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Federal Income Tax
University of Missouri School of Law
Hoyt, Christopher R.

HOYT // FEDTAX // SUMMER 2015

HISTORY/TAX POLICY

WHY do we have taxes? So gov’t spends $ on:

Local/ City & County level: Public schools (K-12), sanitation, roads

State: Schools (K-12, colleges), prisons, highways

Federal: National defense, social security, poverty programs

HOW is $ for taxes raised?

Local: Property tax, sales tax doesn’t make sense. (People could travel from one county to another too easily, thus avoiding the tax.)

State: 50/50 between income tax/sales tax

§ 9 state w/out income tax: Fla, TX, Nevada, Oregon, New Hampshire (but a huge property tax)

§ Sales tax:

· Easier to enforce than income tax

· But: recessive à poor people pay proportionately more than rich people

o Whereas income tax is a Robin Hood kind of tax.

Federal: Income tax 45%, Corp income tax 11%, social security tax 37%, excise tax 3%.

HISTORY of income tax

Under original Const – head tax (proportionate to population)

1800s-1910: Source of revenue for gov’t came from import tax (customs)

Civil War: Congress passed income tax (temporary)

§ BUT declared unconstitutional by Supreme Court à “Head tax” = in proportion to population

1913: 16th Am – gets rid of head tax (tax can be levied on a state), only very rich (2%) paid income tax of 6%. During WWI taxes increase, estate tax enacted (rich taxed double). 1932: Gift tax (life & death)

1939: 1st IRC (Title 26 of US code – tax statutes organized)

WWII: increase in % population paying taxes (6% à 75%)

1954: IRC reorganized & overhauled

1986: huge amendment – Internal Revenue Code of 1986 as amended. (Reagan)

How a TAX BILL becomes LAW

Compromise

§ Virginia Plan — original plan for the Const

§ Connecticut Amendment: tax bills can only start in the House, other bills in Senate.

1. Starts in House, drafted by Ways & Means Committee

2. Proposed law goes to House floor, they pass bill

§ House more in touch with the people à House controls taxes, can be voted out sooner.

3. Goes to Senate, new bill drafted by Senate Finance Committee (popular – 19/100 Senators)

4. Proposed law goes to Senate floor (law different from original one was b4 Finance committee)

5. Goes to Joint Committee for reconciliation, draft 1 bill

6. Goes to both House & Senate to approve

7. Goes to President to sign or veto

8. If President signs, then incorporated into Code

What should tax law accomplish – POLICY OBJECTIVES

Adam Smith said there should be four main goals of a tax.

(1) Economic Efficiency – want system that does not affect behavior

§ does interfere with efficient allocation of resources

(2) Equity (fairness) – should be seen as fair by taxpayers à more likely to comply

§ Horizontal equity – 2 people w/ same income should pay the same amount of tax

§ Vertical equity – based on income levels, rich pay more than poor

· Marginal Tax Rate – more u make the higher the rate.

· 2010: INC 35%, LTCG 15%, DIV 15%, 2011: INC 39.6%, LTCG 20%, DIV 39.8%

2013: INC 43.3%, LTCG 23.8%

(3) Simplicity – cheap to collect

§ sales tax & property tax win over income tax (harder to implement)

(4) Specific economic & social objectives

§ smth that could have been accomplished w/ direct spending

§ eg: encourage home ownership, quality childcare for 2 working parents, pick out daycare provider but take tax credit.

TAX EXEMPTIONS/FILING STATUS

Form 1040:

AGI (adjusted gross income)

– Standard deduction – 2015 NUMBERS

($6300 single OR married filing separately/ $12,600 married filing jointly/ $9250 for HoH + additional standard deductions if 65+ &/or blind) OR itemize

– personal exemption/dependent exemptions

$4000 single/ $8000 married + # of dependents – QC or QR who must also file their own return

Dependent’s return

AGI

LESS Standard Deduction – limited to greater of $1050 or [Earned Income] + $350, but up to $6300.

= Taxable income

à no need to file if AGI < standard deduction + personal exemption. But you still may want to if you have had money for taxes taken out of your check over the year. Get the money back.

Filing status — (violation of horizontal equity; based on last day of the year)

Single – not 65+ or blind (high tax rate)

Head of household (2/3 – ½ btw MFJ & S)

Married, filing jointly à MFJ (lowest tax rate)

DOMA – marriage btw man & woman – same sex couples can’t file married filing jointly

Married, filing separately à MFS (highest tax rate) (only recommend if divorce not final, especially if you think your spouse is cheating on his taxes.)

Surviving spouse/Qualifying widower à SS / QW (can use MFJ in first year after death, then can use QW for 2 years after IF they have a dependent child that qualifies.)

Head of Household (single/unmarried parent)

QC & QR, but QR cannot be through member-of-HH test, only through relationship test: i.e. cousin or unrelated dependent can never give basis for HoH filing status.

1. Unmarried taxpayer + 2. Maintaining a HH where you live w/ dependent(s) – must live together, must be principle home of the dependent (a qualifying child or qualifying relative who meets the relationship test) [ie. pay more than ½ cost for appt/house].

EXCEPTION to Unmarried:

Abandoned spouse – other spouse not home for last 6 months of the year; and the one who has the home has a dependent child, not a dependent relative (Otherwise, would have to file MFS) (Spouse who left must file a MFS).

EXCEPTION to Lives – Dependent parent does not have to live w/ taxpayer, but taxpayer pays at least ½ cost of maintaining home for parent = file HofH

EXCEPTION: Lives – Child living w/ you does NOT have to be a dependent of you (divorced dad claim child as dependent, but child lives w/ mom = mom can be HofH)

Maintaining a HH that includes a dependent unrelated friend who does qualify as a dependent

NO HoH filing status à file Single b/c does not satisfy relationship test.

FROM THE BOOK: To qualify for HoH rates, a taxpayer MUST:

Pay for more than half th

pouse on separate returns.

Neither spouse is required to file a return. (See page 3-17).

(6) Citizen/residency or Canada/Mexico.

Tiebreaking rules – not required, only if there is a fight btw parties: (parent wins, whoever has custody of child the longest, if joint – parent w/ more income, person w/ most income).

Qualifying RELATIVE

Benefits (1) Dependency exemption ($4000)

(2) HoH tax credit

Test

(1) Relationship (or member of HH) – related by blood – lineal ascendant, collateral ascendants (uncles, aunts), certain in-laws. Cousins – the only who do not meet.

A cousin may meet a member-of HH test & qualify as a dependent, but will not meet the relationship test -> no HoH filing status.

(2) Support – 50%+ paid by taxpayer – shelter, food, clothing, medical care.

Multiple support agreement – only one gets dependency exemption when mother in a nursing home & each of 3 children pays 1/3 of cost.

(3) Gross Income test – less than exemption amount, i.e. not if income > $4000/ year.

(4) Joint Return – if dependant is married, must file joint return & cannot be claimed as a dependent UNLESS would not have to file.

(5) Citizenship/residency or Canada/Mexico.

REGULATIONS – interpretations by executive power.

Eg 1.451-1 – 451 is the statute interpreted. “-1” is the type of regulation – income, procedural, estate, etc.

· (1) interpretive regulations – dep’ment of treasury.

o Courts more lenient to overturn but only if it conflicts w/ the statute (even if other interpretations can be reasonable).

· (2) legislative regulations – Congress instructs the Secretary of Treasury to come up w/ a regulation. à Courts give a lot of deference.

· 461 section, (h) subsection, (2) paragraph (A) subparagraph (ii) sub-sub-pararaph.

· Words of limitation – for purposes of subsection, for purposes of this title.

WHO IS THE TAXPAYER?

· 2 sources of income:

o Labor (services) — “Income is taxed to person who earns it” (Lucas v. Earl, 1930)

§ Garnishment: Chambers: Amts garnished are not excludable from income, full AMT taxed.

§ Agent: Schuster: Nun who turned checks over to org was earning wages on her behalf and not as agent, therefore wages were taxable

· Is the K w/ the order to do the job, or w/ the nun?

· She will get a charitable deduction though (only 50% taxed).

· Different eg: a plumber is an agent of Sears.