Tax Outline

Taxation Outline
 
Introduction to Federal Income Taxation
 
The 1913 Income Tax Act
Set a very low rate of taxes with only a small portion of the American public paying taxes
Important: Under the tax system, employers are required to withhold from their employees’ compensation a sum, determined by reference to a specially formulated schedule, which approximates the federal income taxes an employee will own.
Functions of the Tax System
(1) Raising revenues for the government
(2) Allocating the cost of public goods and services among Americans on an ability-to-pay basis through a PROGRESSIVE RATE STRUCTURE whereby high-income taxpayers pay a larger fraction of their income than low income taxpayers.
(3) Tool of social policy reflecting the social concerns of Congress.
Example: Section 163 allows taxpayers to deduct home mortgage interest to encourage home ownership
Example: Section 121 provides a substantial exclusion for gain on the sale of a principal residence to encourage home ownership and minimize tax as a factor in deciding whether to sell one’s home.
Example: Section 170 allows for deductions of charitable donations to encourage individuals to support charities; this deduction also indirectly subsidizes various social programs.
(4) Allows Congress to implement economic policy
Example: Section 168 allows companies to depreciate certain tangible property rapidly encouraging investment in new equipment.
 
Resolution of Tax Issues Through the Judicial Process
If the Commissioner of the Internal Revenue Service in income tax, i.e., claims that the taxpayer has failed to pay all that is owed, the taxpayer may:
Refuse to pay the tax and petition the Tax Court for a redetermination of the deficiency; or
Pay the deficiency, file an administrative claim for refund, and upon denial of the claim, sue for refund in federal district court or the United States Court of Federal Claims.
Trial Courts
Important: Three Courts have original jurisdiction depending on the course of action taken by the taxpayer
(1) The Tax Court
Only court in which the taxpayer commences an action for redetermination of a deficiency without paying the asserted deficiency
Cases are tried by a judge without a jury and the judge will either:
(a) Allow the decision to stand, or
(b) Refer it to the full court for review
Important: Reviewed opinions are given greater weight
(2) Federal District Court
The District Courts have jurisdiction in any tax case against the United States seeking a refund of tax, regardless of the amount involved
Tried by juries
Important: A taxpayer cannot litigate a tax action in federal district courts without first paying the amount in dispute and then commencing a refund action.
Venue: A taxpayer must bring the action in the district in which he or she lives; if the plaintiff is a corporation, it must bring the action in the district where it maintains its principal place of business
 
(3) The United States Court of Federal Claims
The Court has jurisdiction over all tax suits against the United States regardless of amount.
Jury trial is not available
PJ: Jurisdiction extends throughout the United States regardless of residence
Important: A taxpayer cannot litigate a tax action in federal district courts without first paying the amount in dispute and then commencing a refund action.
Appeals
Appeals from the Tax Court are heard as a matter of right by the Federal Court of Appeals of the United States.
Jurisdiction is in the court in which the taxpayer resides.
Important: It was not until 1970 that the Tax Court regarded itself as bound by the decisions of federal appeals courts.
As with other decisions, those relating to matters of taxation are reviewable by the United States Supreme Court.
 
Analysis of a Taxpayer’s Tax Liability
Five Basic Questions Addressed by an Income Tax System
(1) What items of economic income or gain will be includable in gross income?
(2) What items of expense will be allowable as deductions?
(3) When is an amount included in income? When is the taxpayer entitled to claim a deduction for an amount that is clearly deductible?
(4) Who is the taxpayer—who is going to be taxed on items of income?
(5) What is the character of the items of income or the deductions?
Evaluating Tax Liability
(1) What is the applicable tax rate?
Look to the Tax Reform Act of 1986, Section I for applicable rate
Highest current rate—35% for income and a 15% cap on capital gains
(2) What is the tax rate applied to—that is, what is the tax base?
Section 1(a)
The appropriate tax rate is applied to the “taxable income of the taxpayer”
Section 63(b)
For individuals who do not itemize their deductions, the term “taxable income” means “adjusted gross income MINUS (1) the standard deduction, and (2) the deduction for personal exemptions provided in Section 151.”
Section 63(a)
For all other taxpayers, “taxable income” means “gross income MINUS the deductions allowed by this chapter (Chapter 1 of Subtitle A of the Internal Revenue Code) other than the standard deduction.”
Gross Income (Section 61)
“Except as otherwise provided in this subtitle, gross income means all income from whatever source derived including (but not limited to) (the 15 items listed in the section)…”
Adjusted Gross Income (Section 62)
Gross Income MINUS Certain Deductions
Important: Section 62 is NOT a deduction granting provision! In general, only those deductions listed in Section 62 are taken into account in computing adjusted gross income.
Two Categories of Deductions
Above-the-Line Deductions
Deductions that a taxpayer may consider in determining his or her adjusted gross income
Below-the-Line Deductions
Deductions that a taxpayer may take into account only after the adjusted gross income has been determined
Deductions
Most deductions reflect the notion that our tax system permits a deduction for the costs incurred in producing income; however, a number of provisions are no