TAXATION
Nancy Knauer
Fall 2013
p. 12-17
Current taxes in the United States:
· The Internal Revenue Code of 1986 imposes more than 50 types of taxes.
· Overall tax level as a percentage of total national output has remained fairly constant
o Social Security and Medicare’s shares have increased dramatically relative to GDP
§ Funding social security this way may be adversely affecting private savings
o Payroll tax has grown to fund social welfare programs
§ Middle class is being overtaxed
· Revenue from wages has increased, while revenue from the corporate income tax has decreased.
o Individual income and excise taxes have been steady.
· The sales tax and income tax are the main sources of State revenue
o Shift away from property-tax supplied revenue
· Local taxes come from the property tax
U.S. taxes are about 25% of GDP, low in comparison to the 34% world average.
p. 22 – 39
Terminology
· Income tax = (taxable income) x (tax rates) – (any allowable tax credits)
o Taxable income = gross income – deductions
· Gross income is “all income from whatever source derived.”
o Almost anything can be part of gross income. Yet some things are exempt, like fringe benefits provided by an employer (think health insurance).
§ Includes receipts of service, property, payments to third parties on the taxpayer’s behalf, etc.
o Includes gains from the sale of tangible and intangible property.
§ Taxable gain = sale price – purchase price
· Basis in the property is the portion of the sales proceeds that the taxpayer may recover without incurring tax liability
o Adjusted basis is the purchase price adjusted upward or downward to reflect subsequent expenditures or tax benefits attributable to the asset
§ If the adjusted basis exceeds the sales price, there is a loss
§ Gains and losses are only taken into account when they are realized through a sale or other disposition of property
· Deductions
o Deductible: Expenses incurred in the production of business income and expenses to earn investment income
o Non-deductible: Personal expenses
§ Some personal expenses are deductible as itemized deductions
· Adjusted gross income = gross income – expenses
o Taxable income = Adjusted gross income – (personal & dependency exemptions +standard or itemized deductions)
§ Standard deduction is a flat amount specified by the Code that varies with marital status, which may be deducted regardless of actual expenses
· If taxpayers are entitled to itemized deductions in excess of the standard deduction, they will claim the itemized deductions instead of the standard deduction
§ Itemized deductions are all allowable deductions other than the deduction allowable in arriving at adjusted gross income and personal exemptions
· Deductions from gross income are preferred over deductions from adjusted gross income
o Because taxpayers only benefit from deductions from adjusted gross income when they total more than the applicable standard deduction
· AGI, standard deductions, and itemized deductions are applicable to individual taxpayers
o Corporations simply subtract all allowable deductions from gross income to obtain taxable income
· Some expenditures (like machines or buildings) must be capitalized to be deducted – that is, added to the taxpayer’s adjusted basis in the property with respect to which the expense was incurred.
o The taxpayer recovers some of these capital expenditures over a period of means by annual deductions for depreciation or amortization
§ In other words, they cannot be immediately deducted in that fiscal year
o Other expenditures can only be recovered upon the sale of the asset
· Capital gains and capital losses come from the sale of property the taxpayer has held for a specified period
o Long-term capital gains taxed at more favorable rates than ordinary income
o Capital losses are less deductible than ordinary losses
· The income tax is a progressive tax.
o Distinguish the average tax rate from the marginal rate applied to the last dollar of taxable income
§ Average rate = total tax due / total taxable income
§ Marginal rate = last dollar of taxable income
o Remove deductions from total taxable income before calculating taxes due
· A credit represents a direct reduction in tax, while a deduction reduces a tax liability by an amount of (deduction) x (marginal rate)
o Deductions are more useful for wealthier taxpayers
o Credits are nonrefundable, meaning they only offset tax liability
CALCULATING A TAX LIABILITY
(1) Calculate gross income (§ 61)
(2) Subtract “above the line” deductions (from § 62). The resulting figure is known as adjusted gross income (§ 62)
(3) Subtract the “below the line” deductions = the sum of person exemptions (§ 151) and either the standard deduction or itemized deductions (start with §§ 63 and 67). The resulting figure is known as taxable income (§ 63).
(4) Apply the tax rate schedules (found in § 1) to taxable income to determine tentative tax liability
(5) Subtract any tax credits from tentative tax liability
· *Remember: deductions reduce income, while credits directly reduce tax liability.
· The remaining amount is final tax liability.
ALTERNATIVE MINIMUM TAX
Do this if the taxpayer’s liability is too low because of tax preferences that reduce their liability.
· 26% on income up to $175,000. 28% on the excess.
· AMT is a broader income tax base that is reduced by fewer deductions, exclusions, and credits than the regular base.
· The minimum tax must be paid whenever it is greater than the regular tax for which the individual otherwise would be liable
You choose the taxable year to which income tax is assessed by two me
vidual use of a government service, such as national defense
· Expenditure tax – progressive tax rate to a consumption tax
· Flat tax – split between individual and business taxes, both of which equal sales.
Majority of taxes in the world: (1) income; (2) wages; (3) consumption; and (4) wealth
Supreme Court’s role in tax creation:
Art. I, § 2, clause 3: Forbids direct taxation
· No one is really sure what a direct tax is
16th Amendment – allows the income tax
· Art. I, § 7, clause 1’s requirement that revenue-building bills originate in the House of Representatives is basically a nullity; as long as the original bill originates in the House, it doesn’t matter what the Senate does to it, even if it completely changes the character of the bill.
· Art. I, § 8’s requirement for a uniform tax is irrelevant now because of U.S. v. Ptasynski, (exempting Alaskan oil from the Crude Oil Windfall Profits Tax of 1980).
Challenges to Congress’s ability to levy taxes only succeeds lately when the tax interferes with First Amendment rights.
Legislature’s role in tax creation:
· Congress’s power to levy taxes is only checked by the President’s veto power
o But the President himself initiates a lot of tax legislation
§ The Department of the Treasury, specifically
· Taxes are first considered by the Committee on Ways and Means
o The senatorial counterpart is the Senate Finance Committee
Cesarini v. U.S.
Facts: Πs purchased a used piano and found $5000 cash inside of it seven years later. They paid the tax on the sum, but then sued for a refund, claiming that the windfall was not including in gross income under § 61.
Held: The windfall was taxable income.
Discussion: 26 U.S.C.A. § 61(a) is the relevant provision for determining what to include under gross income. This section lists items, but does not limit gross income to what is listed. §§ 101 deal with the items to be specifically excluded from gross income – windfalls are not one of them.
The court pointed to specific language from the 1968 Treasury Regulations that included “treasure-troves” (or windfalls) as taxable income.
· If you are looking for an exemption, you must point to the specific listed exemption; otherwise, the broad language of § 61 will make your income taxable.
