a. History of Taxation
i. 1862: Lincoln passes first income tax:
1. $600-$10,000 @ 3%
2. $10,000+ @ 5%
3. Repealed in 1872
ii. 1894: New income tax put into place
1. $4,000 @ 2%
2. Did not include gifts and estates taxes.
3. Was repealed in 1895 since it was a “direct tax” not proportioned across the populations of the states.
iii. 1909: Congress passed a tax on corporate income.
iv. 1913:16th Amendment was passed making the income tax constitutional.
v. WWII: Tax changed from a class tax (only the upper classes) into a mass tax with a much larger base.
vi. 1954: Gigantic new codification of the tax law.
vii. 1986: Major revision to the tax code, but not a whole new codification since the sections remained the same.
viii. 2001: Massive reductions to both the rate and base set to repeal in December of 2010.
b. Broad Overview of the Tax System
i. Gross income-§62 Deductions= Adjusted Gross Income
1. This is the “line”. Deductions before are “above”, deductions after are “below”.
ii. Then AGI- Personal Exemption- (Standard or Itemized Deductions)= Taxable Income
iii. Taxable Income * Rate= Tax Due
iv. Tax Due – Credits + Alternative Minimum Tax = Actual Tax Liability
v. Marginal tax rate v. Actual Tax Rate
1. Marginal= the rate paid on the last dollar of tax liability.
Ø Whenever doing tax planning it is the marginal dollar that matters.
2. Actual= the average rate paid across the progressive system.
c. Metrics for assessing tax policy
i. Efficiency: It is impossible for a tax system to be completely efficient. There are times that social policy dictates that a tax would be better to be inefficient (e.g., excise taxes on tobacco).
ii. Equity: Horizontal equity across people in similar economic situations; Vertical equity: tax liability rises with the ability to pay.
II. Identifying the Taxpayer
a. The Marriage Penalty
1. In community property states the individual incomes of the married parties, when dealt with separately, remained the same. Community property states allowed income to be distributed between the two parties, thus lowering the total liability. This made it attractive to be in a community property system. (Poe)
2. In 1948 the government extended (doubled) the lower income bracket for married people. This system benefited marriage and appeared to be unfair for single people.
3. 1969 the congress adjusted this by extending the single income brackets to be more than half of the married brackets. As a result there is a sort of penalty for married couples when they both earn a salary.
Ø E.g., a couple each make 50k. Single their liability is 10813 * 2= 21,626, married= 23,765.
ii. Requirements to be married for the purposes of taxation:
1. A federally recognized marriage
Ø E.g., homosexual marriages are not recognized under DOMA (Muehler).
2. 12/31 is the cut-off date for marriage that year. If you are married by New Years then you are considered married for the whole tax year.
3. Divorce ends marriage because the couple ceases to enjoy the benefits of marriage (Druker).
iii. Druker v. Commissioner
1. F: Married couple files their tax returns as single individuals to contest the “marriage penalty”. IRS responds with a tax bill which they appeal to the tax court, where they lose. They then appeal to the Court of Appeals.
2. I: Is the “marriage penalty”, meaning that married couples who both earn income are taxed at a higher rate than they would be if they were both single, constitutionally valid?
3. H: The marriage penalty is valid and it is impossible to have a progressive tax system without either penalizing married or single peoples.
iv. HHHhh Revenue Ruling 76-255
1. I: Will a couple be considered unmarried for a tax year if they secure a divorce before the end of the year with the intent of remarrying in the following year?
2. H: No. The IRS states that “sham transactions”, whereby couples manipulate their marital status to manipulate their tax liability, cannot change the marital status of the filers. Instead, they must file as a married couple.
b. Assignments of Income
i. Except for a few exceptions, we tax the person who earned the income. The person who earned the income has the power to distribute it as they please (the economic power), and thus they are the ones who are taxed.
ii. Lucas v. Earl
1. F: Before the income tax was instituted, taxpayer and his wife signed a contract that equally distributed the husband’s income between him and his wife. They were assessed tax as if he was the only one with income, and they challenged the rule.
2. I: Can a husband and wife sign a contract that distributes the income of one party evenly amongst them? And if so, will their taxable income be split or assigned to one party?
3. H: The contract between the husband and wife was legal and upheld. But still, income is assigned to the person whose services earned the money, and thus cannot be circumvented through the contractual splitting of income. More specifically, income is assigned to the person who has control over it (and control was exercised when he contracted it over).
Ø Lucas is differentiated from Poe, in which it was held that in community property states income is legally divided between husband and wife, because the decision/power to distribute/control the income was in the hands of the taxpayer, while i
ney spent by the employer to pay off the tax liability be considered income?
3. H: Yes. At the end of the day the employee has greater spending/economic power, and thus he has received income. He makes two arguments that are rejected: 1. That it was a gift, which the court responds to by saying that any money given by an employer to an employee in exchange for services cannot be a gift and 2. That it would create a tax on a tax, which the court responds to by saying that it wasn’t a question before them, and won’t be charged as such.
Ø The taxable payment of tax is not an insolvable problem and mathematicians have devised ways to set up a plan where an entire tax burden can be paid for. This can be important in overseas employment.
Ø It’s important to note that he would end up with extra economic power if he were to receive this payment.
b. Statutory Exclusions under §132
1. In the 1970s there was no statute that dealt with how fringe benefits should be treated. This led to a big uproar that they should be income.
2. In the 1980s the IRS dealt with this problem by issuing §132. It has been under constant revisions since.
ii. §61(a)(1) includes fringe benefits as income “except as otherwise provided”.
iii. §132 Included fringe benefits:
1. No additional cost services
2. Employee discounts
3. Working condition fringes
Ø To have a working condition fringe the fringe must have been deductible from income under §162 if it were not given as a fringe.
4. De minimis fringes
5. Qualified transportation fringes
6. Qualified moving expense reimbursements
7. Qualified retirement planning services
iv. Other fringe benefit exclusions:
1. §119: Meals and lodging furnished on the employer’s premises are not included as income.
Ø These fringes support the interests of the employer
2. One does not gain income if they are paid to do something primarily for the benefit of the employer. This is determined by looking at the intention of the payor.
v. §83: Property given in exchange for services is taxable at the fair market value of the property.
1. Exception: It is not taxable until it is under the control of the employee.