Select Page

Federal Income Tax
University of Iowa School of Law
Ward, Larry D.

Basic Federal Income Taxation: Ward: Fall 2006
Chapter 1: Introduction
I.        The Constitution and the Income Tax
A.     Art I, § 8 allows C to law and collect taxes, duties, imposts, and excises and is limited in 3 ways:
1.      “Direct” taxes must be apportioned among the states
2.      Bills for “raising revenue” must originate in House of Reps
3.      Taxes must be “uniform throughout the US
B.     Apportionment of Direct taxes
1.      Art I, §2: Representatives and direct Taxes shall be apportioned among the several States…according to their respective Numbers…
2.      Art I, §9: No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.
3.      Apportionment requirement was limited to “direct” taxes, so as not to apply to “indirect taxes on exports and imports, and on consumption”
4.      Distinction between direct and indirect dpends on the form of the tax
5.      16th Amendment (1913): Gives Congress the power to lay and to collect taxes on incomes without apportionment among the several States, and without regard to any census or enumeration.
C.     The Origination Clause
1.      Art I, § 7: Bills for raising Revenue shall originate in the House of Reps
2.      This has become a formality – if the Senate wants to launch a major tax leg, it has only to approve “amendments” to one of the House bills, deleting whatever it finds desireable
D.     The Uniformity Clause
1.      Art. I, §8: Requires that taxes be “uniform throughout the United States”
2.      This requirement
a)      Does not prohibit a progressive tax or a tax that distinguishes between different sources of income.
b)      Requires that taxes be “geographically uniform” in the sense that “whatever plan or method Congress adopts for laying the tax in question, the same plan and the same method must be operative throughout the United States.”
II.     Basics of the tax system
A.     Federal Income Tax
1.      Accounts for 65% of Federal revenue
a)      56%—Personal Income Taxes
b)      9%—Corporate Income Taxes
2.      Main function is the raise revenue
3.      Revenue Act of 1913 imposed progressive tax on individual incomes
4.      Much of today’s tax law is found in regulations promulgated by the Treas department
a)      Regulations are either “legislative” or “interpretive”
B.     Taxes aren’t simply enacted to bring dollars into the treasury, but also to absorb purchasing power from individuals so that inflation won’t rise rapidly
1.      It reduces the effectiveness of people and companies that compete w/ gov resoures
2.      We would have too many dollars chasing a limited amount of goods, so we would have inflation if we didn’t have taxes
3.      Gov is pulling purchasing power out of econ so that we’re less effective competitors for the goods and services we and gov wants
C.     Non-revenue raising purposes of taxes
1.      Taxes promote certain transactions: Charitable donation tax benefits (lead to good educational systems in the United States)
2.      Redistribution of Wealth
3.      Stabilize/Stimulate economic growth
4.      Provides educational aid
D.     Goals of the Tax System
1.      Fair & Equitable
2.      Won’t impede productivity/incentive to work
3.      Simple & non-exploitable
E.      $115-$125 billion/year to comply with tax laws
1.      includes: lawyers, tax prep., record-keeping, admin & enforcement
III.   Ranking of Tax Authorities
A.     Internal Revenue Code
1.      This is the tax law itself
2.      Comprised of §26 USC
B.     Treasury Regulations
1.      Given a lot of deference by courts; Upheld unless they clearly contradict the Code
2.      §7805—Secretary of Treasury has the ability to enact regulations to clarify & support the Code
3.      Treasury Regs are how the Treasury interprets the Code
4.      Proposed Treasury Regulations: Regulations the Treas submits for public comment before adoption or withdrawal
5.      Temporary Treasury Regulations: Regulations offered w/o comment period and remain outstanding for 3 years; often renewed
C.     Rulings
1.      Private Letter Rulings (PLRs)
a)      Treasury will give an interpretation on how a trans will be taxed before the trans takes place
b)      May be relied upon only by the parties who the ruling was specified by (G can change its mind about this type of transaction for later parties)
2.      Revenue Ruling
a)      Gives general guidance on an issue/transaction so that PLRs are no longer needed for parties to be able to rely on the interpretation
b)      Gives the IRS’s view of a type of transaction
3.      Revenue Procedure: Gives IRS’s view on a procedure
4.      Acquiescence Announcement
a)      Non-acquiescence: The govt. lost the case and didn’t appeal but next time this issue comes up the govt. may defend their position again
b)      Acquiescence: The govt. lost and admit/accept that the court’s holding is correct; thus, taxpayers can rely on these decisions safely
IV. Tax Litigation Forums (Places tax litigation can begin)
A.     Tax Court
1.      19 tax court judges specialized in tax law
2.      Can get into Tax Court w/o first paying the tax
3.      Appeal lies with Circuit Court of Appeal
a)      Golsen Rule: if the appeal lies to a circuit that has already decided, the Tax Court will follow their ruling even if tax court thinks it’s wrong
B.     Court of Federal Claims
1.      Appeal lies to Court of Appeals for Federal Circuit
2.      Must file a refund to get into this court
C.     Federal District Court
1.      To get into US District Court taxpayer must pay the alleged tax deficiency and then file for a refund
2.      Only court that a jury might be obtainable
V.     Tax Controversies
A.     Burden of Proof
1.      §7491—burden of proof now shifted to govt. to prove facts in certain situations
2.      BOP remains w/ TP unless: (these limit the impact of the BOP change)
a)      TP exhausts all admin. appeals within IRS
b)      TP cooperates fully with G
c)      TP complies with all record-keeping requirements
B.     Audit
1.      .5% of personal returns get audited
2.      5% of small business returns
3.      37% of larger firms
C.     30-day letter: given if auditor and TP can not reach an agreement and you have 30 days to appeal to an appeals officer who has the ability to settle/compromise
D.     90-day letter
1.      this is a notice of deficiency and allows you to enter the Tax Court
2.      have 90 days after notice is mailed to file a petition with the US Tax Court
3.      failure to file an appeal will allow the govt. to assess the tax and begin collection
E.      Statute of Limitation
1.      §6501(e): Gives govt 6 years to begin collection on an item completely omitted that exceeds 25% if the gross income stated in the return; Supreme Ct. said you have to completely omit the item for this section to apply
2.      §6501: no S/L if TP acts fraudulently; no S/L if TP fails to file a return
VI. Taxpayers and Tax Rates
A.     What is income?
Income = Consumption + Δ in Wealth = Consumption

J.       Arguments “Against” progressive taxation
1.      Wealth is a reward for those who’ve earned it and they shouldn’t be punished via a heavier tax rate
2.      Why tax a productive person but not a non-productive person?
3.      Social Darwinism—why punish those who’ve “won” in the market?
4.      Hurts Incentive to work: Leisure becomes more valuable than earning income
K.     Possible Bases for Taxes
1.      Income
2.      Wages/Salaries
3.      Consumption
a)      Sales Tax
b)      Receipts Tax
c)      Value-Added Tax
(1)   Not used in America, but popular in Europe
(2)   Taxes are imposed at each step in production thus each person is watching the other so avoidance is difficult
(3)   VAT is packed into the price when consumer buys the goods
d)      Excise Taxes
(1)   Main use is “sin taxes”
(2)   Only certain products are taxed (esp. liquor & tobacco)
(3)   Producer is only looking at the MPC (Marg. Private Cost) but these products often have external costs so we add taxes to reach the Marginal Social Costs (MSC) so the entire cost is borne by the consumer [MSC—drunk driving, lung cancer, etc.] (4)   These are for altering behavior more than for collecting revenue
e)      Consumption taxes are generally regressive – we’re focused on end user, not intermediary
f)       It’s possible to have a progression consumption tax by having a deduction from the amount saved [i.e. IRA accounts give you tax deds for what you save, but there are limits on contribution] L.      Wealth as a tax base
1.      Property Tax: Local level (funds schools, etc.): ad valorem (in accordance w/ its value)
a)      Every state imposes this
b)      Tax is primarily assessed against real property (property you can’t move or hide), not personal property
c)      Most real estate tax goes to support public schools
d)      Progressivity of property tax in regards to income: 
(1)   In England a long time ago, wealth was held in property, so it was progressive
(2)   Now, wealth is held in intangible property, so it’s not progressive
(3)   If you’re a renter, the legal incidence of the property tax is on the LL, but the T will bear the burden of the tax
2.      Federal Estate Tax – Since 1916
a)      Value of property transferred at death
b)      Imposed on the decedent’s estate
c)      Rationale: try to prevent the aggregation of wealth b/c it is thought to impact the economy & it is unfair – the wealthiest people weren’t paying their fair share
d)      US has more concentrated wealth holdings than any other nation and estate tax was meant to alleviate this
(1)   Top 1% of wealth holders have 33% of wealth of the country
(2)   Next 4% have the 26% of wealth
(3)   Next 5% have 6.5%
(4)   Next 10% have 13%
(5)   Bottom 80% only have 16% of wealth
e)      Imagine the even greater discrepancy without and estate tax