflect the notion that our tax system permits a deduction for the costs incurred in producing income
§         While gross income is given an expansive definition, deduction provisions are narrowly construed
o        Every time you have an expense that you believe is deductible, you must find a specific code section authorizing the deduction
 
   $
SOURCE
ALLOWED AS [ABOVE/BELOW THE LINE] DEDUCTION?
60K
Paid wages
§162(a) provides that these amounts will be deductible as trade or business expenses; ABOVE THE LINE DEDUCTIONS per §62(a)(1)
20K
Various business related expense
§162(a) provides that these amounts will be deductible as trade or business expenses; ABOVE THE LINE DEDUCTIONS per §62(a)(1)
500K
 
 
 
[10K] Construction of building
Permitting deduction for full $500K would distort: taxpayers required to capitalize by §263. This cost is a capital expenditure pursuant to Reg §1.263(a)-2(a)
§168 allows building to be depreciated: spreading technique for recovering cost of property
[Assume 10K] §168 is ABOVE THE LINE DEDUCTION per §62}(a)(1)
5K
Expense incurred in commuting to work
Where one lives is a matter of personal preference: See Reg §1.162(e) and §1.162(e)(1)(b)(5). NOT A DEDUCTIBLE EXPENSE
1K
Bank fee for managing account
§         Higgins- no §162 for managing investment account: investing stocks and bonds is not a trade or business
§         §212 provides deduction for expenses paid or incurred during the taxable year “for the production of income”
§         BELOW THE LINE DEDUCTION
24K
 
 
 
[18K] Mortgage: (6K p

r § 67(b), certain miscellaneous itemized deductions are NOT subject to the 2% floor
o        Taxpayer’s deductions for home mortgage interest [§67(b)(1)] , state income tax/real property tax, [§67(b)(2)] and charitable contributions [§67(b)(4)] are not subject to the 2% rule
§         Bank management fee IS subject to the rule
o        The $1,000 expense does not exceed 2% of the adjusted gross income of $230K, therefore it is NOT deductible
o        Thus, the taxpayer’s itemized deductions are cut back from $39,800 to $38,800 by §67
 
Below the line deductions
            Management fee…………………………$1,000
            Interest……………………………………18,000
            State income tax……………………………8,000
            Real Property taxes………………………..3,800
            Charitable Contributions…………………..9,000
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            TOTAL                                                $38,800
§68 Limitation——————————————-$2,100
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ALLOWABLE ITEMIZED DEDUCTIONS         $36,700
 
The § 68 Overall Limitation on Itemized Deductions [apply AFTER §67] §         Otherwise allowable itemized deductions are reduced by 3% of the amount by which the taxpayer’s adjusted gross income exceeds an inflation adjusted “applicable amount” (or if lesser, the reduction is 80% of otherwise allowable itemized deductions)
§         Assume applicable amount is $160; taxpayer’s exceed this ($230K) by $70K, 3% = $2,100
§         Therefore, allowable itemized deductions are reduced from $38,800 to $36,700
However, the allowable itemized deductions of $36,700 exceed the standard deduction of $10,000 so taxpayers should itemize deductions!