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Federal Income Tax
Temple University School of Law
Abreu, Alice G.

Federal Income Tax/Abreu Fall 2011
Gross income for the year (§ 61)
Above the line deductions (listed in § 62(a) but allowed by §§161-197, 211-220)
EQUALS ————————————————————————
Adjusted gross income (§62)
Below the line deductions:
o   Standard deduction (§63) or
o   itemized deductions (not listed in §62 but allowed by §§161-197, 211-220 and limited by §§67-68)
Personal Exemptions– § § 151-152
1.         Introduction
Reasons for taxes
·         Collect revenue
·         redistribute wealth
·         distribute govt benefits
·         promote social policies
o   encourage some activities, discourage others
o   promote charities
o   promote econ growth
o   stimulate particular econ activity
3 ways to evaluate the tax system
·         1. Equity and fairness
o   Equity
§  Horizontal equity: similarly situated tax payers should be treated the same way
§  Vertical equity: 2 taxpayers differently situated ànot treated the same way  (higher income pay more)
o   Fairness
§  Taxpayers must perceive system as fair or else they will cheat
·         2. Simplicity and administrability
o   Administrability-the IRS must be able to administer it
o   Simplicity-taxpayers must be able to understand and file taxes
·         3. Efficiency
o   Cheap for people to file, cheap for govt to administer
o    Quick returns
o   Tax neutrality-don’t want ppl to modify behavior b/c of taxes (mkt disruption)
o   Sometimes govt does interfere
§  Encourage charitable contributions
§  Encourage homeowners- Tax deduction on interest on home, property taxes
·         tax base x tax rate=what you owe – deduction=what you pay
2.         The Tax Base
·         Tax base = amount that the tax rate is applied to
·         US- tax base = “taxable income” (hybrid of income and consumption tax)
Def of taxable income:  gross income— allowable deductions
1.      Gross income (§61)
o   § 61(a) General definition.—Except as otherwise provided in this subtitle, gross income  means all income from whatever source derived, including (but not limited to) the following items
§  broad definition
2.      Subtract From Gross Income exclusions and so-called above-the-line deductions. (§ 62(a))
·         Less broad: 2 categories
·   1. Real decreased in wealth
·   2. Generally related to business or investments
3.      Adjusted Gross income
4.      Subtract From Adjusted Gross Income below-the-line deductions (or the standard deduction).
=Taxable Income
Income  tax
·         tax base is income (most fair)
·         income: real cash that you can spend, wages from job, easily convertible
o   not baseball cards and stocks –fluctuate in value
·         requires realization
o   def: affirmative act that converts property into income (ex. Sale)
o   rationale: simplicity and administrability
Haig Simon tax base (income)=changes in wealth + consumption
·         changes in wealth
o   baseball cards and stocks included
·         consumption
o   money you spend, personal consumption
·         Cons of haig simon
o   Administrability and simplicity-hard to track everyones changes in wealth and everyones consumption
·         4 reasons we deviate from Haig Simon
o   1. Introduce consumption tax principles into the code
§  Goal: Increase savings
o   2.  Policy reasons
§  Promote econ policies –deductions for charitable contributions, homeowners
o   3. Administrability
§  Realization requirement-need something to trigger income
o   4. Abuse
§  People cheat, congress wants to preserve revenue
Consumption tax
·         tax base is consumption, ex. Sales tax
·         Diff b/w income tax and consumption tax
o   Savings included in income tax
o   Consumption tax doesn’t include savings, just what you spend
·          Pros of consumption tax
o   People think we don’t save enough, would be better off if we did, income tax discourages saving
o   Easier to administer
·         Cons of consumption tax
o   Regressive-larger burden on low income people
o   Not necessarily easier
How to reduce taxes
·         1. Shrink tax base
o   Most people try to do this
o   2 ways
§  1. Reduce amt of gross income
§  2. Increase deductions
·         2. Shrink tax rate
3.         Tax Rates
·         Tax liability=tax base X tax rate
·         US system : use marginal tax rts to make progressive system
·         Code §1
o   4 diff groups
§  1(a) married ppl with joint returns
§  1(b) heads of households
§  1(c) unmarried individuals
§  1(d) married individuals filing separate returns
§  1(a)-1(d) Not good lawàgo to 1(i)
§  1(f) brackets change every year, adjust for inflation every year
§  1(i) Bush tax cuts, lower marginal rt, lower bracket, split 15% tax rt into 10% and 15%, 5 bracketsà6 brackets
·         (go to p ixàbush tax cuts)
·         Marginal tax rt: tax rt that applies to the last dollar, next dollar you’d pay
·         Bracket: each row is a bracket
·         Everyone gets the benefit of every rate structure
·         Effective tax rt: proportion of what you pay in tax compared to taxable income ( income  divided by amt you paid) always less than marginal rt
3 rate structures
1.      Progressive
·         as income goes upàtax rt goes up
·         Today’s highest rt: 35% (has been as high as 91% in 1950s)
·         Pros: most fair
2.      Proportionate
·         Everyone pay same proportion of income
·         Pros: most fair
3.      Regressive
·          As income goes upàtax rt goes down
·         Fed and state taxes (leveled out by income taxes-progressive)
4.         Authority
§  1. Statutes 2. Common law
Part II: Income Tax Fundamentals – Realization and Basis (aka, When Does a Taxpayer Have Income?)
Changing definition of income
Haig Simon- changes in wealth + consumption
Macomber-gain derived from capital, labor, or both combined
§61- all income from whatever source derived
Modern definition of income: (1) Accession of wealth (2) that’s clearly realized, (3)over which taxpayer has dominion or control  (Glenshaw Glass)
Shifting of definition of realization
Macomber-gain derived from capital, labor, or both combined (derivation is important-need to pluck fruit off tree)
Shift: Helvering- can be more than just capital and labor, eliminates Macomber def of realization: realization is about administrability and timing
Modern realization requirement: Cottage Saving:  low bar for realization
Current definition: changes of wealth over passage of time do not constitute income until there is an exchange for cash, affirmative act
5.         The Basics and the Statute
·         Rule: changes in wealth due to passage of time alone and changes in value do not have tax consequences
o   Rationale: administrability, liquidity
·         Goal of all tax: all wealth goes into tax base once
·         Basis def: measure of your after tax investment, measure of amt you’ve already paid tax on, in tax base, taxed once, don’t want it to be taxed again (ex. Price you paid for baseball card), gets removed from sale price and you are taxed on the difference
o   Basis is a good thingàmore basis, less gain, less tax
·         Realization: event that triggers tax consequences, no income until realization occurs, but doesn’t mean taxpayer has income
o   Ex. Sale 
o   Policy arguments for realization: liquidity and valuation, administrability
o   Has changed over time: low bar, broad, liberal rule, can argue almost anything is a realization
·         Recognition: event that occurs, after this, can be taxed
o   Can’t have recognition without realization
·         Both realization and recognition must occur to be taxed
·         Baseball card hypo
o   Card purchaseàin our system, nothing happensàneed realization (sell cardàtax)
o   Under Haig simonsàchange in value
Code §61-gross income defined
·         Income defined from whatever source derived
o   Includes gains from dealings in property (baseball card)
Code §1001 determination of amt of and recognition of gain or loss
§1001(a): how to compute a realized gain
o   amt realized –adjusted basis =realized gain  
o   amt realized=amt of cash you get from sale
o   if negative numberàrealized loss
§ 1001 (b): Amt realized=Sum of mo

realized losses if materially different, change in legal entitlement, permit deduction
·         Blackmun dissent: angry, doesn’t like FHLBB dictating when realization occurs, how can mortgage swaps structured to be the same can be different for tax purposes
·         Effects of cottage savings: open the floodgates to tax shelters, sets low bar for losses and gains
·         Takeaway point: Realization is a problem, need it to make tax system work, but it complicates things 
·         Rule: taxable disposition of property occurs when there is an exchange of materially different property, if bundle of sticks changesà we have material difference
Part III: What is Income?
9.         Non-cash Compensation – Meals and Lodging
Code § 61(a)
Rule: benefits provided for the convenience of the employer à not incomeànot taxable
Benaglia v commissioner (hotel manager living at hotelànot incomeànot taxable)
·         Facts: Manager of hotel got Free room and board, meals at hotel, lived in suite, didn’t pay taxes (reported no income)
·         Issue: are meals and lodging for hotel manager taxable income?
·         Holding: Benaglia didn’t have income, those benefits are provided for the convenience of the employer, for the convenience of the employer, not taxable
·         Reasoning: staying at hotel b/c of employment, not as compensation or personal convenience, manager could be needed at any time, would not choose to live like this if it wasn’t free
·         Dissent: agree that it wouldn’t be fair to tax him for the full value because he doesn’t value it as much, but he’s getting economic benefit and being relived of obligation to pay for housing and food, should have some income  (but administrability problem to find out how much)
Code § 119 meals or lodging furnished for the convenience of the employer
(a) for employee, spouse, dependantsàexclude meals and lodging from gross income if
            (1) meals furnished on premises
            (2) employee required to accept lodging on business premises as condition of employment
·         Employer paying income taxes, groceries, rent for youà income, employee must include payments in income
·         Rule: discharge of obligation is the same as a cash payment
·         Rationale: administrability   
10.       Non-cash Compensation – Employee Fringe Benefits
Problem: how to value noncash compensation so we can tax it
Answer: §132
·         Fringe benefits should be treated as incomeàfollow set of rules, sometimes win, sometimes lose
Code § 132 certain fringe benefits
(a)   list of things that CAN be considered NOT income
1. no additional cost servs (extra flight ticket)
2. qualified employee discount (Ralph Lauren)
3. working condition fringe (use of co property)
4. de minimis fringe (coffee, not cash)
5. qualified transportation fringe (parking, transit pass)
6. qualified moving expense reimbursement
7. qualified retirement planning services or
(b) no additional cost servs def
o   1. Offered to customers in ordinary course of line of business
o   2. No substantial additional cost
(b)   qualified employee discount def
o   must not exceed
o   (A) gross profit percentage of property or services offered to customers OR
o   (B)  20% of price
 (d) working condition fringe def
(e) de minimis fringe def
(h) certain individs treated as employees for purposes of (a)(1) and (2): dependent or spouse, (3) parents of employees in the case of airlines