Tax Outline

Federal Income Tax Outline—Mazza – 2006
I. Sources of Federal Tax Law
A. Generally
1. All tax code à 26 USC
B. Enacting Tax Laws
1. President comes up with tax plan.
2. Tax policy comes from House Ways and Means Committee.
3. HWMC will conduct hearings and people will give testimony as to what should happen.
4. After the hearings a bill will be drafted.
5. A House report will be drafted containing legislative history explaining the changes and the reasons for the changes.
6. Debates on the bill.
7. Then it goes to the Senate
8. Finance committee will hold hearings and then a bill is drafted that will be different than the House.
C. IRS
1. Division of the Treasury Department. Derives its power from Congress.
2. Publications: (in order of hierarchy, the TAX CODE comes first)
a. Treasury Regulations: formal authoritative interpretations of the law. Provide examples of how the law should be applied, explanations of the statute. Regulations carry the force and effect of law: TPs may rely on these.
b. Revenue Ruling: the IRS’ application of the code to a specific fact situation. Not as authoritative as regulations, but TP may rely on it if the TP’s facts are similar to those in the ruling.
c. Revenue Procedure: procedural in nature, TP may NOT rely
d. Private Letter Ruling (PLR): letter from the IRS responding to a TP’s question. Binding only on the TP who requested the ruling. May be requested for transactions that have not been recorded in a filing. IRS charges 750 for the first PLR, also have to bill your client to draft it. TP bound to the IRS’s determination.
D. Judicial Structure
1. 95% of tax disputes end in settlement
2. Three choices of forums:
a. Federal District Court
i. File where taxpayer resides, must prepay, appeal to circuit court of appeals, only one with a jury
b. U.S. Tax Court
i. national jurisdiction: can hear a case from any state. Comes to KC twice a year.
ii. Only court to hear deficiency cases: Do NOT have to prepay the liability; 95% of cases go to tax court
iii. If case is technical, tax court might be good, b/c judges are experts; Appeal to circuit court of appeals- TP home
iv. Golsen rule for precedent: Says that the tax court will follow the precedent of the court of appeals that will hear the case next. Doesn’t stop the tax court from registering their dissatisfaction.
c. Court of Federal Claims
i. Operates out of DC, but judges will travel, can get hearing in KC; Appeal to circuit ct of claims, Must prepay
II. TAX POLICY
A. Fairness: why does a tax system need to be fair? If it was perceived to be unfair, we would have a drop in compliance: gov. would have to spend more to collect taxes, which would reduce revenue, etc.
B. Three Criteria Used in Evaluating Taxes (Equity, Efficiency, Simplicity)
1. Equity
a. Tax equity requires that those with greater ability to pay taxes should pay more tax.
b. Types of fairness: Horizontal and Vertical
i. Horizontal Equity: TPs who are similarly situated should be treated the same. Reflects with the notion that those within the same economic income should pay the same amount of tax.
ii. Vertical Equity: those TPs who have a greater ability to pay should pay tax at a greater percentage
1) Alternative Tax Bases:
1. Income: people with the same income ordinarily pay the same taxes, while people with greater income pay a greater amount of income tax
2. Wealth: used as a base for estate taxes
3. Consumption Theory: Income = consumption +/- change in net worth (synonymous with savings). Consumption: must consider whether you are receiving something fort the exchange. Ex. Comparison between going to the hospital or a restaurant.
c. Progressive Rate Structure Better?
i. Benefits Theory: tax rates should be determined based on the benefit the person receives from the government. Higher income TPs tend to receive more benefits from the federal gov. than lower income TPs (especially with military protection and land ownership).
ii. Marginal Utility of Money: another argument for progressive rates. If have little money, each and every dollar is more important to you, therefore, it is okay to tax wealthy people more. Problem: personal subjective considerations, but impossible to prove.
iii. Head Tax: simplistic, efficient for lower income people, but not equitable (violates vertical equity) b/c it is regressive. Lower income TPs would pay a higher percentage of their income.
2. Efficiency
a. Definition: requires that a tax interfere as little as possible with people’s economic behavior.
b. Economic Neutrality: the idea that the tax system should not affect decision making b/c then it will interfere with the free market, which will produce the most efficient economy w/o interference
i. Questions:
1) Is it Neutral?
2) Does it affect individuals decision making?
3) Does it help the country produce the greatest amount of economic output?
ii. Tax system is efficient when it promotes economic growth and inefficient when it inhibits such growth.
iii. Efficiency refers to the extent to which incentive provisions provide benefits to TPs other than the intended beneficiaries.
3. Simplicity: a feature of any tax system that is equitable and efficient. If a tax system is too complicated = more noncompliance, a higher burden on TPs to comply, and burden on gov. to enforce.
a. Complexity is inequitable b/c TPs with equal abilities to pay may have different tax burdens b/c of their unequal abilities to understand or manipulate the tax rules.
b. Head Tax: simplistic, efficient for lower income, but not vertically equitable b/c it is regressive.
III. Tax Calculation
A. Tax Rates:
1. Marginal Rate: the tax rate of the last dollar of taxable income: important for planning purposes b/c determine the value of any deductions.
2. Average Rate: total tax liability / tax base. (average is always below the marginal)
3. Effective Rate: total tax liability / taxable income
4. There are 5 different tax brackets. They are explained in §1 and §3.
a. The TP must multiply their [taxable income] x [tax rate] = [tax before credits] Gross Income (§61)
– Minus: expenses incurred to generate revenue (above the line deductions) (§62)
– Equals à Adjusted Gross Income (AGI) (§62)
– Minus Personal and Dependency Exemptions (§§ 151–152)
– Minus
o Standard deduction 63(c), (f) (set by congress) OR
o Itemized Deductions (these are below the line deductions) 63(d); (under §67(a), certain types of itemized deductions (Miscellaneous itemized deductions) are deductible ONLY to the extent they exceed 2% of TP’s AGI.
– Equalsà Taxable Income (§63(a), (b))
– Multiply taxable income by tax rates (IRC §§ 1 & 3)
– Equals à Tax Before Credits
– Minus any applicable Tax Credits (§§21–23) (these are dollar for dollar credits)
o Tax withheld by employer
o System is designed to over withhold so that most people get a refund
– Equals à Tax Due or Owed
Example:
Couple earning 10,000 taxable income à 10% rate
Couple now earning 20,000 taxable income à 10% on the first 14,600, and 15% on the remainder.
The marginal tax rate is 15% this refers to the last dollar that is taxed.
The Average or Effective Tax Rate: = 2270/20,000 = 11.35 %
Thus, when you move up a tax bracket the only portion of your income that is taxed higher is the money that goes above the tax level.

20,000 Taxable Income:
14,600 at 10% = 460
5,400 at 15% = 810 (15% is the marginal tax rate)
Total Tax = 2,270
2,270 / 20,000 = 11.35% (this is the average or effective Tax rate)

Tax Credit is dollar for dollar credit.
Deductions reduce GI or AGI so they are not dollar for dollar.
Dollar value of Deduction: Marginal Tax Rate * amount of Deduction

IV. Gross Income
A. Assignment of Income Doctrine: the tp may not transfer or divert his income to another party. Fruits of one’s activities are to