ALICE ABREU – TAXATION – SPRING 2011
Introduction – History & Definitions
· The first income tax was established under Lincoln to finance the Civil War. Under his system, there were three rates (0, 3 & 5). This tax system was repealed after the war.
o Marginal rate: tax paid on the last dollars of income;
· Alternate definition: how you measure what the benefit of a deduction is (the higher the marginal rate, the more valuable a deduction is)
o Effective (average) rate: the average tax rate (includes marginal rate and lower brackets); the effective rate will always be lower than the marginal rate because it is an average of all rates applied to a particular individual.
· In 1894, the income tax raised a constitutional issue: According to the Constitution (& the court), If a tax is a direct tax (on the people) then it must be apportioned according to population of the states. Therefore, the income tax was held unconstitutional.
o In 1913, the 16th amendment was adopted so that Congress would have the power to lay taxes on incomes without apportionment.
· Three Important Pieces of Legislation:
o 1986 Internal Revenue Code: goal was to reduce rates & make it revenue neutral (so they expanded the base by bringing more things into the definition of income and lowering number of deductions)
o 2001 Bush Tax Cuts
o Obama leaves Bush Tax Cuts in place through 2012
· Zero Rates:
o Provide this bracket straight up (as Lincoln did)
o Provide an amount that never makes it into taxable income (current US system)
Goals of the Tax System
· Horizontal equity: want to tax people who have similar economic circumstances (similarly situated) to have the same rate of tax
o Flat tax? Wages used as a base and not completely proportional
o Regressive tax? Amount of tax goes down as your income rises?
· Retail sales; payroll tax
· Vertical equity: people who have more pay more; solved by a progressive rate structure because of the diminishing marginal utility of money
· Efficiency: whether a tax system interferes with economic decisions
o Most efficient type of tax is a head tax: everyone has to pay this regardless of anything but these are tremendously unpopular — vertically inequitable
· Simplicity: makes the tax system administrable
Identifying the Taxpayer
· District Courts: must pay the deficiency and bring suit following it up
· Claims Court: may pay deficiency and bring suit following it up — goes to Court of Appeals for the Federal Circuit
· Tax Court: may REFUSE to pay deficiency & within 90 days must petition the Tax Court for review
o Acquiescence: When Commissioner loses in Tax Court, can choose to follow the decision and have IRS follow the Tax Court — same effect as a revenue ruling
o Non-acquiescence: Commissioner loses but does not agree; doesn’t follow up because the case is weak
The Taxable Unit
· Community property: half of anything a married person makes belongs to the other person in the marriage (CA, TX, NV)
· Common law property: individual ownership of what is made (PA, NJ, NY, DE, MA)
· Poe v. Seaborn: allows community property rule for federal income tax purposes, but this leads to horizontal inequity:
o Example: In a community property state, married couple makes $100,000; but this is split into $50,000 each. Their rate will be lower than the individual who makes $100,000 and is taxed at the higher marginal rate.
o Solved: Married couple is now the unit of taxation after 1948 —> new problem
o Single people are now unhappy so Congress moves from 2 brackets to three brackets with an inbetween rate for single people. —->
· If you marry a rich person and you don’t work: bonus; but if you are both rich then there is a marriage penalty:
Taxation of the Family — Marriage Penalty
· Druker v. Commissioner (1982): [Drukers wanted to apply single rates to married filing separately returns claiming that the government unfairly discriminated against those who were married with both spouses working] Marriage penalty ruled not unconstitutional because it is impossible to design a progressive tax system when all individuals are tax equally not depending on marital status
o Married filing separately: just half the tax rates for married individuals but no joint and several liability (unlike married filing jointly but there is an Innocent Spouse section 6015)
o Spouses earn equal amounts = marriage penalty because they have higher rates of tax than single individuals; but also a marriage bonus where couples who earn unequal amounts pay less taxes (than single people)
Dissolution of the Family: Separation & Divorce
· Revenue Ruling 76-255: true nature of the transaction must be considered in light of the plain intent & purpose of the statute. Cannot be tax avoidance.
o Annulment or divorced to file separate returns: annulment is the only way the couple can file separate returns at the end of the year
o Sham Transaction: quick marriage is a sham transaction if it does not have any meaning other than for the purposes of avoiding tax liability
· But divorce can have other ramifications: if you die on a day you are divorced then the other person isnt entitled to your money
Defense of Marriage Act
· Congressional act that says marriage is between a man and a woman and other states do not have to recognize another state's marriages
· Chief Counsel Memorandum 200608038: Poe v. Seaborn does not apply to civil unions — but this changes and currently the IRS WILL respect state community property law regardless of the gender of the parties (CA & civil unions)
· Mueller v. Commissioner (2001): [Gay man wanted to file a joint return with partner] Because he was not married under Illinois law, could not file a joint tax return so he had a failure to file.
o To NOT be liable for failure to file, the failure must be:
· Due to reasonable cause
· & NOT due to willful neglect
Assignment of Income
Income from Services
· Lucas v. Earl (1930): [H&W entered agreement that they would share their income — divide his income in half and provide it to her] Clients —$$—> Earl —$$—> Wife
o Money is taxable only to Earl because it was money received for services that he rendered to the clients (not his wife; he was merely then gifting the money to his wife once HE received it) — so the money is NOT taxable to his wife
Income from Property
· General rule: Income from property is taxed to the owner. A gift of property shifts the income from the property to the transferee. A gift of the income from property does NOT shift the tax.
· Helvering v. Horst: [Horst gives bond coupons to son & argues that the bond coupon income is NOT taxable to him] Bondholders –$$—> Mr. Horst —coupon($$)—> Horst Jr.
o Money is taxable to Mr. Horst because he still holds the bond that is producing the income (same as if he went & collected the coupon money himself and then gifted it to his son)
o If OWNERSHIP & CONTROL are transferred: then taxable to tr
o If a flight attendant flies to Hawaii in a seat which would otherwise have been empty, is the value of the airfare taxable to him? No, 132(a)(1) it is a no-additional cost service exclusion and 132(b) provides the definition
· What if the flight attendant takes a first class seat & eats the meal?
§ Regs 1.132(2)(a)(5)(ii): Flight attendant meals are merely incidental (de minimis fringe & no additional-cost service)
· What if the flight attendant's wife accompanies him on the trip & also flies first class on an otherwise empty seat?
§ 132(h)(2): Any use by the spouse or a dependent child of the employee shall be treated as use by the employee. (so if wife flies by herself, this provision still applies)
§ If the “spouse” is domestic partner/legal same sex spouse: it IS taxable to employee because of Defense of Marriage Act = (NOT a spouse)
§ What about a parent of the flight attendant?
· SPECIAL RULE! 132(h)(3): Parents of flight attendants are treated as the employee (BUT THIS IS THE ONLY PROVISION WHERE THE PARENTS CAN DO THIS — Chairman of Ways & Means had a flight attendant daughter…)
o Non-Discrimination Rule: Sheraton allows employees who earn more than $100k to stay in their hotels:
· 132(j) says the employee WILL be taxed because can only be excluded if the highly compensated employee is NOT discriminated in favor of or against
· What about parking for highly compensated employees? No non-discrimination rule for parking because the only fringe benefits that ARE subject to the non-discrimination rule are no-additional cost services & qualified employee discount (NOT qualified transportation fringe)
o Qualified Transportation Fringe:
· $175 allowed for parking and is adjusted for inflation
· Monthly transit passes are only $100/month — flush language of 132(f)(1)(b) says transit = parking temporarily
· Bicycle reimbursement: Not subject to inflation
o On premises gyms:
· Operated by employer; on premises; substantially all the use of which is by employees of the employer, their spouses & dependent children
o De Minimis Fringe:
· Difficult to account for — administrative convenience; employer provided eating facilities; occasional meal money is de minimis
· United States v. Gotcher (1968): [Mr & Mrs Gotcher take an all expense paid trip to Germany so Mr Gotcher could decide if he wanted to open a VW dealer — trip half paid by his employer; half paid by VW] Mr. Gotcher's trip expenses are excludable, but Mrs. Gotcher's trip expenses are NOT excludable (because she didn’t attend anything for business)
o If taxpayer doesn’t have a choice in going or not, then it is an exclusion
o Primary motivation was business (not pleasure)
o 132 does not address this problem because there is NOT YET an employee-employer relationship