Sources of Federal Tax Law
I. Sources from the Constitution is the 16th Amendment (1913) “Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration”
a. The Internal Revenue Code –primary source, last amended in 1986.
b. Regulations – issued by the treasury department. The older the reg is the more likely a court is to uphold it, due to congressional acquiescence of its existence.
i. Promulgation of Regs – § 7805(a). Notice, comment, hearing, publication in the Federal Register.
ii. Challenging a regulation you must prove that the reg is unreasonable & contrary to congress’ intent.
c. Revenue Rulings – Rulings which are published for general interest. Can be relied upon by anyone. Generally describe a hypo and give an answer and outlines issues.
d. Revenue Procedure – Statements of the Service regarding its internal management operations, they have a general effect upon T’s rights/duties with respect to statutory provisions.
e. Letter Rulings – are responsive rulings to a particular T’s request for advice on the tax consequences of a specific transaction
II. Case Law – two types of decisions
a. Regular Decisions – generally involve important issues in tax which may not have previously been resolved.
b. Memorandum Decisions – generally involve application of settled points of the tax law to particular facts. Usually are not published
i. Effect of Decisions from the Tax Court – when the Tax Court rules against the Commissioner, he will either issue a notice of acquiescence or of nonacquiescence.
1. Acquiescence – indicates that the IRS accepts the decision.
2. Nonacquiescence – indicates that the IRS doesn’t accept the Tax Court conclusion and intends to continue challenging T with respect to the issue before the court.
III. Tax Litigation –
a. Trial Courts – When the IRS asserts a deficiency T can either (1) pay the deficiency and file an administrative claim for a refund, and upon denial of claim sue for a refund in federal court or (2) refuse to pay the deficiency and petition the tax court.
i. The Tax Court – must deny liability to be in this court. A very sophisticated trial court since its judges deal with Tax issues 24/7. Bench trial. Headquartered in Washington DC, its judges regularly travel around the country.
ii. Federal District Court – must first pay deficiency to be in this court. Cases may be tried by juries or judges. Action must be brought in the US District in which T resides, or in the case of a corp its principal place of business.
iii. US Court of Federal Claims – Has jurisdiction over all tax suits regardless of amount. Only bench trials. The jurisdiction is throughout the entire US. Thus one’s residence is irrelevant.
b. Appeals –
i. From The Tax Court – are heard as a matter of right by the Federal Courts of Appeals, jurisdiction is in the circuit in which T resides.
ii. From the Federal Court of Claims – these appeals go to the US Court of Appeals for the Federal Circuit, which has exclusive jurisdiction of an appeal from the US Court of Federal Claims.
iii. From the District Courts – as a matter of right, these cases are appealed to the appropriate federal court of appeals in the circuit in which T resides.
1. Golsen Rule – The rule that the Tax Court follows the precedent of the court of appeals for the circuit where the taxpayer resides.
c. Strategy for Appeals – wide forum selection (Tax Court, US District Court, US Court of Federal Claims).
i. Consider one’s finances when choosing a forum (i.e. paying the deficiency)
ii. Bench Trial v. Jury Trial
iii. Expertise of Tax Court Judges
iv. Favorable Precedent
A. Tax Expenditures (supp. pg. 53-65)
B. Tax & Public Policy
1. Reasons for Income Tax
a. finance gov’t
1) printing more $ would cause inflation
2) gov’t could sell bonds to borrow $
i) but this causes competition between gov’t & private sector, raising interest rates
ii) only defers cost to later generations
2. Alternatives to current tax structure
a. flat tax – bad b/c $ isn’t worth the same to everyone
3. 3 criteria used to judge an income tax system
1) people must perceive system as fair or compliance will decrease, forcing gov’t to spend more forcing compliance, ultimately raising tax rates
2) types of fairness
i) horizontal equity – people in similar econ. positions have similar tax
– how do we decide who’s similar?
— ability to pay
— wages – alone this doesn’t consider investments
— wealth – alone this doesn’t consider liquid assets
*** income (consumption +/- change in net worth (savings))
—- this is extremely broad (doesn’t look at source of receipt)
— look at benefits people derive from gov’t
— too difficult to determine what benefits whom & to what extent
ii) vertical equity – those unequally situated should be treated proportionally different
b. econ. Efficiency
1) econ. neutrality – tax system doesn’t affect person’s econ. decision-making process
i) this is a falsity, b/c all taxes affect econ. decision making
2) arguments for & against tax cuts for the wealthy (supply side economics):
i) for: greater savings = more econ. investment = higher productivity = higher wages = higher tax receipts
ii) against: decreases gov’t $, causing gov’t to increase taxes or borrow
3) tax system may be econ. efficient if it corrects an inefficiency existent in the market
i) e.g., increases the savings rate
1) overly complex systems encourage wrong answers/cheating
4. Does it make sense to cheat?
a. assume you report an item of gross income & have to pay $2k
1) if you fail to report & they find out you’ll have to pay $2k, plus about $250 in interest, plus a civil fraud penalty of 75%. Thus the total is $3750 BUT if you multiply that by the 1% chance of being caught it’s only $37.50.
– Those with equal ability to pay should pay equal amounts of tax. Those with unequal abilities to pay should pay different amounts.
– Efficiency Criterion – tax should interfere as little as possible with people’s economic behavior. All taxes will have efficiency costs, which will change the incentives to engage in various activities and is likely to affect people’s behavior.
– Simplicity Criterion – Tax goals and systems should be simple, administratively and practically.
– Three Complexities with Tax System – Rule, Compliance, and Transactional
· Rule = refers to the problems of understanding and interpreting the law, this emanates from the statues and the regs.
· Compliance = the complexity that one encounters in complying with the law, that is keeping the required records and filling out the appropriate forms.
· Transactional = complexity that arises when T organizes their affairs to minimize taxes.
Progressive Rate Structures
Pros = (1) essential to taxation based on ability to pay, (2) deliberate mechanisms for reducing economic inequalities, (3) necessary to produce proportionality of the overall tax burden by offsetting the effects of other more regressive taxes, (4) benefits of government expenditures increase progressively with income and wealth.
Cons = (1) importance of particular preferences to the individual T cannot be measured objectively, (2) progressive tax has done little to reduce the economic disparities in USA, (3)
· Three tax policy goals (1) equity, (2) efficiency, (3) simplicity
· §62(a) are the above the line deductions (ea
his spouse, and if the spouse, for the calendar year in which the taxable year of the T beings, has no gross income and is not the dependent of another taxpayer.
§151(c) – “Additional Exemption for Dependents” – An exemption of the exemption amount for each individual who is a dependent (as defined in §152) of the taxpayer for the taxable year.
§151(d) – “Exemption Amount” – SEE SECTION IT IS LONG.
§152 See pg 130 – “Dependent Defined”
§152(a) – “In General”
§152(c) – “Qualifying Child”
§162(a) See pg 135 – “Trade or Business Expenses”
Gross Income: General Principles
I. Income Defined – The concept of “income” developed by the congress, the courts, and the Treasury is both widely inclusive and elastic.
a. 16th Amendment – “Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states and without regard to any census or enumeration.
b. 1913 Tax Act Definition – “Net income of a taxable person shall include gains, profits, and income derived from salaries wages, or compensation…or gains or profits and income derived from any source whatever.
c. §61(a) – “Gross income means all income from whatever source derived, including (but not limited to) the following items:” See §61(a) for list.
d. Eisner v. Macomber – “The gain derived from capital from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets.” (This has been limited to stock dividends)
e. Glenshaw Glass Case – “Undeniable accessions to wealth, clearly realized and over which the taxpayer has complete dominion.
II. Realization of Income
a. Realization in Any Form – realization can be in money, property, or services. Reg. §1.61-1(a)
i. Services Paid for in Property – fair market value of the property is the measure of compensation. §1.61-2(d)(1).
ii. Property Paid for in Services – the value of the services received is the amount of compensation. §1.61-2(d)(1).
1. Fair Market Value – is defined as the price a willing buyer would pay a willing seller, with neither under a compulsion to buy or sell, and both having reasonable knowledge of relevant facts. §20.2031-1(b).
b. Realization Requirement – realization events must be reported and are not limited to cash. §1001(b). Realization events are difficult to see all of the time.
i. Policy Arguments About the Realization Requirement
1. Assume congress could tax “mere” appreciation. Taxing each year’s appreciation would more nearly match tax income and economic income; thus it would place on the same tax footing persons who are economically situated.
2. Tax laws should not discourage sales of property, and that the realization requirement does so by permitting each year’s unrealized appreciation to go untaxed, thus levying the entire tax in the year of disposition.
3. SEE PG 29 of CASEBOOK
c. Imputed Income – There is no tax on imputed income. Problems of valuation and liquidity and is objectionable for other reasons. Raises equity and efficiency problems. If it were taxed it would have administrative nightmares.
d. Bargain Purchases – Purchasing an asset a bargain price, generally does not constitute gross income. Though if one acquires an asset through bargain purchase and sells the asset, then we have a realization event with income present.
i. Distinguish transactions that aren’t at an arm’s length in the employment setting!!! In such a setting it is usually seen as gross income. Reg. §1.61-2(d)(2)(i).