Federal Basic Income Tax Outline-Ward-Fall 2010
A. The Constitution and the Income Tax
Article I § 8 of the Constitution allows Congress to lay and collect taxes, duties, imposts and excises. This power is limited in three ways:
· Direct taxes must be apportioned among the states
o Article I § 2: Representatives and direct taxes shall be apportioned among the several states according to their respective numbers. . . and
o Article 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
o The history of the direct-tax provisions show only that taxes on imports, exports, and consumption were not direct. There were numerous definitions of what a direct tax was.
o Since 1913, the 16th amendment has allowed Congress to tax incomes without apportionment, making moot the question whether an income tax is a direct tax.
· Bills for raising revenue must originate in the House of Representatives; and
o Article I § 7: Bills for raising revenue shall originate in the House of Representatives
o This has become a formality. If the Senate wants to launch a major piece of tax legislation it has only to approve amendment to one of these bills
· Taxes must be uniform throughout the United States.
o Article I § 8 states that taxes must be uniform throughout the United States.
o Does not prohibit a progressive tax or a tax that distinguishes between different sources or uses of income.
o The uniformity required is 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 method must be made operative throughout the United States.
B. Income Tax Legislation and Regulations
The income tax is the federal government’s major source of revenue. In 2004, individual income tax represented 49.1, corporate 11.53, and employment 35.56 percent of revenue.
Much of today’s tax law is found in regulations promulgated by the Treasury Department. Regulations are the law unless invalid. The Supreme Court has said that tax regulations must be upheld if they implement the congressional mandate in some reasonable manner. A recent case has said that if the statute is silent or ambiguous, the question for the court is whether the agency’s answer is based upon a permissible construction. These are published in Title 26 of the CFR. Regulations are either:
· Legislative- regulation issued under a specific statutory grant of authority to the Treasury Department to make rules on a particular subject
· Interpretative- issued under § 7805, which authorizes the Treasury Department to prescribe needful rules and regulations.
Temporary regulations are issued without a comment period in situations in which the Treasury considers immediate authoritative guidance important. § 7805 requires that all temporary regulations be issued as proposed regulations as well. These expire within 3 years of issuance, but nothing prevents the Treasury from reissuing.
C. The Internal Revenue Service
The IRS consists of those Treasury Department employees under the Commissioner of Internal Revenue. When the code empowers the IRS to do something, it does so by granting the power in question to the Secretary, a term which includes any Treasury employee or agency to whom the Secretary has delegated authority. The IRS enforces taxes and provides interpretative guidance by:
· Issuing Revenue Rulings- answering a legal issue concerning interpretation by answering a specific fact pattern
· Issuing Revenue Procedures- traditionally dealing with procedural matters, but increasingly on substantive issues.
· Publish notice- If the IRS wants to provide guidance before a regulation or ruling can be issued.
· Weekly Internal Revenue Bulletin, which are cumulated into bound volumes.
· Letter rulings in response to taxpayer requests for guidance on contemplated transactions. Letter rulings are made public and are available to lawyers and accountants.
D. Tax Controversies
Under the self-assessment system, taxpayers are required to file returns and pay taxes due. When returns are received, they are checked for mathematical accuracy, some are selected for audit, a process involving investigation of the return’s accuracy. Most disputes arising at the audit level are settled by agreement between taxpayer and the revenue agent. If agreement is not reached, the Service will send the taxpayer a 30 day letter explaining its determination, which the taxpayer can appeal. If not appealed, taxpayer receives 90 day letter, requiring taxpayer to pay in that time.
-The Service may assess a tax within 3 years of the due date or the actual filing date, whichever is later. If a return omits an amount greater than 25 percent of the gross income, the Service has 6 years. If the taxpayer files no return or files one that is false or fraudulent with intent to evade, there is no statute of limitations. If the taxpayer pays but objects, the taxpayer files a claim for refund.
-Tax disputes not settled can be litigated in the Tax Court (if the tax has not been paid) or by suit for a refund in a federal district court or the Court of Federal Claims. The Tax Court is an Article I court with only deficiency jurisdiction, and so cannot be availed of by a taxpayer who has paid the tax in full. Most tax court cases are heard by a single judge. Cases are appealable to circuit courts. Decisions of the Court of Federal Claims are appealable to the Court of Appeals for the Federal Circuit.
-The Service sometimes announces the Commissioner’s acquiescence or non-acquiesence in court decisions, used to inform tax lawyers and government employees of the service’s position. The commissioner’s acquiescence does not bar the government from assessing a tax even though the taxpayer would not owe the tax under the holding of the case in which the commissioner acquiesced. § 7430 provides for the award of attorney’s fees and other costs for taxpayers who substantially prevail with respect to either the amount in controversy or the most significant issues. Certain rates and limits are set under this statute.
E. Taxpayers and Tax Rates
The progressive tax system- the tax on a high income is a larger percentage of the income than the tax on a low income. Proportional means that income is taxed at the same level for all income. Regressive means that marginal rates decrease as income decreases. Social security is regressive. The main justifications for progressivity include:
· Tend to equalize after-tax incomes with pre-tax incomes
· Declining marginal utility of money
· Ability to Pay
· Borrow during low income years while repaying during high income years
Over the past 25 years, changes in the rate schedules seem to reflect a great reduction in the progressivity of the income tax. Highest rates have fallen from 70 percent to 35 percent. However, the tax base has broadened in that time. Therefore, progressivity is still largely intact.
II. The Concept of Income
A. Basic Tax Computations
The starting point in determining the taxpayer’s liability is calculating gross income, defined in § 61 (a) to embrace “all income from whatever source derived,” and then goes on to list certain categories. The list says that it is not an exhaustive list, so even if a particular receipt is not listed, it does not necessarily follow that it is excludable from gross income. The definition of 61(a) applies “except as otherwise provided,” so other provisions may have to be consulted in determining whether an item is includable in gross income.
-Two important sets of statutory rules provide guidance on 61:
· Inclusionary rules: these are located from §§ 71-90, and typically state “gross income includes.”
· Exclusionary rules: these are located from §§ 101-139A, and begin “gross income does not include.”
The inclusionary and exclusionary rules may be used as devices for providing special tax relief for certain kinds of favored income.
After gross income has been determined, deductions to which the taxpayer is entitled are subtracted. The taxpayer can take deductions only for amounts allowable by some provision of the Code. For individual taxpayers, allowable deductions are taken into account in two steps:
· First, some deductions, those listed in § 62 are subtracted from gross income, yielding a figured called adjust
of property: The basis of property shall be the cost of such property, except as otherwise provided in this subchapter and others.
4. Illegal Gains
James v. United States- When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. In such a case, the taxpayer has actual command over the property taxed, the actual benefit for which the tax is paid. This standard brings wrongful appropriations within the broad sweep of gross income.
Expressly promulgated in Treas. Reg. § 1.61-14(a).
-§§ 7201 and 7217 define various tax crimes (willful attempt to evade tax; felony) (willful failure to file a return, supply information, or pay tax; misdemeanor). Although illegal gains are taxable, they are often not taxed. A non-tax criminal who wants to avoid becoming a tax criminal too should file a tax return reporting income from illegal activities and describing those activities, at least briefly. By making the statement, the taxpayer would have waived his 5th Amendment right not to incriminate himself; but the 5th cannot be used to justify failure to file on the theory that filing by a criminal would be incriminatory.
C. Recovery of Capital
Measuring income in the sense of gain or profit requires making an allowance for the costs of earning income.
Someone who sells property computes realized gain on the sale by subtracting the property’s adjusted basis from the amount realized upon the sale. Basis in the case of a sale or exchange determines the amount of gain subject to the amount realized. The cost of the property represents income on which the taxpayer has already been taxed. When the property is sold, the taxpayer is permitted to recover that previously taxed investment tax-free, as we only tax income. Basis adjustments are required because the taxpayer’s previously taxed investment may change with the passage of time. The taxpayer’s recovery of capital takes place at the stage of calculating gross income.
2. Dividends, Interest, and Rent
When a taxpayer buys property and derives dividends, interest, or rent from the property, those accessions to wealth are includable in the taxpayer’s gross income. The basis does not enter into the calculation of either the gross income from the property or the taxpayer’s taxable income; instead, it is left for use when the taxpayer makes a disposition. The shortcoming of this system is that it is elective, as taxpaying corporations can choose to reinvest earnings rather than pay dividends, which essentially represents a tax-free increase to wealth.
The cost of acquiring an asset with a life extending substantially beyond the close of the year is a capital expenditure. In the case of a limited-life asset used in profit-seeking activity, the recovery of the taxpayer’s previously taxed investment in the property usually is achieved through depreciation. This is a method of allocating the asset’s cost over its useful life. The depreciation deduction offsets a corresponding amount of gross income and allows that income to