Personal Income Tax
Hamill
Fall 2012
I. Introduction to the Federal Tax System
a. Overview of the Course and Some Historical Perspectives
i. What is a tax?
1. Compulsory payment imposed on citizens to meet public needs
2. Has to be compulsory b/c nobody would pay on their own
3. Suffer penalties for failure to pay
a. Tax evasion- not paying taxes legally owed; criminal penalty
ii. 3 big issues in tax
1. Level of revenues
a. How much tax to raise and for what
2. Accountability issue
a. Revenue raised must be spent wisely and in manner decided in Step 1 (“level of revenues”)
b. A tax dollar earned should be spent on something with more than a dollar in value, or you have accountability waste.
3. Burden for paying taxes
a. Base*rate (huge ethical issue)
b. Most time spent on determining base b/c if base is miniscule, then tax rate does not matter (ex. Mitt Romney has huge base)
iii. History of Taxation
1. Articles of Confederation collapsed b/c it had NO taxing power; states never volunteered payment under that system
2. Tax at the heart of new constitution in 1789; strong central taxing power created
3. Ratification of 16th Amendment in 1913 was huge turning point
a. Commerce Clause important for business and tax
b. People try to argue tax unconstitutional b/c of DP or taking but almost always fail
c. Federal (constitutional) tax challenges almost non-existent; state challenges under CC more frequent (trying to shift money outside state borders)
b. The Legal System Applicable to Federal Tax Law
i. Issues:
1. How do we get tax? Why are we legally compelled to file a return?
2. What system do we have? What are tax laws?
3. What should we have? (policy)
ii. Issue 1: How do we get tax? Why are we legally compelled to file a return?
1. IRC passed by Congress, making taxation a fed law area
a. 1939→1954→1986
b. Tax laws change each year, but revision years mean big changes
2. All tax legislation MUST start in the House (look up process in tax research binder)
a. Legislative body that is closest to the people b/c turnover every 2 years if constituents do not like decisions
b. Within the House, tax legislation starts with Ways and Means Committee
3. Regulations (TR binder)
a. Treasury Dept.’s elaborations on what Code says; broad power to issue
b. Must go through administrative process with notice-and-comment period
c. As long as Regs do not conflict with what statute says, then valid
4. Private Letter Rulings (PLRs) (TR binder)
a. A t/p contemplating a particular transaction sends a letter to the IRS with details of a tax issue
b. Want IRS to tell them in advance whether or not it agrees with characterization of the tax issue
c. T/p charged a fee for IRS to deal with PLR
d. Not binding (no force of law) on anyone except for t/p who got PLR; t/p has to disclose everything about PLR on return with that particular transaction
e. Purpose of using PLRs in practice: gives good idea of IRS’s mood on a particular tax issue
5. Self-reporting system
a. T/p’s responsibility to accurately report what is legally required and pay what is legally owed
i. Report income, deductions, credits, w/h, etc. on own
b. Getting refund is exactly like giving interest free loan to govt.
c. Audits
i. IRS field person goes through records to determine if returns are legally accurate
ii. Point where there might be disagreement b/n IRS field person and t/p
iii. Deficiency letter sent when IRS thinks return is wrong, more payment needed
1. If t/p does NOT have a reporting position, t/p has committed tax evasion
2. If t/p DOES have a reporting position, then in area of tax controversy
d. Tax controversy
i. If t/p does NOT want to pay tax, go to Tax Court in DC
1. If t/p loses, then have to pay for interest over the time delayed; do not get penalties though
ii. If t/p wants to pay and then fight for a refund, go to U.S. Court of Federal Claims or U.S. District Court
iii. Loser normally appeals
1. Tax Court and District Court → U.S. Court of Appeals for circuit where t/p resides
2. Court of Federal Claims → U.S. Court of Appeals for the Federal Circuit
iii. Issue 2: What do we have? What are tax laws?
1. Have to start with gross income
2. Taxable income = gross income-allowable deductions
3. Policy behind deductions:
a. Business deductions must be allowed, or you would not have an income tax
b. Personal deductions should not be allowed (interest on home mortgage and charitable contributions allowed for policy reasons)
c. Cannot easily categorize b/n the 2
iv. Issue 3: What should we have? (policy at end of units)
c. Time Value of Money overview
i. Timing of receipt influences value; payment today worth more than payment later; losing value b/c of length of time and lost investment income
ii. IRS
1. Wants to collect as much tax as possible as soon as possible
2. Wants gross income to show up in taxable year as early as possible b/c results in tax payment as early as possible (gives govt. time value of money advantage)
3. Wants to disallow deductions or to delay them to latest possible year (economic advantage of deduction then becomes miniscule)
iii. T/p
1. Wants to pay as little tax as possible (not illegal to minimize payment)
2. Either does not want gross income at all, wants to exclude what it has, or wants to delay it
3. Delay of gross income to later period means delay of tax payment; want to accelerate deductions to decrease gross income
II. Defining Gross Income
A. The Outer Limits of Gross Income
§ 61. Gross income defined
(a) General definition.–Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;
(2) Gross income derived from business;
(3) Gains derived from dealings in property;
(4) Interest;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Alimony and separate maintenance payments;
(9) Annuities;
(10) Income from life insurance and endowment contracts;
(11) Pensions;
(12) Income from discharge of indebtedness;
(13) Distributive share of partnership gross income;
(14) Income in respect of a decedent; and
(15) Income from an interest
makes sense; no intellectually consistent difference b/n gifts and treasure trove
– Reasons for §102:
o 1) Lack of any serious move for repealing it
o 2) Political inertia (seems to be part of natural order of things)
o 3) Political resistance by those who benefit by its persistence
o 4) Enactment of the federal wealth transfer taxes, whether or not the wealth has been “subject to” the income tax in the hands of the transferor
§ Not good argument though b/c wealth transfer taxes only reach small portion of gratuitous transfers since it only kicks in at certain amount of wealth
§ Gift tax is like back-up to estate tax; do not want large estates to avoid estate tax by giving away items as gifts without taxation
– Double taxation issue (drawing on p. 333)
o Sympathetic argument – most gifts are within families; seems unfair to tax on parent’s income and then tax income to recipient of gift (usually children)
o Inconsistency with §102 though
§ Children do not have to pay tax on tuition, but housekeeper has to pay tax on after-tax dollars received from homeowner
§ Both seem to be providing service/work to earn money (study, cleaning)
§ Both meet realization; do not have to have hands on money for realization to occur
· As if children had cash in hand and paid college
· As if housekeeper had cash in hand and paid power bill
o Rule to explain double taxation: “Thou shalt only tax income once to the same t/p.”
§ T/p’s within the same family are considered the same t/p
§ How tuition and housekeeper situations are differentiated
How to qualify for a gift exclusion:
– Commissioner v. Duberstein http://www.casebriefs.com/blog/law/income-tax/income-tax-keyed-to-freeland/the-exclusion-of-gifts-and-inheritances/commissioner-v-duberstein/
o USSC came up with standard of “detached and disinterested generosity,” “out of affection, respect, admiration, charity or like impulses”; critical consideration is transferor’s “intention”
o Duberstein
§ Received a Cadillac from another business man after giving info about potential customers; Duberstein did not include in gross income and giver deducted as business expense
§ Men worked for different companies so did not have employment relationship (arm’s length)
§ PH: TC held that transfer was not a gift and should be included in gross income; 6th Circuit reversed and said it was a gift that should not be included in gross income
§ Holding: USSC agreed with TC that car was NOT a gift and should be included in gross income b/c it was given with the intention to increase business
o Stanton v. U.S.
§ Stanton worked for church and then retired; was given $20K as retirement present
§ Stanton had stopped working so did not earn money
§ PH: DC held that money was a gift and should not be included in gross income; 2nd Circuit held that money was NOT a gift and should be included
§ Holding: not enough facts for USSC to make a decision, remanded with new “detached and disinterested generosity” standard; Stanton won on remand (seen as a gift not included in gross income)
§ §102(c) passed later though to cover employer-employee relationship
· When under employment umbrella, cannot argue for a gift; either included as gross income or excluded as fringe benefit
