Taxation I
Jennifer Bird-Pollan
Fall 2014
I. Overview
a. Preface
· §7805(a) gives Secretary of the Treasury the power to “prescribe al needful rules and regulations for the enforcement of this title”
· when conflict arises between equal weights of authority, we use the “last in time” rule
· Congress writes the code pursuant to their taxing power under the 16th Amendment. IRS enforces the code
b. Applicable Tax Rates
i. Filing Status
· Determines tax rates
· Rate x tax base = tax
· Four filing statuses
· Married filing jointly/surviving spouse (2 yrs.)
· Head of household
· Unmarried
· Married filing separately
· §1(a)-(e): Different Rates
· §7703(a) “Married”: If you’re married on the close of the taxable year or at time of death
· §2(a): Surviving spouse: 2 years and residence of child/stepchild
· §3 DOMA – marriage = one man and one woman. Windsor à unconstitutional
· (f)(1): Tables prescribed for year code, but treasury secretary issues specific tax tables
· Income tax rates are progressive; not flat like sales tax. You pay more tax if your base is higher
· Arguments for Progressivity:
· Higher TPers receive more benefits from use of tax dollars, so it makes sense that they should pay more tax
· Wealth redistribution
· People with more money can afford to pay more taxes: marginal utility of money (after so much money, it’s just gonna sit there—you’re not gonna spend it)
· Arguments against Progressivity
· Complicated?
· Diminishing return of work
· Horizontal equity: annual basis penalizes TPers who earn more income in 1 year. If next/previous year is much lower, it doesn’t matter. Each year stands alone.
c. Determining Taxable Income
i. 61(a): “Gross income” = all income from whatever source derived
· 2 step analysis:
· Whether the $ is income.
· If so, is the income excluded?
ii. 62(a) doesn’t authorize deductions, but rather lists 18 specific deductions that may be taken (above-the-line)
iii. 63 2 methods for computing taxable income
· (a) = taxable income means gross income – itemized? deductions (other than standard deduction)
· (b) = adjusted gross income – standard deduction and deduction for personal exemptions
d. Personal Exemptions
i. TPers who don’t itemize get to claim personal exemptions, which are authorized by §151
ii. Can also be claimed by TPers who itemize
iii. Cannot be taken above-the-line or to compute AGI (adjusted gross income) – must be taken after
iv. Congressional policy: some percentage of income goes to basic needs
e. Basic Themes of Tax:
i. Time value of money. You want your money now so you can invest it and make more $ with that same amount.
ii. Substance over Form
iii. Each year stands alone
iv. Horizontal and vertical equity
II. Computing Tax Liability
a. Standard & Itemized Deductions: §63
i. Itemized deductions = below-the-line
· Limitations
· §67 “miscellaneous itemized deductions” reduces deductions by 2% of AGI (2% Haircut)
i. AGI = $100,000 (2% =$2,000) IDs = $3,500
Amount allowed = $3,500 – $2,000 = $1,500
ii. §67(b) lists 12 “regulars” that are not subject to the 2% HC. The expenses in this list are not miscellaneous itemized deductions, but rather basic itemized deductions. “Other than” language!
· §68 phases out amount of itemized deductions by most affluent tax payers (but never below 20%)
i. 68(c) = 3 deductions that are not subject to the phase-out
ii. Standard deduction = §63(c)
· There are certain deductions everyone should get for basic living costs and shouldn’t have to keep receipts
b. The Tax Ladder
Gross Income, § 61
– Deductions, §62
____________________
= AGI, §62
____________________
– Personal Exemptions
– Standard Deductions §63(b) or Itemized deductions §63(d)
= Taxable Income, §63
i. Problem 2-1 p. 39
Part A:
· Gross Income: Salaries ($95,000) + other income ($5,000) = Gross Income ($100,000)
· Above-the-Line §62 deductions: moving expenses (8000) + deductions related to rents/royalties (2000)
· remember, the authority to take these deductions comes from different parts of the code. Ex. Moving comes from §217
· AGI: So GI (100,000) – §62 deductions (10,000) = $90,000 AGI
· Personal Exemptions: §151. In this case, we have two TPers. Here, we use §151(d)(1) to get $4,000 in personal exemptions because there are two TPers, not because there’s a TPer and a spouse §151(b).
· Standard or Itemized Deductions:
·
i. Here, misc. not allowable, so we have to use the basic $8,500 only. 80% of 8,500 = $6,800
c. The 3% of excess is the lesser of the two, so the $8,500 will be reduced by $2,700 = $5,800
d. However, our std deduction = $6,000; so they’ll take the standard deduction.
c. Credits v. Deductions
i. TPers typically prefer credits over deductions because credits are a $ for $ reduction in taxable income. Credits are the same amount for everyone.
ii. Deductions are better for larger incomes because they’re more valuable with the more income because of progressive tax structure because a % is applied to $ amount
iii. Refundable tax credits can reduce taxable income below 0, resulting in a check from the IRS. Non-refundable tax credits can only reduce your taxable income to 0 and no further.
Income
Not Income
Complete dominion & control
Bargain purchase (transaction at arm’s length)
Treasure trove
Unrealized increase in value
Illegal income
Imputed income
Barter exchange
Gifts (unless from employer)
Neighborly kindness
III. The Meaning of “Gross Income” à “The answer never is to tell them not to report shit.”
a. Judicial and Administrative Definitions of Income à IRC §61(a); Treas. Reg. §§1.61-2(d)(1); 1.61-14(a)
i. Haig-Simons definition of income: income = consumption + change in wealth
· Consumption = how much you spent;
· Change in wealth = what did you start with, and what did you end with?
· Changes in wealth can have a great impact on well-being, but this formula lacks a realization component
· $100K house, now worth $500K. Are you better off when it was $100K? social capital/non-economic value, increased property taxes.
· It lacks a realized event! If taxes increase because the value of the home has increased, you would have to sell your house if Congress follow Haig-Simons
· Also, hard to keep track of value. Would require getting an appraisal every year
