Federal Income Tax Outline

FEDERAL INCOME TAX OUTLINE
Professor McCormick
Fall 2011
 
Part I: Characteristics of Income
 
I.       WHAT IS INCOME?
a.      3 Considerations in Income Tax Law:
                                                              i.      Fairness (favors deductions)
1.      Prevent the “no fair” result
2.      Horizontal equity:
a.       Similarly situated TPs should be treated the same
b.      Reflects ability to pay
3.      Head Tax: each citizen pays same dollar amount à regressive
4.      Regressive Tax: tax of poorer individuals represents greater percentage of their income than that of richer individuals à sales taxes
5.      Flat tax: each individual pays tax equal to same percentage of their income
6.      Effective tax rate: average rate (total tax/total income)
7.      Marginal rate: rate at which your next dollar of income will be taxed à way to quantify the costs and benefits to the taxpayer and to the govt when we change the income tax base
8.      Upside down subsidies: deductions & exclusions provide great benefit to those at the higher tax rate than the lower
                                                            ii.      Efficiency (favors deductions)
1.      Tax systems should not (unintentionally) distort investment decisions
                                                          iii.      Practicality/administrative feasibility (disfavors deductions)
1.      Cost of compliance;
a.       Cost of figuring out what in the world the tax law means
2.      Cost of enforcement;
a.       Cost of chasing after people
b.      Auditing
c.       Cost of Collection
d.      Cost of Jail
e.       Cost of Litigating cases
b.      Practical Rules about Taxing Income
                                                              i.      We tax income per tables in § 1 of code
                                                            ii.      We tax capital assets at a rate of 15%
1.      § 1221 – Defines Capital Asset – property held by TP whether or not connected with trade/business
2.      However, if a capital asset is held less than one year (> 1 year) it is taxed at normal rates per § 1
 
 
 
 
 
 
II.    WAYS TO DEFINE INCOME
a.      Eisner v. Macomber (1920): Income = the gain derived from capital, labor, or from both combined à based on SOURCE
                                                              i.      Capital – interest from investments
1.      Lottery winnings would not be considered “income” under this definition because it’s not likely that playing the lottery is considered an “investment”
                                                            ii.      Labor – salary, etc.
                                                          iii.      This case defines income being based on how it is earned
                                                          iv.      This case has been overruled
                                                            v.      Creates problems w/equity & fairness à some people not taxed on windfalls
b.      Haig-Simmons: Personal income is the sum of…
                                                              i.      the market value of rights exercised in consumption (that is, if you earn money and immediately spend it, that money counts as money); AND
                                                            ii.      the change in the value of the store of property rights between the beginning and the end of the period in question (aka, accumulated savings)
1.      EX: This year I earned $100K at Davis. My house appreciated $100K. What is my income under Haig Simmons? The $100K in salary and the $100K in increased value 
2.      Problem: “Liquidity:” The $100K in increased home appreciation may not actually be realized money – you might not have the liquid case to pay the taxes
3.      Applies to capitalization of business expenses
c.       Section 61 (CURRENT): Gross income = income from whatever source derived (very broad)
                                                              i.      Elaboration in Glenshaw Glass (3-prong test):
1.      accession of wealth à does it make you richer?
2.      clearly realized à timing – when we are going to make you recognize income
3.      upon which the TP has complete dominion à if there is still a chance that this will be taken away from you, we won’t tax you yet
III.  
IV. NON-CASH BENEFITS
a.      Should non-cash Benefits be taxed?
                                                              i.      Fairness Argument:
1.      Yes, because there would be a huge unfairness if you were not taxed on the benefit received.  A similarly situated person who was receiving cash – it would be unfair to them
                                                            ii.      Efficiency Arguments
1.      It would skew the market. Everyone would gravitate towards the jobs that paid in non-cash benefits. Feds would needlessly lose money on those people receiving non-cash benefits.
2.      It would encourage employers to give employees non-cash items worth less than their salary because the employee would still come out ahead.
a.       EX: Would an employee want $400 cash or a $100 yoga lessons?
                                                                                                                                      i.      If you are in a 30% tax bracket, save $30 in taxes
                                                                                                                                    ii.      Government loses $30 in taxes
b.      EX: employee receives $100 in yoga lessons that are only worth $90 to them à is it fair to tax them for $100?
                                                                                                                                      i.      Deadweight loss: employer spends certain amount that is worth less to recipient
                                                                                                                                    ii.      Counter-argument: employee can sell the yoga lessons for FMV
                                                          iii.      Regulation § 1.61-1(a) – Gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services
                                                          iv.      Reg. 1.61-2(d)(1)): If you do receive a non-cash benefit it is taxed at the FMV (no matter what it’s supposidly “worth” is to you)
1.      Treasury the designated authority to explain what the Code means
2.      These “Regulation” sections are binding but less important
b.      General Rule (EMPLOYEE): Non-cash benefits are taxed at FMV, unless they are specifically excluded under § 119 and § 132.
c.       General Rule (EMPLOYER): Non-cash benefits are allowed to be deducted by the employer
d.      Two Types of Non-Cash Benefits
                                                              i.      For the convenience of the employer
                                                            ii.      Fringe benefits
e.       For the Convenience of the Employer
                                                              i.      If you are compensated by non-cash benefits for the convenience of your employer à NOT INCOME
                                                            ii.      Convenience of the Employer Rule: benefits may not be considered compensation when they are primarily for the benefit/convenience of the employer and convenience enjoyed by the employee is incidental.
1.      Benaglia v. Commissioner: Benaglia worked at a hotel chain in Honolulu. He was living in a suite and received meals from the hotel, but did not report this as income on his tax return.
a.       Issue: Is the room and board considered income?
b.      Holding: Benaglia is not taxed on the room and board. It is NOT considered income, because he had no choice to live in the hotel. He is being “forced” by his employer.  We know that he was living there “for convenience of the employer” because it was absolutely necessary for his job.
                                                          iii.      Section 119: Meals and Lodging Non-Cash Benefits. (Rule that codifies Benaglia)
1.      a) Meals and lodging furnished to employee, his spouse, and his dependents, pursuant to employment
2.      There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employer for the convenience of the employer, but only if
a.       in the case of meals, the meals are furnished on the business premises of the employer, or
b.      in the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment
3.      How to take Advantage of § 119:
a.       EX: Farmer Grant owns a farm. He’d like to pay lower taxes. He can deduct his personal expenses by incorporating a farm (so he is a business), hiring himself as an employee, and stipulating that he must live in the house in order to keep the farm running. Therefore, under § 119 he can deduct all meals and FMV of lodging because they are (1) meals are furnished on the business premises (the farm), and (2) the farmer must accept the lodging as a condition of his employment (or so he will say).
4.      Kowalski: SCOTUS determined tha