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

FED INCOME TAXATION
SPRING 2010, PROF ABREU
OUTLINE WITH INCLUDED CODE WALK THROUGH
 
 
I. INTRODUCTION
 
Syllabus # 1: Introduction
·         Taxation: process by which a gov’t transfers resources from the private to the public sector
o    Goals of Federal Tax and Fiscal Policies
§ Facilitate growth of nation’s economy
§ Do justice in distributing burdens and benefits of gov’t
§ Raise revenue adequate to finance government’s expenditures
A. HISTORY
·         Prior to Civil War: NO income tax-duties, excise taxes, tariffs (consumption taxes)
·         1862: Lincoln passes first income tax-repealed in 1872
·         1913: 16th Am allows Congress to levy taxes on income w/o apportionment by states (Fed IT constitutional)
·         WWII: Income tax became tax of masses (raise funds for war)
·         1954: gigantic new codification of the tax law; 1986:  major revision to the tax code
B. BROAD OVERVIEW
·         Computation of IT:
o     GI-Deductions=AGI
o    Then, AGI-Personal Exemption-(Standard/Itemized deds)=TI
o    TI x Rate=Amount due
·         Gross Income: all income from whatever source derived
o    Gains. Amount realized in excess of the basis
o    Basis. Portion of sales proceeds that the TP may recover w/o incurring tax
§ Adjusted Basis. Basis adjusted to subsequent expenditures or tax benefits attributable to asset
·         Losses/gains are only taken into account as they are realized
o    Deductions: for individuals, those deductible expenses involved in business and investment income (as opposed to personal expenses which are generally are not allowable
§ Reduces tax liability by the amount of the allowable ded multiplied by the TP’s marginal rate
o    Itemized Deductions: allowable deductions other than those allowed in the calculation of AGI and Personal Exemption
o    Credits: direct reduction in tax in the amount of the credit
·         Rate-at what % to tax
o    Types of rate structures
§ Progressive: the more you make, the higher the rate you have to pay
§ Proportional: flat tax; applies 1 rate to all TPs
§ Regressive: more you make, the lower the rate (i.e. sales tax-rich people pay less in proportion)
o    Marginal v. Average Rate
§ Average/Effective Rate: tax applicable to TI as a whole
·         TI=100K; 0-40k at 25%, 40-100k at 50%
o    40k x .25=10k; 60k x .50=30k; 10k+30k=40k
·         Avg. Rate: tax due/TI=40k/100k=40%
§ Marginal rate: applicable to the last dollar of TI
·         i.e. $500 income; $0-$200 bracket is 0, $201-500 at 10%; MR=10%
·         always higher than average rate and it is important in planning transaction
·         Note: TP better off to report gains in a year when her marginal bracket is low (Assuming same tax rates, it is better to pay taxes later rather than now)
o    0 Bracket: how much money you can bring in before the government charges a tax on it
§ There is NO 0 bracket in the rate structure, but we get the same effect w/the Standard Deduction
·         Three criteria for evaluating Tax System (TAX POLICY)
o    Equity: implemented by tax base
§ Horizontal: similarly situated people should be taxed similarly (but what is “similarly situated”)
§ Vertical: those with the greater ability to pay should bear more of the burden (progressive rate)
o    Efficiency: goal of tax system is to have as little impact on the market & decisions people make as possible. This is only true if object of taxation is solely raising revenue, but taxes are often enacted to affect behavior (i.e. tax on alcohol, cigarettes, etc)
§ Tax Expenditure: tax goody & flip side of efficiency; deliberate inefficiency so as to affect behaviors
o    Simplicity/Administerability: ease w/which TP may comply w/system; ease w/which system is administered
§ The more you try to target a benefit to a specific group the more complex you make the system
II. IDENTIFYING THE TP
 
Syllabus # 2: The Unit of Taxation: to whom should an item of income be taxed?
·         Possible Taxable Units: Individuals, Married people, Children, Corporation, Estate/Trust
A. Married Couples
·         History of Income Tax and Taxable Unit
o    1913-1948: Individual is unit of taxation regardless of marital status
§ Caused horizontal inequity among married couples (Higher liability if 1 spouse earned most of income)
o    1930: Poe v. Seaborn (USSC): Allowed married couples in community property states the benefit of “income splitting”- each spouse taxable on ½ of community income regardless of which spouse earns it
§ Marriage would then generally reduce tax burden
§ Marriage remained neutral to taxes in common law states
o    1948: Congressional response: Joint Return & Marriage Bonus-Extended “income splitting” to CL states and enacts the joint returnàmarried couple is unit of taxation + special rate (widen bracket twice as far)
§ Marriage Bonus: given progressive rate structure, bonus if you’re married and penalty if you are single
·         EX: Bracket for married-10% up to $100k; For singles-10% up to $50K then 50% up to $100k
o    Married couple making $100k= $10k tax liability
o    Individual making $100k= $30k tax liability (50k x .1 + 50k x .5)
§ Pros and Cons
·         Pros: 1) reduced tax burden on married couples- must support 2 ppl (pooling) and possibly kids (less disposable income); 2) ensured horizontal & geographical equity for married couples
·         Cons: 1) put individual TPs at serious disadvantage, 2) doesn’t consider imputed income for non-working spouse; 3) obligation to support isn’t limited to marriage (i.e. elderly, children)
o    1969: Congressional reform: Marriage Penalty- Congress increased number of tax schedules & increased break point for single TPs
§ Marriage Penalty: 2 wage-earning married couples, whether filing jointly or separately, have higher tax burden than if they filed as 2 single people (both making roughly equal amounts)
§ Marriage Bonus Limited: couples whose income is primarily/solely by 1 spouse will still enjoy bonus
§ Single Persons: More reasonable tax structure; still generally pays more than married couple, but not as much as before
·         EX: 10% Bracket for single extended from $50k to $70K so $100k results in $22k liability
o    1993: Eliminates Marriage penalty in the 15% bracket (§ 1(f)(8))
§ Marriage penalty occurs for couples making similarly high salaries. They don’t reap benefit of balancing income with spouse.
·         EX: Each spouse’s TI=100k, both are taxed 10% on the first 70k and 50% on the remaining 30K (22k each); if married filing jointly: TI=200k, 10% up to 100k, 50% on other 100k (60k)
·         EX: single TP: If TI=100k, 10% on the first 70k and 50% on the last 30k = 22k
o    2001: “Marriage Penalty Relief Provision” expires in 2011
§ Increased deductions for married couple/Increased base (bracket)/Adjusted EITC
o    Bottom line: Three things cannot coexist: progressive taxation, equal treatment of equal income married couple, AND equal treatment of individuals. As long as we have progressivity, we are stuck choosing: do we want H.E. among married people (penalty/bonus) OR all people.
·         Rule: Marriage penalty doesn’t deprive the fundamental right to marriage; it is a consequence of but it does not prevent marriage
o    Druker v. C: married couple w/both partners making large incomes; challenged constitutionality of marriage penalty by filing “married filing separately” returns but applying single rates; Court ruled against TP
·         Rule: The federal tax code’s distinctions b/w married TPs & unmarried economic partners is constitutionally valid b/c classification was a consequence not a cause of unmarried status
o    Mueller v. C: P claims economic partner w/gay b/f & wants to be taxed as a married person to get marriage bonus; Court rules against TP
·         Determination of Marital Status
o    Determined on NYE of each yearàif married by NYE then you’re considered married for the whole tax year
o    Validity of marriage is generally based on state law or law of country in which

s an agency for a service, and then the agency’s agent is sent to perform the services & the agent is contractually obligated to turn over any proceeds to church, agent does NOT have income
o    Reasoning: agency relationship & religious order controlled/restricted agent’s use of $$
o    If no K & agent was acting in his own capacity then gives $$ to churchàpmt for services is taxable to agent
·         RULE: TP who simply refuses to accept compensation for future personal services w/o designating an alternative recipient does NOT have income
o    Reasoning: $ wasn’t beneficially received and TP has no control over $
 
2. Income from Property
·         Gift of property (TREE): serves to shift tax from property owner to transferee (NO income; giving the tree away)
·         Gift of income from property (FRUIT): does not shift tax, it is income to TREE and taxable to TREE
·         RULE: tax liability attaches to ownership (TREE) [Blair v. C] ·         RULE: person who is to receive the income as the OWNER of the beneficial interest is to pay the tax
o    Blair v. C: Father creates a trust. Assigns half to widow & son. Widow dies & income goes to the son. The son then assigns his own kids a portion of that income. Ct held assignments of trust were valid & son’s children became owners of the interest
§ Reasoning: Blair signed away everything he had a right to & no longer has ownership interest of trust
·         Blair only ever had the fruit, so fruit essentially becomes the tree & by assigning his interest to his sons, he gives away the tree
§ Compared to Lucas v. Earl, Earl is different b/c he enters into K to give away his income, but retains control b/c by choosing to work or not he is affecting the amt that his spouse is entitled to. Blair never had control over how much the trust makes
·         RULE: person who owns the source of the income (TREE) & controls its disposition pays tax
o    Helvering v. Horst: TP owned bonds and assigned only the coupons to his children so as to pay fewer taxes. Ct still charged TP (owner of the bond) w/the tax.
§ Reasoning: 1)TP still owned the TREE 2) power to dispose of income=ownership of that income 3) H.E
o    TAX PLANNING: § 102 excludes gifts from income, but gifts of income from property are not excludable (so interest coupon from bonds are no gifts). So, give away the entire property (the Bonds).
·         Compare Earl, Blair, and Helvering:
o    Earl’s K was not motivated by tax avoidance, so result was independent of that. TP in Helvering purposely assigned the coupon to have less of a tax liability. Blair cannot transfer the trust & only the interest, so he assigned away all he ever had (the right to receive the income).
·         SYNTHESIS: Income is taxed to earner of services OR owner of property
o    Tax law follow the earner-whether it is a person or property
§ TP may assign the right of income w/o tax liability if he assigns the whole property interest, but TP may not escape taxes for the value of his services b/c he cannot assign himself away
o    POLICY: tax the tree
§ Income from income from personal services, the tree is the sweat of TP’s brow
§ Income from property, the tree is the is the property itself