Taxation I Fall 2015 Outline
A. Sources of Tax Law
– What are the goals of a tax regime?
§ Horizontal Equity:
· Treat similarly situated taxpayers the same.
§ Vertical Equity:
· Differently situated taxpayers should be treated differently.
o Raising Revenue
o To encourage/discourage certain behavior’s/activities (tax as a regulatory tool)
o “Wealth distribution”
o Economic tool (stimulating certain economic behavior/industries)
– Practical goals:
§ Need something that works for both 145 Million taxpayers who self-report their income and an agency with limited staff and funds.
§ Need a system which people will not deem overly absurd or burdensome or they will not participate en masse and the system won’t work.
Actual Sources of Tax Law
– The US Constitution is the final check on all tax law and the express grant of Congress’s authority to collect an income tax and promulgate the Internal Revenue Code.
o Constitution allowed a “direct” tax only if apportioned among the states by population.
§ Initial attempts to impose an income tax were struck down as unconstitutional direct taxes.
o The authority for an income tax therefore comes from the Sixteenth Amendment to the Constitution.
§ “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
– The Internal Revenue Code (hereinafter, “IRC”)
– The Treasury Department Regulations
o Authorized either by the general authority found in §7805(a) or under a more specific grant in a particular provision.
– Revenue rulings and revenue procedures published by the IRS.
– Tax Court decisions.
Focus of Our Inquiry:
– What is the tax base?
o For our purposes, taxable income. (line 43 on form 1040).
B. Big Picture Concepts: Income, Structure and Deferral
What is Income?
– Our income tax is not a pure income tax.
o Rather, is a mix of income and consumption tax.
– Income is almost anything you receive of value.
– Income is almost anything of value which you receive.
o Income, from a tax-geek perspective, is essentially how much you could spend in any given period and be as well off at the end of the period as you were at the beginning. Question is really how much could you spend so that you're as well off as you were at the beginning.
· Highly subjective/individual inquiry. Would have to make a full-fledged inquiry into what each person deems necessary to achieve their standard of living.
· Definitional problem: how to define standard of living.
· Administrability problems.
– Haig-Simons Definition of Income
o Since the 50’s, we’ve had the Haig-Simons Definition
§ Income = Consumption + Change in Net Wealth
– An income tax truly based on Haig-Simons would be inadministrable.
o Would have to keep track of all changes in wealth on an almost daily basis.
o Would have to come up with a system to assess the value of all assets.
o People would cheat the system.
– Thus our income definition modified to suit these realities is:
o Income = Gross Income – Allowable Deductions.
Exclusions, Deductions and Credits, Generally:
– Exclusions and deductions: have the same effect in the end, though removed from Gross Income at different stages of the tax equation.
o Exclusions depend on the source of the income while Deductions depend on its use.
o Exclusions come out above the line and Deductions below.
§ Exclusions offer less hoops than Deductions.
– Credits: reduce tax liability directly while exclusions and deductions reduce it only indirectly by reducing taxable income.
– Deferral: After answering whether income belongs in the tax base, question becomes when it should be included in the tax base.
o Mostly deals with when we tax appreciation in the value of property.
o When taxpayer can defer payment, he can theoretically hold it and earn interest, whereas by allowing the deferment, the government loses money.
o Value of deferral depends on the length of time the taxpayer can hold onto the money and the rate of return her can receive on that money.
II. WHAT IS GROSS INCOME?
A. The Beginning: Income and Realization
§61: Defines Gross Income.
– (a) “…Gross income means all income from whatever source derived, including (but not limited to) the following items:
o (1) Compensation for services, including fees, commissions, fringe benefits, and similar items;
o (2) Gross income derived from business;
o (3) Gains derived from dealings in property;
o (4) Interest;
o (5) Rents;
o (6) Royalties;
o (7) Dividnes;
o (8) Alimony and separate maintenance payments;
o (9) Annuities;
o (10) Income from life insurance and endowment contracts;
o (11) Pensions;
o (12) Income from discharge of indebtedness;
o (13) Distributive share of partnership gross income;
o (14) Income in respect of a decedent; and
o (15) Income from an interest in an estate or trust.”
– Realization: The government generally is concerned with liquidity, does not consider something as income until it is realized, which in most cases means converted into cash, though can and does include non-cash items under various circumstances.
Eisner v. Macomber: Mrs. Macomber owned 2,200 shares in Standard Oil. Standard Oil declared a 50% stock dividend and she received 1,100 additional shares, of which about $20,000 in par value represented earnings accumulated by the company—recapitalized rather than distributed—since the effective date of the original tax law.
Current statute expressly included stock dividends in income, and the government contended that those certificates should be taxed as income to Mrs. Macomber as though the corporation had distributed money to her. – See more at:
– Stock dividend could not be considered income, as t
if such taxes are to be paid by the purchaser.
– Section 1001(c): Recognition of Gain or Loss
o Recognized Gain/Loss= entire amount of gain or loss, unless otherwise provided.
– Section 1011: Adjusted Basis for Determining Gain or Loss
o Section 1011(a): General Rule:
§ Adjusted Basis = basis (determined under Section 1012 or other applicable sections) adjusted as provided in 1016.
o Section 1011(b):Bargain Sale to Charitable Organizations
§ ? I DON”T GET THIS. FIGURE IT OUT.
– Section 1012: Basis of Property – Cost
o Section 1012(a): Basis = Cost (except as otherwise provided in this subchapter).
o Section 1012(b): Special Rule for Apportioned Real Estate Taxes
§ Cost of real property does not include real property tax amounts treated under section 164(d) as imposed on the taxpayer.
o Section 1012(c): Determinations by Account
§ (1) In General: In case of sale, exchange or disposition of a specified security, this subsection shall be applied on an account by account basis.
§ (2) Application to Certain Regulated Investment Companies:
· (A) In General: Except as provided in subparagraph (B),
COME BACK TO SECTION 1012!
How this all works:
– Basically: Amount Realized (1001(b)) – Adjusted Basis (1012) = Gain Realized (1001(a))/Gain Recognized (1001(c)).
– Example: Have 50 shares of stock purchased for $50k, sell for $80k.
o Amount Realized = $80,000 (amount received as per 1001(b))
o Minus Adjusted Basis ($50k; Cost of stock, as per 1012) = $30k
o Gain Realized = $30k (as per 1001(a)), and all of it is recognized as per 1001(c), resulting in Gain Recognized = $30k. Thus, $30k is taxable and includable in Gross Income.
– IN CASE OF PARTIAL SALE, reduce the basis in the equation in an amount equal to the proportion sold.
o Example: Only sell half the stock for $40k. Value was $80k, so $40k was 50% of the total value.
§ Thus, reduce basis by 50%, which is $25k in this case.
§ Equation becomes:
· Amount Realized = $40k (1001(b))
· Minus Adjusted Basis ($25k)(1012) = $15k.
· Gain Realized: $15k (as per 1001(a), and all recognized under 1001(c), resulting in gain Recognized = $15k. $15k is taxable and includable in Gross Income.
– Exceptions for land/easements in cases where it is impossible to apportion the value.
o In these cases, allow the taxpayer to use up his basis first, then begin tallying income.
o See Inaja Land below.