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

TAX OUTLINE – PROFESSOR WARD
Introduction
Views of Income
Economist (Haig-Simons) view:
                                                               i.      I = Consumption – change in wealth.
Tax Controversies – Ways to Try Tax Cases
Scrutiny of a tax return by IRS – if they want to examine closer they send an audit letter.
                                                               i.      30 day letter: 30 days to appeal your case within IRS – meet with appeals officer.
                                                              ii.      90 day letter (Notice of Deficiency)
1.        Ticket to the tax court; it is the period of time you have to file a petition.
a.       Taxpayer is always the petitioner, Commissioner of IRS always respondent.
b.       Tax court ONLY has deficiency jurisdiction, not refund.
                                                                                                                                       i.      If you lose, go to Court of Appeals
2.       Alternatively, you can pay the tax and attempt to get a refund, and if IRS denies your claim or sits without action for 6 months, you sue the govt for refund and you have choice of courts:
a.       US District Court
                                                                                                                                       i.      You are plaintiff and sue government
                                                                                                                                      ii.      If you lose, go to Court of Appeals
b.       Court of Federal Claims
                                                                                                                                       i.      Appeal goes to Court of Appeals for Federal Circuit
Golsen Doctrine: Tax Court not bound accept to the particular appeals court in which appeal would lie.
 
Chapter 2. The Concept of Income
Basic Tax Computations
Steps to Determining taxpayer’s federal tax liability
                                                               i.      Determine Adjusted Gross Income (AGI): GI-DEDS
1.       Determine Gross Income
a.       Definition: All income from whatever source derived. [§ 61(a)]                                                                                                                                        i.      § 61 is not all-inclusive.
                                                                                                                                      ii.      Rule: If it is income, it is part of gross income
                                                                                                                                    iii.      Inclusionary Rules [§§ 71-90]                                                                                                                                     iv.      Exclusionary Rules [§§ 101-139A] 2.       Subtract above the line deductions to which taxpayer is entitled, which yields adjusted gross income
a.       Rule: You cannot take a deduction unless you can find specific authority for it in the Code (i.e § 162(a) allows a deduction for ordinary business expenses – specifically authorizes a deduction)
b.       §62: Sets out allowable deductions or “above the line deductions”
                                                                                                                                       i.      So once you find a deduction, § 62 tells you at what point to take the deduction.
                                                              ii.      Determine Taxable Income (TI =AGI – ID or SD and Personal Exemptions) [Taxable Income defined in § 63)
1.       Subtract from AGI either:
a.       Itemized Deductions [§ 63(d); 164(a)(1)]; or
                                                                                                                                       i.      Examples: home mortgage interest, taxes paid to state government, medical expenses
b.       Standard deductions
                                                                                                                                       i.      § 63(c)
                                                                                                                                      ii.      Look for additional standard deductions (i.e. if taxpayer has attained age 65) [§ 63(f)(3)] c.        Also subtract personal exemptions [§ 151-152]                                                             iii.      Apply applicable tax-rate schedule for taxpayer’s filing status to compute the tax before credits.
                                                            iv.      Subtract any credits to which the taxpayer is entitled to arrive at amount of tax due.
Accessions to Wealth
In General
                                                               i.      Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955)
1.       Issue: § 61(a) – are treble damages out of antitrust settlement part of “income” as defined in that section?
a.       Rule: Compensatory damages are treated as income.
2.       Holding: Punitive damages is “income”.
3.       Reanactment Doctrine: If Congress amends the statute but does not overturn a court decision in doing so, it has in effect ratified the decision.
a.       Supreme court not persuaded by this in this case.
Gross Income from Sales
                                                               i.      Realization Requirement: The tax system does not tax appreciation or allow a deduction for losses) until a taxpayer disposes of property.
1.       Do not tax a until realization event occurs.
a.       Realization Event: complete disposition of the property (i.e. sell or exchange the stock)
2.       Statutory authority comes from §61(a)(3): “Gains derived from dealings in property” are included in gross income.
a.       Look to regulations (1-1.61(6)(a)) interprets § 61.
3.       This is a major departure from the economist view of income – they do not pay attention to realization events.
4.       Effects of realization requirement
a.       Places control in hands of taxpayer as to when tax occurs, allowing them to minimize tax on gains or maximize deductions of losses.
5.       Rule: A gain is not included in gross income unless it is recognized.
                                                              ii.      Computing a Gain on a Transaction.
1.       § 1001(a): Gain realized = Excess of amount realized – property’s adjusted basis. (GR=AR-AB)
a.       Amount Realized: §1001(b) – Sum of any money received plus the fair market value of property other than money received.
b.       Adjusted Basis: §1011(a) – the basis determined under §1012 adjusted as provided in § 1016
                                                                                                                                       i.      Adjusted basis = unadjusted basis +/- adjustments
1.       Unadjusted basis = cost (amount you pay)
c.        1001-1(a) interpreting § 1001. Computation of gain or Loss
                                                                                                                                       i.      “the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property different materially either in kind or in extent, is treated as income or as loss sustained.
2.       §1012: The basis of property is its cost.
                                                            iii.      Exception to the realization requirement in order to be taxed
1.       Rule: Treasure trove constitutes gross income when reduced to undisputed possession. [§ 1.61-14(a)] a.       1.61-14(a) has generally been read a requiring the inclusion of income of the value of found property.
b.    

ell us the basis, which is cost.
a.       Rule: If A receives a 30,000 car for compensation, the cost basis is $30,000 income recognized on receiving the car, not, the amount of money (zero) paid for the car.
                                                                                                                                       i.      Tax Cost Basisrefers to the unadjusted basis of property whose value was included in gross income (or amount realized, as in the case of property received in a taxable exchange).
1.       Examples of tax cost basis: §§ 1.62-2(d)(2)(i); 1.83-4(b)(1).
b.       Rule: Opportunity cost is not included in basis calculations
                                                                                                                                       i.      Example: Lawyer earns 300,000 writing a book for a year, but would have earned 100,000 if she had worked as an attorney – the basis is 0 and the amount realized is 300,000. 100,000 opportunity cost is NOT deductible.
                                                                                                                                      ii.      The Role of Basis:
1.       The role of basis is that it represents previously taxed income that you have invested in the property and you want to avoid taxing people twice. This is why opportunity cost should not be included in basis because you never were taxed on it.
                                                            iii.      Transfers of Property as Compensation for Services: Section 83
1.       Introduction
a.       § 83: how to deal with transfers of property to employees with strings attached.
2.       Employee
a.       Rule: According to § 83(a), an employee generally must include in income the value of property received as compensation at the earlier of the property’s (1) ceasing to be subject to a substantial risk of forfeiture or (2) becoming transferable.
                                                                                                                                       i.      Substantial Risk of Forfeiture: Property is at risk so long as the employee’s rights in the property are conditioned upon the “future performance of substantial services.” [§ 83(c)(1)]                                                                                                                                       ii.      Transferable: Employee’s rights transferable only if transferee not subject to a substantial risk of forfeiture. [§ 83(c)(2)]                                                                                                                                     iii.      Substantially non-vested property: Property that is both nontransferable and subject to substantial risk of forfeiture. [§ 1.83-1(a)].
1.       Rule: The employee is taxed when the property becomes substantially vested.
a.       Rule: Amount included in income = value of property at time it substantially vests(FMV) – amount paid by employee. [§ 83(a)].
b.       Rule: Employee’s basis for property= amount paid by employee + amount includable in employee’s income (tax cost). [§ 1.83-4(b)].