Select Page

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

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 principal, 18K interest)
§ See §262: mortgage payments are a personal expenditure: no 6K deduction
§ What about the 18K? §163(a) allows a deduction for all interest paid or accrued within the taxable year on indebtedness
o   §163(h)(3): Home mortgage interest is “qualified residence interest: an exception to the general §163(h) exclusion for personal interest
§ The 18K is a BELOW THE LINE DEDUCTION
3.8K
Real property taxes
§ See §164(a)(2) even though this is a personal expense, congress allows a BELOW THE LINE DEDUCTION for state/local property taxes
3K
State/local sales tax
§ §164(B)(5) instructs taxpayers to deduct either state and local income taxes OR sales tax. Because income taxes are greater than sales taxes, that is the deduction they will make.
8K
Estimated state income taxes; liability is 10K
§ As cash method taxpayers, can only deduct the $8K they have paid, not the $10K liability.
§ State income tax: $8K allowed as a BELOW THE LINE DEDUCTION under §164(a)(3)
9K
Donation to church
§ §170: deduction for charitable contributions; however §170(b)(1)(A) limits deduction

flation
§151(d)(3): exemption reduced by 2 percentage points for every $2,500 by which the taxpayer’s AGI exceeds a specified, inflation adjusted “threshold amount”
Assume inflation adjusted threshold for joint return is $235K; we don’t exceed this so we are ok
Regulation §151-1(b) tells us that because we have two taxpayers, we take two exemptions
Also assume that taxpayers have 2 dependent/minor children: thus they are allowed 2 more exemptions under §152(c)
Assume personal exemption is $3,400 x 4= $13,600
 
FINAL CALCULAION
AGI…………………………………………… $230,000
            Itemized deductions…………………….-36,700
            Personal exemptions……………………-13,600
                                                                        (50,300)
_____________________________________________
TAXABLE INCOME……………………….$179,700
 
Tax Rates[See IRC § 1(a) and § 1(i)] Important for computation of preliminary tax liability and determination of whether it is affected by maximum capital gains provisions of §1(h)
Purpose of 1(h) is to provide preferential tax rates for net capital gain
Tax Credits [See IRC § 21-53] §31 Most common tax credit- the credit for withholding taxes paid through the year by employers on behalf of the employees
 
Consider the difference between a deduction and a credit
A credit reduces one’s tax on a dollar for dollar basis
A deduction reduces taxable income, providing a reduction in tax that is dependent on the tax bracket of the individual
Example: A $1,000 deduction result in a $350 tax savings for a person in a 35% tax bracket; however, only a $150 tax savings for a person in a 15% tax bracket
By contrast, a $1,000 tax credit saves a person $1,000 in taxes regardless of the bracket
 
CHAPTER 2: GROSS INCOME: CONCEPTS AND LIMITATIONS                                           
 
A. The search of a definition of Income
 
§ Modern federal income tax originated with the Sixteenth Amendment:
§ 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