Federal Income Tax Outline

Federal Taxation Outline
 
I.          expenditure and taxation at different levels of government
 
 
Expenditures
Taxation
Local Govt
1.      Schools
2.      police, fire sanitation
1.      property tax
2.      sales and income tax would not be successful b/c nobody wld want to live in a place w/ high sales and income taxes
State Govt
1.      education
2.      hwys, etc.
1.      income tax (≈ 50%)
2.      sales tax (≈ 50%) ® regressive in that it hits the poor more than the rich
3.      as an exception, some states don’t have any income tax (e.g., SD has no income tax, but over 300 casinos which allow video poker machines – a big revenue raiser); some states don’t have sales tax, some don’t have either (e.g., NH)
Fed Govt
1.      defense
2.      social programs (e.g., SS)
1.      44% ® individual income tax
2.      9% ® corporate income tax
3.      40% ® social ins. taxes and contributions (SS tax ≈ sales tax b/c certain fixed percentage regardless of what you earn goes to SS tax; SS is the most tax Americans on average pay)
 
II.        tax policies / objectives of tax law
1.                  economic efficiency ® resources must be allocated in best manner
2.                  equity / fairness
(a)                horizontal equity ® 2 people in the same economic situation should pay same taxes
(b)               vertical equity ® the rich should pay more than the poor => progressive rates – every additional dollar is taxed additionally at a higher rate
3.                  simplicity
(a)                sales tax meets this objective – it is very simple
(b)               income tax is very complex, which discourages compliance b/c more sophisticated taxpayers are able to avoid taxes better
4.                  specific social and economic objectives ® encouraging this or that objective
e.g.          child care could be provided in either of the 2 ways – the govt could either provide child care or could give a tax deduction to allow parents to take their children to the day care of their choice (even a relative) – the 2d option is more efficient
                another example is encouraging homeownership by mortgage tax breaks
 
III.       history and legislative process
1.                  history
(a)                before the early 1900’s most revenue came from customs tax
(b)               during Civil War income tax was used both by the Federal Union and the Confederate States of America to raise funds to finance the Civil War, but after the war ended the need for additional revenue disappeared and the income tax was repealed
(c)                Const. said that tax should be in proportion to population (i.e., the same amt for everyone) => it was unconstitutional to tax the rich more than the poor
(d)               ratification of 16Am to the US Const. in 1913 sanctioned both the Federal individual and corporate income taxes
(e)                1939 – revenue laws were codified into the Internal Revenue Code of 1939 (Title 26 of U.S.C.)
(f)                interestingly, in 1939 less than 6% of the population paid tax, while in 1945 over 74% of the population were subject to Federal income tax
(g)               current Internal Revenue Code of 1986 is largely based on the provision of the 1954 Code
2.                  legislative process® see attached copy of Figure 2-1 and Figure 2-2
3.                  admin sources of the tax law
(a)                treasury dept regs® considerable authority as official interpretation of tax statutes
(i)                 arranged in the same sequence as the Code
(b)               revenue rulings® official pronouncements of the Natl Office of the IRS
(i)                 give examples on how the IRS wld apply a law to specific fact situations
(ii)               interpret the tax law, but do not carry the same legal force and effect as regs and usu. deal w/ more restricted problems
(iii)             often result from a specific taxpayer’s request for a letter ruling
(c)                revenue procedures® deal w/ the internal mgmt practices and procedures of the IRS
(d)               letter rulings® issued for a fee upon a taxpayer’s request and describe how the IRS will treat a proposed transaction for tax purposes
(i)                 only apply to the taxpayer who asks for and obtains the ruling, but can offer guidance
(e)                treasury decisions (TDs) ® issued by the Treasury Dept to promulgate new regs, amend or otherwise change existing regs, or announce the position of the Govt on selected ct decisions
(f)                determination letters® issued at the request of taxpayers and provide guidance on the application of the tax law
(i)                 usu. involve completed, as opp. to proposed, transactions
(ii)               not published and only made known to the party making the request
4.                  hierarchy of laws
(a)                Code
(b)               US Supr Ct decisions
(c)                Regulations from Dept of Treasury
(i)                 legislative ® when Congress wants it to be part of law (almost as binding as Code itself)
(ii)               interpretative ® when Congress says how they want to interpret it (this interpretation trumps individual interpretation)
(iii)             procedural ® Congress just tells you how to do it
(iv)             proposed (not really the law – just tell you what the law will be)
(v)               temporary (the law)
(d)               Ct of Appeals
(e)                Trial Ct (must go to a fed ct about any fed tax issue – it will be thrown out from a state ct)
(i)                 US Tax Court (only 1 ct)
(1)               regular decisions (published by the official rptr)
(2)               memo (published by private rptrs, but still as binding)
(3)               Small Cases Division → S case (≤$50,000) – like binding arbitration (no way to appeal)
(4)               officially based in Wash, DC, but judges travel to different parts of the country and hear cases at predetermined locations and dates
(ii)               US Dist Ct
(1)               can only handle refund litigation
(2)               appeal to the corresponding Cir. Ct
(3)               go to private svcs to find these decisions
(iii)             Ct of Federal Claims (Wash, DC) (only 1 ct)(refund only)
(1)               commercial disputes – expensive b/c you must go to Wash, DC
(2)               most favorable forum for issues having an equitable or pro-business orientation as opp. to purely technical issues and those requiring extensive discovery
(3)               worth of going there held in your favor in a prior decision
(4)               appeal to the fed ct of app in your Cir.
(5)               go to private svcs to find these decisions
(f)                IRS (last source of law – although your opponent, can help you)
(i)                 revenue ruling (all IRS agents have to follow this)
(ii)               announcement
(iii)             notice
(iv)             PLR’s and TAM’s
(1)               PLR’s are issued for a fee
i.        almost bullet-proof – they will leave your alone if you have a PLR
ii.      but your relatives can’t use it
(2)               TAM (technical advice memorandum) – IRS agent in the field says to the natl office that some matter is extremely hard and wants advice
i.        smtms the lawyer for the taxpayer asks for advice
5.                  tax avoidance vs. tax evasion (= legal tax planing vs. illegal tax planning)
(a)                tax avoidance = tax minimization through legal techniques
(b)               tax evasion = eliminating and reducing taxes through the use of subterfuge and fraud
 
IV.       tax structure
1.                  tax base = amt to which the tax rate is applied
(a)                in Fed income tax, tax base = taxable income
2.                  tax rates = applied to the tax base to determine a taxpayer’s liability
(a)                tax is proportional if the rate remains constant for any given income level
(b)               tax is progressive if a higher rate applies as the tax base increases
(i)                 Fed income tax
(ii)               Fed gift and estate taxes
(iii)             most state income tax rate structures
 
V.        income tax
 
Formula for Federal Income Tax on Individuals
Income (broadly conceived)
$xx,xxx
Less: Exclusions (income that is not subject to tax)
 (x,xxx)
Gross income (income that is subject to tax)
$xx,xxx
Less: Certain business deductions (usu. referred to as deductions for adjusted gross income)
 
 (x,xxx)
Adjusted gross income
$xx,xxx
Less: The greater of certain personal and employee deductions (usu. referred to as itemized deductions)
-OR-
The standard deduction (including any additional standard deduction)
 
 
 
 (x,xxx)
Less: Personal and dependency exemptions
 (x,xxx)
Taxable income
$xx,xxx
Tax on taxable income (apply tax rate schedules)
$ x,xxx
Less: Tax credits (including Federal income tax withheld and other prepayments of Federal income taxes)
 
 (xxx)
Tax due (or refund)
$ xxx
 
1.                  income (broadly conceived) = all of taxpayer’s income, both taxable and nontaxable, essentially equivalent to gross receipts
(a)                does not include
(i)                 return of capital or
(ii)               receipt of borrowed funds
2.                  exclusions® accident ins. proceeds, annuities (cost element), bequests, child support, cost-of-living allowance (for military), dmgs for personal injury or sickness, gifts received, group term life ins., premium paid by employer (for coverage up to $50,000), inheritances, interest from state and local (i.e., municipal) bonds, life ins. paid on death, meals and lodging (if furnished for employer’s convenience), military allowances, minister’s dwelling rental value allowance, RR retirement benefits ( to a ltd. extent), scholarship grants (to a ltd. extent), SS benefits (to a ltd. extent), veteran’s benefits (to a ltd. extent), welfare pmts, workers’ comp benefits
3.                  gross income § 61 ® alimony, annuities (income element), awards, back pay, bargain purchase from employer, bonuses, breach of K dmgs, business income, clergy fees, commissions, compensation for svcs, death benefits, debts forgiven, director’s fees, dividends, embezzled funds, employee awards (in certain cases), employee benefits (except certain fringe benefits), estate and trust income, fees, gains from illegal activities, gains from sale of ppty, gambling winnings, group term life ins., premium paid by employer (for coverage over $50,000), hobby income, interest, jury duty fees, living quarters, meals (unless furnished for employer’s convenience), mileage allowance, military pay (unless combat pay), notary fees, partnership income, pensions, prizes, professional fees, punitive dmgs, rents, rewards, royalties, salaries, severance pay, strike and lockout benefits, supplemental unemployment benefits, tips and gratuities, travel allowance (in certain cases), wages
4.                  deductions for AGI (trade or business expenses) ® ordinary and necessary expenses incurred in a trade or business, ½ of self-employment tax paid, alimony paid, certain pmts to IRA and Health Savings Acct, moving expenses, forfeited interest penalty for premature withdrawal of time deposits, the capital loss deduction, etc.
(a)                trade or business deductions
(b)               expenses and losses incurred in connection w/ a transaction entered into for profit and attributable to rents and royalties
5.                  deductions from AGI ® taxpayers are allowed to deduct the greater of itemized deductions or the std deduction
(a)                AGI is an important subtotal that serves as the basis for computing percentage limitations on certain itemized deductions, such as medical expenses, charitable contributions, and certain casualty losses
(b)               itemized deductions
(i)                 specified personal expenses, including medical expenses, certain taxes and interest, and charitable contributions
(ii)               non-business expenses
(1)               expenses related to the production or collection of income
(2)               expenses related to the mgmt of ppty held for the production of income
(3)               deductible losses on personal use ppty
(iii)             include, but are not ltd. to, medical expenses in excess of 7.5% AGI, state and local income taxes, real estate taxes, personal ppty taxes, interest on home mortgage, investment interest (to a ltd. extent), charitable contributions (w/in specified percentage limitations), casualty and theft losses in excess of 10% of AGI, misc. expenses (to the extent such expenses exceed 2% of AGI) ® union dues, professional dues and subscriptions, certain educational expenses, tax return preparation fee, investment counsel fees, unreimbursed employee business expenses (after a percentage reduction for meals and entertainment)
(c)                standard deductions = specified amt that depends on the filing status of the taxpayer
(i)                 2 components
(1)               basic std deduction
(2)               additional std deduction ® for taxpayers who are 65 or older and/or blind (if you are both older than 65 and blind, you qualify for 2 addl std deductions)
(ii)               some taxpayers are entitled to a full std deduction, some are not allowed to claim any std deduction, and the std deduction is ltd. for others
(iii)             individuals not eligible for the std deduction (=> must itemize)
(1)               married taxpayers filing separate where either spouse itemizes deductions
(2)               a nonresident alien
(3)               an individual filing a return for a period of less than 12 mos b/c of a change in the annual accounting period
(iv)             limitations for individuals who can be claimed as dependents
(1)