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Individual Tax
University of Mississippi School of Law
Davis, Donna Raye

Individual Tax Outline

Fall 2013

Davis

Introduction

a. Characteristic of a good tax system:

i. Efficient

ii. Fair

iii. Transparent

iv. Pros of an individual income tax

1. Transparent

2. Tied to ability to pay

v. Cons of an individual income tax

1. Different standards of fair

2. Complex

3. Defining income and deductions allowance

4. Charitable contributions

5. Economic policies

b. Definitions

i. Income – gain on property subject to tax (sell price – buy price = income)

ii. Amount realized – money amount you get for selling property

iii. Basis – investment in the property; typically, how much you paid

iv. Gain – same as “taxable income” (amount realized – basis = gain)

v. General rules

1. Disposition of appreciated property is taxable, unless there is an exception

2. In taxes, one would always rather pay later that pay now, i.e. defer tax consequences until later date and time value of money

c. Statute of Limitations

i. Statute of limitations starts to run from the time the return is filed

1. If tax payer gets extension, statute of limitations does NOT begin to run until later date when return is filed

ii. Normal statute of limitations is 3 years

iii. But, if tax payer…

1. Under-reports, may be subject to longer statute of limitations and stiff penalties

a. If by 25% or more, the statute of limitations is 6 years

2. Does not file, then statute of limitations does not start and tax payer will be liable forever

3. Files but commits fraud, the statute of limitations does NOT start to run

d. Audits

i. Government can only audit your return from 7 years of filing (April 15). If late filing then statute of limitations starts to run on the later date.

1. Usually 3 years unless a substantial omission (meaning 25% less) of income then 6 years.

ii. Types

1. Correspondence Audit

a. Lowest level where IRS sends tax payer letter stating that he owes money. tax payer either sends money or explains that he doesn’t owe it. Through the phone or mail

2. Office Audit

a. Middle level where tax payer gets letter from IRS and must bring records to IRS office

3. Field Audit

a. Highest level – IRS comes to tax payer to look at books and records

iii. Possible Outcomes

1. Agent finds no additional tax liability

2. Taxpayer gives up and pays

3. Dispute

e. Which court will tax payer be in?

i. Tax court – hears ONLY deficiency cases (i.e. tax payer owes more money to IRS)

1. Pro – do not have to pay tax in order to get judicial review / decision

2. Con – NO jury trial

ii. District court – hears ONLY refund claims (tax payer overpays IRS, asks for refund, and IRS refuses)

1. Pro – can get a jury trial, which helps if client’s story induces sympathy

a. Can you convert deficiency into refund case to get a jury?

b. Yes! Pay tax, and receive refund.

2. Con – government already has your money

f. Ethical Issues

i. What to report is ultimately up to client

ii. ALWAYS put lawyer’s advice in a letter or memo

Ch. 2 – Gross Income

I. FORMULA FOR CALCULATING TAX LIABILITY

a. Net income * tax rate = tentative tax liability

b. Tentative tax liability – credits = tax liability

c. Additions found in § 61 et seq.

d. Deductions found in § 161 et seq.

II. IMPORTANT CODE SECTIONS

a. Gross Income – § 61

b. Adjusted Gross Income – § 62

c. Personal Exemption Deduction – § 151 – determined by Revenue Procedures

i. money3,700 currently

ii. Dependents? Kids § 152

d. Standard Deduction – § 63 – determined by Revenue Procedures

i. Single – $5,800

ii. Married – $11,900

e. Tax Rates – § 1 – determined by Congress

i. Series of rate brackets in tables

ii. Progressive rates – as income rises, rate rises

iii. Change every year to reflect inflation

iv. Marital status is important

f. § 7703 – Determination of Marital Status

i. Joint Tax Return = J & S Liability

ii. Innocent Spouse Relief – limits liability for spouses when …

1. It is an amount over a certain dollar limit;

2. The spouse did not know of the inaccurate tax position (rare); AND

3. The spouse did not benefit from the position taken on the return.

g. Note – mistake on form is NOT binding of federal government

III. TAX RATES

a. Marginal Rate

i. Highest rate bracket at which you are paying tax (excess over base amount)

b. Effective Rate

i. Percentage of taxes paid based off of AGI

c. Capital Gains – typically <15%

i. Pull out of gross income because you get a lower rate

IV. GROSS INCOME DEFINED – § 61

a. All income from whatever source derived, unless excluded by law, and including but not limited to:

i. Compensation for services, including fees, commissions, fringe benefits…

ii. Gross income derived from business

iii. Gains derived from dealings in property

iv. Interest

v. Rents

vi. Royalties

vii. Dividends

viii.Alimony and separate maintenance payments

ix. Annuities

x. Income from life insurance and endowment contracts

xi. Pensions

xii. Income from discharge of indebtedness

xiii.Distributive share of partnership gross income

xiv.Income in respect to a decedent; AND

xv. Income from an interest in an estate or trust

b. Generally includes items that add to the taxpayer’s net worth

c. Concerned with the substance received, not the form of income

i. Gross income may be realized in ANY form

1. I.e., money, property, or services

d. Realization requirement – income is NOT taxed until realized

e. Imputed income – NOT taxed-services you provide for yourself

V. SOURCES OF TAX LAWS

a. U.S. Constitution

i. 16th Amendment: Congress has a right to collect tax without apportionment

b. Statutes

c. Regulations

i. IRS in charge

ii. Binding on IRS and tax payers

iii. Are subject to challenge

iv. What’s the standard for overturning regulations?

1. Tax regulations are held to the same standard (Chevron)

a. Has Congress spoken directly on the issue? Is so, then the statute must follow the intent of Congress – If not, can be overturned

b. Often however, regulations cover ambiguous parts of statutes, so t

paid. A benefit is received.

2. Having someone pay your obligation is exactly the same thing as if you paid your obligation – it’s all gross income – no need for actual receipt of income, the benefit is sufficient

a. Discharge of debt by third party will be gross income.

b. Glenshaw Glass does not require the accession to wealth to be “in hand.” Receiving the benefit of the item is sufficient to satisfy Glenshaw Glass.

e. Bargain Purchases

i. Intentional – parties know the thing is worth more yet sold for less

1. Affects gross income because you receive some benefit

2. Realization event

3. Exercises dominion

4. Often occurs within the context of employee stock options

ii. Unintentional – parties didn’t know the thing was valuable

1. No realization event if the value of the object is not known

2. Is bargaining present? Compensation?

3. Nothing changes once you discover it is worth more – it’s just like the appreciation of stock (not taxable) – no realization

a. If the item is sold, then the gross income must be accounted for

f. McCann v. United States

i. Facts – Company flew certain employees to Vegas for fun, not business

ii. Rule –

1. Compensation to employee in form of trip (non-cash benefit) is gross income

2. Cash bonus is NOT a Gift

3. Requirement to go and meaningful business component would take trip out of gross income

4. Would be different if all employees because would lose compensatory value.

5. Where is dividing line? Davis – issue of fact for the jury

iii. What are you required to include as gross income? FMV of trip

1. Ask – Primarily for the benefit of the company, or primarily for the benefit of the employee? Substantive meetings?

g. Tax Benefit Rule

i. A mistaken assumption regarding a tax benefit must be corrected in the second year

ii. Example

1. Rent building for 20K/year and deduct all because you plan on it being business expense. However, 6 months into lease, you close business and live in building. Thus, you only spent 10K (6 months) as business expense.

2. The mistaken assumption (deduction of additional 10K) must be corrected the following year

h. Services / Property vs. Money as Income

i. If services are paid for other than in money form, the FMV of the property or services taken in payment must be included in income

ii. If services rendered at stipulated price, that price presumed to be FMV of compensation received in absence of evidence otherwise

iii. For business trips, examine facts to determine if business trip was really compensation (McCann)