Individual Income Tax Outline
16th Amendment: Allowed income tax. Previously, it had been considered a “Direct tax” and therefore unconstitutional. (Tried it during civil war . . . uncon).
Must consider: 1) economics, 2) administration (recording), and 3) non-tax policy when trying to determine what should be taxable income (in the basket) and deductions (out of the basket).
Def’n: 1) Income: Gain on property subject to tax (Sell price – buy price = income).
2) Amount Realized: Dollar amount you get for selling property.
3) Basis: Investment in the property.
4) Gain: Same as “Taxable income.” (amt realized – basis = gain).
General Rule: Disposition of appreciated property is taxable, unless there is an exception.
Client wants to sell house. Bought with husband, but they’re getting divorced. She got MS house in settlement; he got FL house (which he lived in while working). She wants to sell, buy horses.
LAW: § 1041®property settlement/disposition b/t spouses are not taxed as an income gain. The basis remains the same.
§ 121®If meet all the requirements, the sale of a residence will be tax-free.
§ 121: Exclusion available for gains realized on sale or exchange of principal residence
A. Exclude up to $250 (single) or $500 (if file joint return, either owns, both use house, and neither has used 121 within past 2 years).
a. If file jointly and one doesn’t meet use req’t, can’t get $500. Can still get $250.
B. Must OWN and USE as principle residence for 2 yrs in past 5 yrs
a. Doesn’t have to be continuous 2 yrs (750 days in 5 yrs)
b. Temporary absence is OK (even if rent house)
C. Ownership: In case of divorce or death of spouse, ownership includes period of time the residence was owned by the other spouse.
D. Principle Residence: Main test is: “Where do you spend the majority of your time?” State law def’n of “principle residence” is not applicable.
(1) Location of residence v. taxpayer’s principal business location
(2) Amount of time taxpayer and family spend at residence **most important
(3) Involvement in community
(4) Voting and licensing registration
E. Uncontrollable Circumstances/Employment Change: You can still get the exclusion if you don’t satisfy the 2 yr own/use req’t b/c of changed employment. Fraction, there 1 yr, you get ½ exclusion. (Time/2 * 250K or 500K)
F. Only can use once every 2 yrs.
G. Depreciation (like if you used part of house for business) is subtracted from the excludable amt.
H. Acreage around the house may be considered part of the residence.
§ 1041: Marriage Exception
A. No gain is recognized if transferred to 1) spouse (if separated, still married), or 2) incident to divorce (property settlement)
B. It is considered as a gift.
Punishment for Bad Advice: 1) Tax Preparer Penalty®Significant bad advice, you can be fined.
2) Malpractice, 3) You can be barred from dealing with the IRS.
Order of Authority: Starting w/ revenue rulings, they aren’t binding.
1) Const, 2) Statute (IRS code by Congress), 3) Regulations (Treasury Department), 4) Revenue Rulings (By IRS), 5) Revenue Procedure (IRS), 6) Private Letter Rulings, 7) Legislative History (used to explain statutes, prior law, reasons for change, etc.) 8) Case law.
Revenue Rulings: Like cases, but decided by the IRS – only binding on govt., not tax payers.
Revenue Procedures: Like a “how-to” guide for doing something.
Private Letter Ruling: Ask IRS’s opinion about tax treatment of something. It is only binding for the particular taxpayer who asks for the opinion. You can use the letters to show that the IRS has been either consistent or inconsistent in their treatment of something. No real authority, though.
Case Law: Often to define terms, Interpret statute/reg.
Independent Judicial Doctrine: Tax Common Law (applies to whole Code)
EX: Assignment of income doctrine: tax must be paid by person who earns.
I. Introductory Stuff
A. Audit – There are 3 levels of audits. **You have a right to have counsel/acc when meet IRS
a) Correspondence audit- IRS just sends letter saying you owe us money. You either send money or explain why you don’t owe.
b) Office audit- bring your documentation and go to IRS.
(i) Never give IRS an original document.
c) Field audit- The come to you. Most inclusive.
(i) Try to control flow of information. Get copies for yourself of what IRS wants
What if you Do owe more $ after the audit? *First, you try to negotiate a settlement price. The earlier you settle, the better price you will get.
1. If you can’t reach an agreement, you get 30-day letter saying you owe IRS money. OPTIONS:
a. Concede liability and pay the money,
b. Request an Administrative appeal (cheaper than trial),
c. Do nothing – then you get the “90-day letter.” 90-day letter is ticket to court.
*During 30 or 90 day, IRS can’t seize any assets UNLESS you are a flight risk.
2. Once you receive your 90-day letter:
a. File petition (same as complaint) in tax ct (file petition, IRS can’t seize prop)
b. Do nothing – Then IRS can seize assets. Lose right to argue if don’t file suit w/in 90 days.
B. TAX CT: Hears only deficiency Cases (taxpayer owes IRS).
– No jury trial (But you do get a specialist judge)
– Appeal to Circuit where taxpayer lives. Golsen: That Circuit’s law
Chapter 2 Problems:
1(A): woman has $75K salary, take home 50K (15K fed tax, 5.5 SS, 4.5 state tax). GI®75
*Old Colony: Report everything, then deduct.
(B): Bonus of 5K; GI®add 5K
(C): Gets desk & chair worth $500 (FMV) for 50.
*Bargain Purchase: Generally, don’t recognize gain until you sell the “bargain.” This is the situation if she and firm didn’t know the value of the desk.
*Exception: If E/er knew value and sold it for less b/c she was an employee, it’s compensation and therefore the 450 should be GI.
*Suppose builder built house and sold for cheap to someone b/c he was friends with that person’s dad. NOT GI, b/c favor wasn’t to buyer, it was to dad.
(D): She took a mandatory trip for business worth $2500.
*Rule: If the trip is compensation (not req’d, get it b/c you did well, etc) ® report as GI
*Here, though, trip was required, she conducted business (E/er also benefited).
*The FMV of trip should be taxed (not subjective value).
2. Buy stk for 1K, EOY1 – 1.5K, EOY2 – 2K, EOY3 – 3K (pledged stk as security on loan), EOY5 – 3500 (stk got burned in a fire, received a new certificate from corp.), Then, gave the stk to a creditor to satisfy a debt.
*GI on (amt worth – basis) when you gave it to creditor. Realized when gave to creditor.
*NOT realized when pledged as security.
*NOT realized when received a new certificate.
*Report found money as GI when you find it. Not Realized until found.
*Why might IRS go to ct over small $? 1) Set precedence, 2) lot of people doing it, binds all.
*Rev R: If you barter for services, you should report the FMV of any services you receive as GI.
*Prob 1(f): She did service for free, to thank her, cousin built her a greenhouse. Distinguishable b/c not bartered for up front. Must anticipate getting something in return for GI.
Old Colony’s Pyramiding: They didn’t pyramid, should have.
*E/ee has $1000 salary. 40% TR. E/er pays $400, E/ee gets $600.
*Suppose E/ee wants $600 and E/er pay all taxes. E/er pays 240, but this is also GI for the E/ee (benefit). 240*0.4, etc . . . COMES out the same. Formula: AT/(1-TR) = BT