Gamage Spring 2015 Outline
Seven Major Questions of Basic Tax
1. What is included in income?
a. Difficult line drawing; stuff of value provided by employers to employees other than cash wages (meals and lodging) – we can’t allow employees to escape taxes on non cash, but we also can’t tax everything of value, would be unadministrable. Also valuable stuff taxpayers receive from sources other than employers: windfalls, prizes, gifts, legal damages. Tax law includes some of these in income, some of the time. Fringe benefits more generally – statutory.
2. When do receipts, gains, and losses affect income?
a. Timing issues – deferral is valuable, sophisticated tax planning is based on delaying taxable income rather than avoiding tax all together. Capital gains won’t be taxed until sold – so if a transaction would trigger the tax gain on assets, clients won’t want to engage in it.
3. How to treat loans and borrowing?
a. Due to combo of timing and borrowing rules, capital income ends up largely escaping tax. Techniques wealthy taxpayers use to largely circumvent taxation of capital income, why these don’t work for labor (such that income tax is arguably a labor tax). What do taxpayers do when they need money from their capital gains? Answer is borrow against these assets. For corporate taxpayers, gain assets are often never sold. Individual taxpayers: buy borrow die strategy.
4. What deductions, exclusions, and credits can reduce taxable income?
a. Various ways in which the tax law allows taxpayers to reduce their taxable income. Overlap with 1st question, but focus here is on actions that taxpayers can take, tax benefits provided by congress. Consider whether deductions are allowed for business entertainment expenses, childcare expenses, home-office expenses. Also non-profit organizations, charitable contribution deduction, variety of other deductions + credits. Also intersection of taxation and antipoverty and social welfare policy. Fax forms as a way of showing how rules fit together.
5. When do expenses reduce taxable income?
a. Timing issue again but this time w/r/t expenses that create tax benefit. So when do expenses reduce taxable income? Tax shelters, rules designed to prevent tax shelters.
6. What is the character of gains and losses?
a. Capital vs. ordinary gains and losses. How do the capital gains and loss rules work? Less important than it used to be (less of a difference between ordinary income and capital gains rates)
7. Who is the taxpayer?
a. Taxation of the family unit (joint filing, divorce, alimony).
*Know that the top bracket rate has declined dramatically over time (today its 39.6%); while long term capital gains rate remained more steady, applies to selling property and investments that have gone up in value – such as stocks (today its 20%)
Calculating Taxable Income/Individual Tax Liabilities
Gross Income à Adjusted Gross Income |
à Personal exemption à Standard or Itemized deductions à Taxable Income à Tax credits
· Above the line:
o Gross income: Computing tax base – Gross income is the total of an individual’s various sources of income. Includes net wages, interest, dividends, rental income, etc. So business losses and some expenses incurred for the production of income are subtracted from earnings. Gross income does not include various exclusions: e.g. untaxed fringe benefits, psychic income, gifts.
o Adjusted gross income (AGI): An individual’s gross income minus certain deductions, e.g., qualifying trade and business expenses and losses get deducted before calculating AGI. This is because the income tax is supposed to be a tax only on net business income. Consist primarily of retirement account contributions. Other above the line deductions include: Alimony payments (§215); Moving expenses (§217); Interest on student loans (§221); Higher education expenses (§222); Health savings accounts (§223). Others specified in IRC Sec 62.
· Below the line:
o Personal exemptions: a flat amount a taxpayer is allowed to subtract from her AGI for each dependent family member in the taxable unit/household, as well as for herself and her spouse (e.g. $3,950). Exemptions thus provide an amount per person in the family on which no tax is owed.
o Deductions:
§ Taxpayers can elect to take standard deduction (e.g. $6,200- 2/3s of people choose this) or
§ Itemize, where taxpayer deducts the total amount of money spent on various qualifying expenses. Usually high income taxpayers choose to itemize. Many important deductions are itemized (e.g. charitable contribution deduction, home mortgage interest deduction, deduction for state and local taxes)
o Taxable income: once we arrive at taxable income, multiply by appropriate tax rates to arrive at tax liability before credits.
o Tax credits: finally subtract tax credits to determine tax liability – the amount to be paid in taxes. Most important for individuals is the earned income tax credit. Also child tax credit, education tax credit.
Major Sources of Authority in Tax
(sources listed in rough order of priority)
· The Constitution
o Most authoritative source of authority when relevant. Interpreted by the Supreme Court
o However, since Glenshaw Glass (U.S. 1955), Congress has almost unlimited powers to define “income.” Hence, the Constitution is usually not important for tax law in practice. Constitution is usually only relevant when the tax law intersects with another constitutional right, e.g. 1st amendment.
§ However, in state and local tax area, the commerce clause restricts what the states are allowed to tax, so constitutional challenges to local tax statutes are not uncommon.
· The Tax Code
o Internal Revenue Code, Title 26 of U.S.C.
o Highest embodiment of tax law as passed by Congress.
o We focus on Subtitle A, Chapter 1.
§ Then by Subchapter à Part à Section à Subsection à Paragraph à Subparagraph à Clause
§ Note that you will sometimes hear corporations described as “Subchapter C” entities, and partnerships described as “subchapter K” entities.
· Treasury Regulations
o Congress has given the Treasury broad powers to interpret the tax law and to pass regulations (IRC Sec. 7805(a)).
o In Mayo Foundation v. United States (2011), Supreme Court held that Chevron deference applies to all types of Treasury Regulations, eliminating the distinction that some authorities had previously held between “legislative” (passed based on specific statutory authority) and “interpretive” regulations (passed based on general authority). No longer very important.
o Note that IRS plays a major role in writing Treasury Regulations
o Congress sometimes grants Treasury specific authority to interpret specific portions of Code provisions.
· Judicial Opinions
o Three judicial forums that hear federal tax disputes
§ 1) Federal District Courts
§ 2) The Tax Court
§ 3) Court of Federal Claims
o Taxpayers can file suit in a federal District Court or in the Court of Federal Claims by paying their assessed tax liabilities and then suing for a refund.
o Taxpayers can file suit in the Tax Court in order to challenge their assessed tax liabilities before paying them.
o Note that the IRS can and often does choose to ignore trial court rulings it does not like until and unless the rulings are affirmed by either the circuit court where taxpayer resides or Supreme Court. IRS has chosen to voluntarily be bound by circuit court decisions. Must abide by Supreme Court.
o The Tax Court
§ Known as the Board of Tax Appeals prior to 1942.
§ Composed of 19 judges appointed by the President.
§ Judges are all based in DC, but they ride circuit to various locations for trials and proceedings
§ Typically, only one judge presides over any case, with the judges each having their own jurisdictions.
§ There are no juries.
§ The presiding judge issues an opinion to the Chief Judge for consideration. The Chief Judge will either let the opinion stand or refer it to the full court for review. If a case has been reviewed, there may be a dissent in addition to a majority opinion.
§ Appeals go to the Circuit Court with jurisdiction over the matter, and then to the Supreme Court.
o Court of Federal Claims
§ Sits in DC, but – like the Tax Court – holds proceedings throughout the county.
§ Appeals go to the Court of Appeals for the Federal Circuit and then to the Supreme Court.
· IRS Rulings
o The IRS is part of the Treasury, but does not report to the Assistant Secretary for Tax Policy (the top tax official in main Treasury).
o It issues Revenue Rulings through a formal process; these have significant persuasive authority (although not binding on the courts).
o Revenue rulings are interpretative and apply retroactively.
o The IRS also issues acquiescence’s and nonacquiesence’s to opinions of the Tax Court. These state whether the IRS agrees to be bound by the ruling or whether the IRS plans to continue to litigate, respectively.
o Private Letters Rulings (PLRs)
§ IRS issues PLRs which are answers to taxpayer questions.
· PLRs are not binding on either the IRS (except with respect to the taxpayer the PLR is issued for) or to the courts.
· Nevertheless, courts frequently cite to them as persuasive authority.
· Also, Taxpayers often rely on PLRs to give them an idea of what the IRS is likely to do, and courts will look to PLRs for guidance on related issues, but PLRs are not binding on either the IRS or the courts (except with respect to the taxpayer the PLR is issued for).
§ Taxpayers pay a fee for PLRS, but the IRS is not obligated to issue a P
dging to them is a real benefit, but their benefit is arguably incidental to purpose of housesitting. Compare with air-b-n-b vs. employee staying in employer’s vacation house for free.
b. Note that “convenience of the employer” test in Benaglia is a variation on the notion of incidental income.
iv. General observations on what is income
1. It often matters how easy it is to quantify the value provided to the taxpayer.
a. Cash received is easy à likely to be considered income.
b. But note that the ease of quantifying value must be compared to the amount of the value. If hard but worth a lot, we may still try to value.
2. It often matters what the motives of the party providing the value are.
a. If the motives are to compensate the taxpayer for the sale of market property or services, then it is more likely that the benefit will be considered “income” to the employer. Conversely, if the motives are something other than paying the taxpayer for market services or property, then it is less likely that the benefit will be considered “income”
b. The more exchange-like/barter-like/market-like a provision of value is, the more likely it will be taxable. Often suggested that market-exchanges are the core of the income tax.
b. Employer Provided Meals and Lodging: The “Convenience of the Employer” Doctrine
i. Before Section 119, there was a regulation that excluded from tax “living quarters such as camps [that] are furnished to the employee for the convenience of the employer.”
1. Benaglia v. Commissioner (Board of Tax Appeals, 1937): Are meals and lodging considered income? Facts: petitioners Husband and Wife live in Honolulu, filed joint income tax returns ’33 and ’34. Husband manages hotels owned by Hawaiian hotels. Supposedly for convenience and performance of duties, he occupied a suite of rooms in hotel and received meals. His salary varied, but neither he nor his employer regarded the meals and lodging as part of his compensation. PP: Tax commissioner added $7,845 to P’s gross income each year as compensation received from Hawaiian hotels to account for room and board. Deficiency notice seems to hold rooms were not for mere convenience. Holding: Court rules hotel employee’s meals and lodging were for convenience of employer and thus should be excluded from taxable income. “From the evidence, there remains no room for doubt that the petitioner’s residence at the hotel was not by way of compensation for his services, not for his personal convenience, comfort or pleasure, but solely because he could not otherwise perform the services required of him.” His continuous and required presence was necessary. Other precedents – Jones v. United States: lodging received by Army officer was not taxable income. Tennant v. Smith: English case, lodging for overnight bank guard was not taxable income. Dissent: Facts that cast doubt on applicability of doctrine here: (1) P was in charge of multiple hotels, wouldn’t he be required to live at all of them then? (2) P was absent for a third of the year. (3) It’s a private contract. Judge cites his letter accepting employment with term of room and meals, letter “clearly shows that the living quarters, meals, etc., … were understood to be compensation in addition to the cash salary.” He was careful to specify it. (4) Just because he was required to live there does not mean he did not benefit from the requirement; “what the tax law is concerned with is whether or not petitioner was financially benefited by having living quarters furnished to himself and wife”
2. Differences between Benaglia and Jones, Tennant:
a. Benaglia’s accommodations are likely much better than Army barracks or bank guard sleeping quarters.
b. Benaglia is in a much better position to negotiate for a customized compensation package than an army officer or a bank guard.
3. Remember, it matters both how (1) valuable the thing is and the (2) motive for why it was given.
