TAX BIRD-POLLAN FALL 2017
CHAPTER 1 | APPLICABLE TAX RATES
Introduction
Base x Rate = Tax liability
(taxable income x % = tax liability)
RATE is determined by filing status, income, etc.
BASE is the amount of taxable income. This is NOT the same as gross income!
A way of keeping track of amounts that have already been taxed in order to prevent double taxation.
If base shrink rate increases and vice versa but you get same amt in tax liability
Tax Authorities (What are the sources of tax law?)
Tier 1:
Internal Revenue Code (primary source, written by Congress)
Treasury regulations (secondary to the Code; issued by Treasury Dept.)
To become a reg à first drafted by the IRS and issued as proposed regs—taxpayers can submit comments and speak at hearings and then it becomes a final regulation.
Treasury Dept. can simultaneously issue a temporary reg at the same time, which is effective immediately
Cases
Treaties (negotiated between the U.S. and other countries)
Tier 2:
Public administrative rulings
Legislative history
Tier 3:
Private administrative rulings
Private letter rulings: Taxpayers write a letter to the IRS and pay $10,000 to get a letter with an opinion; the opinion only applies to the taxpayer who asks for it, but these are usually published for guidance, but still binding ONLY to the party that requests it.
**When there is a conflict in the same tier, the “last-in-time” rule applies and the later authority is controlling.
Tier 1
Tier 2
Tier 3
Internal Revenue Code
Public Administrative Rulings
Private Administrative Rulings
Regulations
Legislative History
IRS Publications
Cases
Treaties
Types of Tax:
-Payroll taxes
-Taxes for unemployment
-Sales tax (state/ county/ local level not fed level)
-fed and state excise taxes (ex on gasoline and gambling)
-Property taxes
*Individual income tax is largest source for fed gov*
Tax Policy Goals:
Efficiency: Certainty for taxpayers for decision-making; ease of administration (relatively easy and inexpensive); does not impede trade or capital
Equitable: Is the tax fair?
Horizontal equity: taxpayers with equal income should be more or less taxed equally
Vertical equity: taxpayers with more income should pay more tax
Tax Policy (system)
Purpose-
In place to raise revenue
Need it to fund stuff
Can provide/ distribute funds to ppl
Tax is a tool for redistributing money
Can use taxes to influence behavior
Ex: tax ppl with long hair
Economic incentives to do things
Ex: taxes for environmental purposes
Ex: taxing corporations/ taxing gas to try and get ppl to drive less
We tax the behavior we don’t like (cigs)
Tax on cigs ex:
-pros- tax to control your behavior so maybe you’ll stop doing something bad for you. Tax now so don’t have
to be big cost for society later like for health care. (purpose- control behavior)
-cons- interferes with your freedom. Some ppl just hooked and won’t care. Unintended consequences- what
are people going to give up to keep smoking (fair)
Tax Rates and Progressivity
Structures:
Progressive: as taxable income increases, so does the rate of the tax
Our tax system now is progressive, but only up to a certain amount ($450k for MFJ)
As income increases, taxpayers pay quantitatively AND proportionately more
As tax increases, so too does tax rates
When discussing progressivity, often talk about effective tax rate (average tax rate; tax/income; liability as a percentage of taxable income) and marginal tax rate (rate of tax applicable to the taxpayer’s last dollar of taxable income.
Because taxpayers get the benefit of the lower tax rates on the first dollars of taxable income, a taxpayer’s effective tax rate will always be less than or equal to his marginal tax rate.
Marginal rate- if you earned one more dollar what would your tax rate be
LOOK AT CHART IN NOTES
Pros:
Ensure that an individual’s tax liability is based on his or her ability to pay
Theory of declining marginal utility of money à there is a diminishing return to the benefit you get from an additional $
Wealthier individuals should bear a higher percentage of total tax burden because they receive more benefits from the use of tax dollars (national security à they have more to protect)
Accomplishes wealth redistribution
Marginal utility theory- what is the highest value of the last dollar earned. Ex bill gates wouldn’t pick up a $50 bill. Arg is- doesn’t cost high income ppl as much pain to be taxed more.
Arg against this- it may not be true that he wouldn’t pick up that $50 and wants to keep all his money.
Cons:
Progressivity makes the system more complex
And thus more expensive to administer
And tax getting in the way of an efficient market (by reducing effort)
Arg against this would be- this is a problem of high taxes not progressivity of tax
Distorts taxpayer decisions (may affect decision to work)
A taxpayer may conclude that extra work and the cost of lost relaxation is not worth the after-tax income (more a con of high tax rates in general, though)
If you know you’d have a 75% tax rate you might not work that hard to get a higher income/ might choose to have less of an income if you know you would be taxed more.
Inequities between similarly situation taxpayers
Creates difference between taxpayer that earns a lot of $ in one year and none in the next year vs. someone w/ standard $
Flat: tax is the same regardless of wealth (ex: sales tax)
Rates are the same regardless of income
Regressive: as taxable income increases, rate of tax decreases (ex: social security)
Marginal rate v. average tax rate?
Haig Simons Income (we don’t use Haig-Simons in our country)
The taxpayer’s personal spendings for the period + taxpayers increase in wealth for the period
-consumption + change in wealth = income
* Under a Haig, Simons based income tax, a person is subject to an annual tax on net wealth whether it is spent or saved.
-Our tax system does not tax appreciation in assets until gain is realized on her sale.
Our system is a hybrid system between consumption tax and income tax (time value of money imp)
May want to add consumption tax
The Impact of Filing Status
Married couples filing joint return, heads of households filing, and unmarried individuals filing.
Married Filing Jointly and surviving spouses (§1(a))
§ 7703(a): “married” means that the taxpayer is married on the last day of the tax year, except that if the spouse dies during the taxable year, the determination is made as of the time of death). (b) has an exception where some spouses living apart are not considered married.
§ 2(a): “surviving spouse” if your spouse died in either of the two tax years immediately preceding the taxable year AND surviving spouse maintain (> ½ cost) of household that is principal place of residence of a dependent child or step-child and to whom the taxpayer is entitled to a deduction under § 151.
Marriage is generally only advantageous when one taxpayer earns the majority of the income
Marriage is a state issue à the IRS said that if same-sex couples are legally married in a state, then they will be married for federal tax purposes
Head of Household (§1(b))
§ 2(b): “head of household” is one who is not marr
e extent that they exceed 2% of AGI, or $2,000. If had MIDs of $3,500, would only be able to deduct $1,500.
Why 2% haircut? One of largest categories of MIDs is unreimbursed business expenses. Congress might be weeding out expenses that might be questionable (business would have paid if legit?) or for administrative convenience—IRS doesn’t need to verify claimed amounts as much because of this limit.
OR Regular itemized deductions (§67)
These are the deductions explicitly listed in §67(b)
ALL itemized deductions are subject to phaseout at higher income levels
§68: When AGI > applicable amount, the amount of itemized deductions otherwise allowable for the taxable year shall be reduced by the lesser of:
3% of the excess of AGI over the applicable amount OR
80% of the amount of itemized deductions otherwise allowable
Ex: If applicable amount is $300,000 and AGI is $400,000, the excess is $100,000. If the taxpayer had $10,000 of itemized deductions, they would be reduced by $3,000 to $7,000.
However, if AGI was $1.4 million, 80% limit prevents all deductions from being wiped out. Instead, taxpayer would just lose 80% of $10,000 (reduced to $2000).
BUT, three deductions excluded from the phaseout in §68(c):
§213 deduction (medical expenses); investment interest (§163(d)); AND §165(a) casualty or theft losses and §165(d) (wagering losses)
Standard Deduction taking Taxpayers:
§63(c) sets forth the amount of the standard deduction, which is adjusted annually for inflation.
Problem 2-1
Personal Exemptions
Deduction for personal exemptions reflects the policy that a certain base amount of income should not be subject to federal income tax. §151(d)(1) states that the exemption is $2,000, but (d)(4) allows it to be adjusted for inflation. ($3900 in 2013)
The personal exemption is phased out for taxpayers with income above a “threshold amount.” §151(d)(3) says that when AGI > applicable amount under §68(b), the personal exemption is reduced by 2 percentage points for each $2,500 that AGI exceeds the threshold amount.
Ex: A married taxpayer has an AGI of $350,000 (threshold amount is $300K for joint return), so the personal exemption would be reduced by 40% (20 increments of $2500 x 2%).
Personal exemptions include:
Exemptions for taxpayer (authorized in §151(b))
This also includes an exemption for the taxpayer’s spouse if the couple files separately and the taxpayer’s spouse has no gross income and is not the “dependent” of another.
Reg. § 1.151-1(b) makes it clear that spouses filing a joint return may claim two exemptions
Exemptions for dependents (authorized in §151(c))
Qualifying Relatives Test (defined in §152(d)).
The individual must have one of 7 listed relationships from §152(d)(2) to the taxpayer or be a member of the taxpayer’s household
Child or descendent of a child
Brother, sister, stepbrother, or stepsister
Father; mother; or ancestor of either
Stepfather or stepmother
Son or daughter of a brother or sister of the taxpayer (nieces/nephews)
Brother or sister of the father or mother of the taxpayer (aunt/uncle)
Child-in-law; parent-in-law; sibling-in-law
