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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 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 to 50% of “contribution base”- §170(b)(1)(F) provides that contribution base = AGI
§ As long as taxpayer’s AGI is at least $18K, the $9K is a BELOW THE LINE DEDUCTION
 
 
 
 
 
 
 
 
Calculation of Mr. and Ms. Taxpayer’s Adjusted Gross Income [GI- above the line deductions] Gross Income—————————————$320,000
Above the line deductions
            Wages………………………………….$60,000
            Office supplies, etc………………………20,000
            Depreciation…………………………….10,000
______________________________________________
            TOTAL                                                $90,000
 
Adjusted Gross Income—————————$230,000
 
Now, taxable income = AGI less itemized (below the line deductions) or standard deduction
§ If a taxpayer’s below the line deductions exceed the standard deduction, the taxpayer should itemize
 
Section 67: the 2% Floor on Miscellaneous Itemized Deductions
§ Certain itemized deductions may not be deducted except to the extent that in the aggregate such deductions exceed 2% of the taxpayer’s adjusted gross income
o   2% of AGI ($90,000) = $1,800
§ Therefore, if

me
 
§ 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
 
§ 1913 Tax Act’s Definition of Net Income
§ The net income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal services of whatever kind and in whatever form paid, or from professions, vocations, business, trade, commerce, or sales, or dealings in property whether real or personal, growing out of the ownership or use of or interest in real or personal property; and also from interest, rent, dividends, securities, or the transaction of any lawful business carried on for gain or profit or gains or profits and income derived from any source whatsoever
 
§ §61(a) Gross income is “all income from whatever source derived”- includes non-exhaustive list of examples
 
Early Case Law interpreting “Gross Income”
 
§ Eisner v. Macomber: Gross Income- the 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; [without capital, labor, or both combined, you probably don’t have income] § Hawkins v. Commissioner- [recognizing that definition of income incomplete]: “there may be cases in which taxable income will be judicially found although outside the precise scope of the description already given”
§ US v. Kirby Lumber Co- the discharge of a corporate debt for an amount less than the face of the debt resulted in income to the debtor: This freed assets that were otherwise going to debt service
§ Roco v. Commissioner- qui tam payments under the federal False Claims Act constituted income
 
B. Income Realized in Any Form
 
§ Regulation § 1.61-1(a): Gross income may be realized in any form, whether money, property, or services. Income may be realized in the form of services, meals, accommodations, stock, or other property, as well as cash
§ Regulation § 1.61-2(d)(1): If services are paid for in property, the FMV of the property taken in payment must be included as compensation. If services are paid for in exchange of other service, the fair market value of such other services taken in payment must be included in income as compensation.
§ Regulation § 20.2031-1(b):Fair market value – the price a wiling buyer would pay a willing seller, with neither under a compulsion to buy or sell, and both having reasonable knowledge of relevant facts