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Tax
Temple University School of Law
Monroe, Andrea

Taxation

INTRODUCTION

The Tax Base
–          The goals of a tax system may be:
a.       Redistribute wealth
b.      Encourage certain economic activity
c.       Encourage certain social activities (deductions for charitable giving, home-buying)
d.      Discourages certain activities (cigarette tax)
e.       Raising revenue
–          In evaluating the tax code, three policy evaluation standards apply:
a.       Equitable
i. Horizontal: are similarly situated taxpayers treated the same?
ii. Vertical: are differently situated taxpayers treated differently?
b.      Simplicity and administrability: Individuals must be able to understand the law in order to pay. It also has to be easy enough for the service to enforce it
c.      Efficiency: Does the tax accomplish its goals? Does the tax inadvertently encourage or discourage behavior?
–          The tax base is income
–         The Haig-Simons definition of income is:
a.       Income = Change in wealth + Personal consumption
–          The problem with the Haig-Simons definition is valuations
–         Calculating a “change in wealth” would require individuals to value everything in their possession at the beginning and end of the year
–         Instead, changes in wealth are taxed once the gain is realized (sale of stock, sale of home), even though the value may have risen over time
–         Because Haig-Simons is unworkable in many respects, the American system uses the following formula:
a.      Taxable Income = Gross Income – Deductions
–          Allowable deductions have two characteristics:
a.       Decreases in wealth (not personal expenses); and
b.      Investments and Business Expenses
–          Some reasons the American system deviates from Haig Simons, and favors consumption tax principles are:
a.       Stimulates economy
b.      Social policy: consumption tax encourages/discourages behavior)
c.       The realization requirement: Pure Haig-Simons is unworkable because it taxes income which has accrued simply because of the passage of time
d.      Abuse
–          Questions to ask when confused about the tax base:
a.       What would Haig-Simons do?
b.      Is there any reason to deviate from Haig-Simons? Policy considerations?

Tax Rates
–          Tax rates have the same theoretical underpinnings as the tax base and the same evaluative methods
–          There are three types of structures that a tax rate takes:
a.       Progressive
b.      Regressive
c.       Flat
–          The federal income tax is a progressive tax
–          The progressive tax has the most vertical and horizontal equitability
–          Some examples of a Regressive, however, tax are:
a.       Sales tax
b.      Consumption taxes
c.       Social Security tax
–          One of the dominant arguments in favor of a progressive income tax is that it must be progressive in order to counterbalance all of the regressive taxes
–          To calculate tax:
a.       Determine taxable income
b.      Find Bracket
c.       Subtract base taxable income in bracket from actual taxable income
d.      Multiply the difference by the marginal tax rate
e.       Add product to base tax
–          Marginal tax rate:
a. Percentage tax above base tax
–          Effective tax rate:
a.       Tax / Taxable Income

THE TAXPAYER

Assignment of Income: Income from Personal Services
Lucas v. Earl
Poe v. Sanborn
Armantrout v. Commissioner
Techner v. Commissioner
–          One of the ways individuals attempt to avoid paying taxes is known as “income shifting”
–          Income shifting manipulates both one’s tax base and tax rate
–          If an individual shifts a portion of his income to another, he reduces his tax base
–          By shifting the income, the taxpayer also may fall into a lower tax bracket, and therefore be taxed at a lower rate
–          The taxpayer may also attempt to shift income to an individual within his economic unit who may pay a lower tax rate on that income (i.e. from spouse to spouse, between units in a business, etc.)
–          Thus, the taxpayer retains control over the income, but the income is taxed at a lower rate
–          In Lucas v. Earl, the SC held that a tax cannot be escaped by anticipatory agreements and contracts to prevent income from vesting to the individual who earned it
–          Thus, income is taxed to the person who earns it; to the wage-earner (Lucas)
–          However, in Poe v. Sanborn, the SC ruled that in a community property jurisdiction each spouse is taxable on one-half of the community income regardless of who earns it
–          The Court distinguished Lucas v. Earl on the ground that, under the WA state community property law, both spouses had an immediate property interest in community income that vested under state law
–          In 1948, Congress provided for the joint return, which treats married couples as the unit of taxation
–          In Armantrout v. Commissioner, the 7th Circuit ruled that income need not necessarily be in the form of cash
–          Any benefits which are the product of the taxpayer’s employment relationship are considered to be income (Armantrout)
–          In Techner v. Commissioner, a taxpayer entered a contest and designated his daughter to receive the prize after he won
–          Because individuals over the age of 17 were ineligible to receive the prize, the taxpayer was not eligible to receive the income
–          Taxpayers who earn income from their personal effort but are nevertheless ineligible to collect the income, are not taxable when they divert that income to an individual who is eligible to receive the compensation (Techner)
–          Techner is difficult to reconcile with Lucas and Armantrout because the taxpayer still had control over who received the income
–          Generally, if an individual has control over who receives the income, then he is taxable on that income
–          Thus, the IRS has refused to acquiesce to the decision in Techner
–          Taxpayers who simply refuse to accept compensation for future personal services without designating an alternative recip

donee is taxable on the income.
–          If the assignment of an interest in property is temporary, however, then the donor retains the power to assign the income in subsequent years and remains taxable on the income derived from the property

The Family Unit: Taxation of Marriage
Druker v. Commissioner
Mueller v. Commissioner
–          There are four problems that marriage causes when it come to income tax:
a.       Theoretical: How do we treat married individuals and single individuals fairly and still have a progressive income tax?
b.      Disconnect: Should different economic units be treated similarly?
c.       Administrability: How is the service going to be able to enforce a tax structure which attempts to treat marriage as a single unit?
d.      Political: Who is married? Who can be married?
–          Before Earl, the individual was the taxable unit. Individuals did not share income with spouses
–          The Earl system also created horizontal equity. It treated similarly situated individuals the same, whether married or not
–          The result in Seaborn, however, held that those living in community property states could share income
–          Seaborn’s result caused problems because similarly situated married couples were treated differently depending upon where they lived
–          In response, Congress allowed married couples to file joint tax returns beginning in 1948
–          This created horizontal equity between married couples, but now singles were often taxed at a higher rate than similarly situated married individuals because married individuals can shift half there income to their spouse
–          In 1969, congress responded by requiring that a single individual’s tax liability is no more than 120% that of similarly situated married couples
–          This, in turn, penalized the two wage-earner married couple who combined tax burden would have been less if they had remained single and filed separately
–          The gist is that in the area of family taxation every legislative decision is fated to be both “over inclusive and under inclusive” (Druker)
–          Thus, courts have consistently rejected challenges to marriage classifications under the tax code (Mueller)
–          In Mueller, the court held that, in order to file a joint return, a couple must be married in fact
–          Mueller argued that homosexual couples living as an economic unit should be able to file jointly