I. General Notes on Federal Income Tax
A. Basic Material
1. The tax law is built around ability to pay
2. Hierarchy of tax law
a) The Constitution/16th amendment
b) Internal Revenue Code
(1) Passed by Congress – the IRS only has authority to the extent they can reasonably interpret the statute
c) Treasury Regulations
(1) Again, the IRS only has authority to the extent they can reasonably interpret the regulation
d) IRS Revenue Rulings/Revenue Proceedings
(1) These are less binding than the previous examples – according to Evans, these are challenged fairly frequently and the odds of success are often reasonably good. (On the other hand, it takes brass cojones to challenge treasury regs, and even more to challenge the IRC)
e) IRS Private Letter Rulings
3. Also note a taxpayer can pay tax on either the calendar or fiscal year.
B. The Basic Tax Formula
1. Personal
a) Gross Income
b) – “Above the Line” deductions
c) Adjusted Gross Income (AGI)
d) – “Below the Line” deductions
e) Taxable Income
f) x Tax Rate
g) Tentative Tax Owed
h) – Tax Credits
i) Final Tax Due
2. Corporate – essentially the same, but without parts c) and d)
C. Tax Terminology
1. Income (see also infra)
a) Taxable Income – derived from gross income
b) Gross Income – defined in §61; “all income from whatever source derived.”
(1) Any realized accretions to wealth is income
(2) Therefore, income need not be cash; income in-kind is also taxable.
2. Deductions – reduce taxable income and thus provide a tax benefit; the amount of benefit increases as the taxpayer’s marginal rate increases.
a) “Above the Line” – Deductions taken prior to computing AGI; always beneficial.
b) “Below the Line” – Deductions taken after computing AGI; may be beneficial depending on floors, phase-outs, etc. based on AGI.
3. Tax Credit – a dollar-for-dollar reduction in tax. Far more beneficial than a deduction.
4. Fair Market Value (FMV) – the price paid between a wil
y).
(1) horizontal equity (people in same situation pay same tax)
(2) vertical equity (progressivity)
d) Thus, a comparison of FIT, a VAT, and poll or head tax looks like figure 1 (see end of document)
3. Progressive Taxation vs. Non-progressive taxation
a) Pro:
(1) Ability to pay (marginal utility of money declines)
(2) Encourages work via income effect
(3) Much wealth is from heredity, genetics, or luck
b) Con:
(1) Problem of interpersonal comparisons of utility (e.g., penny-pinching law firm partner)
(2) Discourages work via substitution effect (e.g., substitute leisure for work)
(3) Reduces property rights
4. Additional policy notes
Sales taxes are regressive because they tax consumers and don’t tax savers, and low-income people tend to be consumers while upper-income people tend to be savers.
