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Federal Income Tax
University of Missouri School of Law
Hawley, Erin Morrow

Three goals of Taxation
                (1): Equity – fairness                      
Ability to pay
                (2): Efficiency
                                Minimally distortive of economic impacts (through incentives)
                                Creation of incentives for different things
                (3): Simplicity
                                Easy to understand to create the ability to comprehend
Primary Social Policy: raise revenue
                Other social policies:
                                Influence economic activity
                                Effect the allocation of resources
                                Education (scholarships, deductions for student loans)
                                Environment (deductions for energy efficient vehicles)
                                Health care
                                Sin taxes
History
                Currently: income tax is the biggest revenue earner
                                Only in the last century is that the case
                Previously: tariffs were the big ones (with the exception being times of war)
                1986: creation of the basis for our current tax code
                                Democrats wanted to broaden the base; Republicans wanted to lower the tax
Congress’ power to tax
                Article 1, Section 8, clause 1: power to lay and collect taxes
                                Direct taxes: must be apportioned (Section 2, clause 3; section 9, clause 4)
                                                Direct Tax: demanded from the very person intended to pay it
                                                                Example: property tax, head tax (everyone pays 10 bucks)
                                Indirect Taxes: must be uniform (Article 1, Section 8, Clause 1)
Indirect Tax: paid primarily by a person who can shift the burden of the tax to someone else or who at least is under no legal compulsion to pay the tax
Section 61: “income from whatever source derived”
                Rent, wages, dividends, gains from sales
Why is apportionment necessary?
                Fairness, particularly in regards to states
Once Congress decides how much money they want to raise, they would apportion the amount to each state based on population                                     
                Pollock: court held that this must happen in regards to rent
Problem: it’s regressive: not based on the amount of rent received, it’s based on population
So someone making a lower amount of money from rent will pay the same as someone making more
That’s where the 16th Amendment came from “from whatever source derived”
                It doesn’t matter if it’s property, it doesn’t have to be a direct tax
Uniformity among the states
Doesn’t say that people in similar situations must be treated similarly, it’s a constraint on geography: people in CN must be treated the same as those in NY
Non-uniformity: can arise through different opinions through the various courts
Tax Court and Court of Claims
                Tax Court: used after the IRS issues a deficiency
                                You receive your notice, you can file in tax court
                                Used to be an administrative agency within the IRS, but Congress changed that
                District Court
                                You have to pay the tax and exhaust administrative remedies
                Court of Claims
                                Have to pay and exhaust administrative remedies
                                Appeals go through the Federal Circuit
Sources of Materials
                Internal Revenue Code: 26 U.S.C.
                Regulations
Mayo Foundation v. United States
26 U.S.C. § 3121(b)(10): deals with FICA taxes and whether or not someone is an employee or a student
                This section provides an exemption for students: “enrolled and attending”
Initial treasury regulation: says it’s on a case by case basis, with hours and course load as the primary factors
Social Security Foundation: treated them as employees: categorically, if you are a resident, then you’re not a student (doesn’t make sense since it’s a case by case basis)
2004: Treasury revises its regulation: “an employee is a student so long as the educational aspect of his service predominates over the service aspect of the relationship with his employer”
                Also added that full time employees cannot be considered a student (> 40 hours/week)
Mayo’s argument as to why it’s invalid: the residents “work” is actually their education
Mistake: answering the question that a professor who takes a night class shouldn’t be exempt
Court runs with the concession that the predominance requirement is important
                What is the mode of analysis that the court uses?
                                Chevron Model:
                                                (1): Whether Congress has “directly addressed the precise question at issue”
                                                                Is it unambiguous?
                                                (2): Is the agency’s interpretation permissible?
                                                                Pretty lenient; just needs to be reasonable
                Court under step 1:
                                It’s not completely clear so they need to continue their analysis
                                                If it had been clear, then the regulation fails
                Court under step 2:
                                Since the statute is ambiguous, they need to decide if the regulation is permissible
                                First, does Chevron apply?
                                                National Muffler
                                                                (1): it hasn’t been consistent over time
(2): when it was promulgated years after the relevant statute was enacted (contemporaneous)
(3): the way the regulation evolved (manner – did it evolve through litigation?)
If these applied, you can view the regulation with increased skepticism
                                                Court says that National Muffler doesn’t apply
                                                                If it had, the regulation would have failed
                                Because Chevron applies, the regulation passes easily
                                                Work predominated over classwork
                                                The 40 hours a week was a reasonable way of determining that
                                                Allowing a case by case basis would increase litigation that isn’t necessary
                Chevron
                                Statutory Authority
Expertise: Congress doesn’t always cover every situation, so these regulations need to be created to cover different situations
Other sources of Authority
                Revenue Rulings: which are the Treasury’s answers to specific questions
                                These are not subject to notice and comment (like the regulation at issue in Chevron)
                                Not necessarily binding; Treasury can reverse course (it always does so prospectively)
                Private Letter Rulings (PLR): similar to the revenue rulings, but they aren’t published
                                They aren’t binding since they aren’t published
                                Guidance, not very persuasive
                                Technical Advice Memorandums: basically the same thing
Action on Decisions: if the IRS loses a case in court, it issues one of these stating that it either agrees or disagrees with the result
Current Tax Structure
Sales tax, property tax, income tax (state and federal), corporate tax, payroll tax, direct sales tax, user tax, estate/gift tax
                Federal: majority comes from income tax
                                There is no federal property tax: it would have to be apportioned
Redistribution: tax the rich people more, disburse benefits through welfare etc.
Basic Income Tax
                Gross Income (all income from whatever source derived)
                – § 62 Deductions
                = Adjusted Gross Income
                – Standard Deduction
                Or – Itemized Deduction
                 – Personal Exemptions
                = Taxable Income
                – Credits
                X Tax Rate
                = Income Tax
Four possible bases of Tax:
                (1): Income: not just wages; dividends, health benefits, etc.
                (2): Wages
                (3): Consumption: what you pull out of the economy
                (4): Wealth: could be an estate tax
Two types of tax reform the US has considered
                (1): Improve the current system
                                Most popular and most politically feasible
                                1986: goals of broadening the base and lowering the rates
                                                Broadening the base: subject more things to taxes (inclusion)
                                                                Things can be known as expenditures
                                Haig-Simons: income = consumption + change in wealth
                                Tax Expenditures: 5 types; money that’s given back after your total tax bill is calculated
                                                (1): Credits
                                                (2): Deductions
                                                (3): Deferrals
                                                                (a): Lowers your rate (or could lower your rate)
When you withdraw, probably are retired, not making as much money, so you’re rate is lower than it would have been    
                                                                (b): Time value of money
                                                (4): Exclusions and Exemptions
                                                                Employee health insurance
                                                                Imputed rental value
                                                                State and local bond interest
                                                (5): Preferential rates
                                                                Capital gains, qualified dividends
                                Tax Expenditures = Spending
The channels are different, but it’s money that the gov’t gives to people for doing certain things (which is the same as spending money on those things)
                (2): Fundamental
                                Look to change the base to a Consumption Base
                                                Hobbes: resources removed from the common pool (J. Stuart Mill agreed)
                                Two ways to implement a consumption base tax
                                                (1): Transactional tax (sales tax)
                                                                (a): Value added tax at the retail level
                                                                (b): Value added tax at each state of production (pure VAT)
      

The FMV of the work of art and the six months fair rental value of the apartment are includible in the gross incomes of the apartment owner and the artist under § 61 of the Code.”
                This Revenue Ruling basically prevents the economy from shifting to a barter economy
Dean v. Commissioner
                Bank requires them to transfer their home to the corporation as collateral
                Corporation owns the home, but H and W still live there
                IRS: argues that the rental value of the home should be included in the H’s income (he’s CEO)
Court: requires him to pay tax on the fair rental value of the home: it’s compensation as part of his job: Salary in Kind
Why is in kind different than imputed?
                Economists: no difference
                But they are treated differently under the tax code
Problems on Page 72
                (1)          (a): No (it’s imputed income, which isn’t taxable)
                                (b): No
                                (c): Yes
                                (d): Yes
                (2)          (a): $200 of income for both
                                (b): No
 
Gifts and Inheritances
§ 102: Basic Rule: GI doesn’t include value of property from gift, bequest, devise or inheritance
                Gift:                       given with a detached and disinterested generosity
                Bequest:              personal property
                Devise:                 real property at death
                Inheritance:       intestate statutes
Commissioner v. Duberstein
                Issue: What do we do with “gifts” that take place in a business setting?
                Government argument: we want a bright line rule
                                (1): Payments to an EE from an ER should be taxable
                                (2): Gift’s cannot be deductible as business expenses
                                (3): A gift involves personal elements
                                (4): A corporation cannot make a gift of its assets
                Court: you can’t create a bright line rule
                                Instead: factual determination as to what the giver intended with the “gift”
                                Additionally: trial court needs to receive large amount of deference: they are present
                                Trial Court: has to evaluate from an objective standpoint: giver calls it a gift: not enough
                “detached and disinterest generosity” – This is the test
                                Applies to gifts, bequests, devises and inheritances
                Duberstein: not a gift
                Stanton: need more info (ultimately was found to be a gift)
Problems on page 84:
                (1):         Because it is a factual basis determination
                (2):         Tips are a part of compensation
§ 102(c): “Subsection (a) shall not exclude form gross income any amount transferred by or for an employer to, or for the benefit of, an employee.”
Treasury Regulation (lists exceptions to 102(c)): 1.102(f)(2): Extraordinary circumstances, natural objects of bounty (family), and if the employee bears the burden: these may be excluded as gifts
                Example: you work for your Dad, and he gives you a TV
Problems on Page 86
                (1): Depends on the circumstances
                (2): Could go either way
(3): $2k from the ER: taxable; the $3k from coworkers: depends on why they gave it to him, but it seems like it’s excluded as a gift
Lyeth v. Hoey
                Court: MA law would treat this as not passing through intestacy
                                So the question for 102(a) is whether the property is acquired by inheritance
                                If it was: not includable in gross income
                Congress intended the tax code to be uniform though, so state law has no bearing
                SC: The petitioner is an heir, so the fact that he settled doesn’t matter: he’s still an heir
                                So it did pass by inheritance and is therefore excludable
Wolder v. Commissioner
                Is the money and stock left to the lawyer a bequest?
                                Test: Look to the intent (page 93) – this is an application of Duberstein
                Holding: it’s compensation: there was a contract, and this is just her payment on the contract
                You could argue that if you just had a promise and not a K, MAYBE it’s not income: probably not