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

Federal Taxation Outline
Hoyt—Summer 2006
· How to Read Statutes
o 101(a)(2)(A)(i)
§ 101 is section
§ (a) is subsection
§ (2) is a paragraph
§ (A) sub paragraph
§ (i) sub sub paragraph
· History of Taxation
o Type of taxes
§ Local/county
· Schools, sanitation
· Largest source of revenue is property tax
§ State
· Education, highways
· 50/50 between income and sales tax
o income tax lower in cities b/c easy to avoid
o retailers collect sales tax for the government
· national sales tax is disadvantageous (regressive) b/c disproportionately paid by poor b/c have to spend all money to live, where rich are able to save money
§ Federal
· Social security, military pensions, social service pensions, national defense, etc.
· 45% income tax of people
· 9% income tax of corporations
· 40% social security tax
· 1% estate taxes
· power given by clause in constitution
o if taxes are leaved on the US population, must be proportional to the population
§ have to have a head tax—meaning if VA and NY had same number of people must collect the same from each person
· problem is that you can’t charge one person more then another
o income taxes were not allowed so government got revenue port taxes
o had to amend constitution to take out the head tax language (16th A in 1913)—only the rich were taxed
§ 1916 revenue act—estate taxes enacted
§ 1921—1st gift tax
§ WWII—only 75% of people were paying taxes
o 1921—tax statutes somewhat organized but were located throughout code
o 1939—dedicated the 19th title of code to taxes
o 1954—during cold war—finally got a comprehensive code, however everything thereafter was the 1954 code amended for 1960
o 1985—Regan said code too complicated, so enacted code of 1986 and is amended every year
· How is tax law enacted
o It is different from any other law
o Constitution gives special rules for tax law
§ Constitution requires that every tax law has to start in house of representatives
· b/c the theory was since the representatives replaced every 2 years, you can vote out the people you didn’t like to change the tax law
· our legislature is based on the two part model of VA house and senate
o CT which was small state objected, proposed 2 amendments that passed
§ Every state had 2 senators and
§ Must start in house
§ Committee in house that controls things (ways and means committee)
§ Senate finance committee
· Is the part of senate that takes the tax bill after it passes in the house
· They add all their ideas to the bill and take out some of the stuff from house
§ Joint Conferences committee
· Committee made up of house and senate reps they find all things that are the same and then barter to get the disputed provisions in
· Then passes in both house and senate and then goes to President who has power to Veto (has never happened)
· What should a good tax system go, Policies
o Economic efficiency
§ Tax law should interfere as little as possible w/ the optimal allocation of resources
§ High tax rates effect peoples behavior
o Equity/Fairness—2 Types
§ Horizontal Equity
· Provides that 2 people in same economic circumstances should pay the same amount of income tax
· Important b/c paying same amount will perceive the tax system as fair
· Violated b/c you pay less taxes if you are married
§ Vertical Equity
· Concept that the rich people should pay more then the poor
· Best example is progressive tax rates (there is a handout)
o Simplicity
§ Is important that the tax law be able to be understood by people—is view of sales tax
§ If a tax code is not simple it leads to people feeling that it is unfair, which can cause people to cheat
§ If the IRS is giving refunds and charging people during an audit on a provision—shows that people are not understanding
o Achieving economic and social objectives
§ We use the tax code often to achieve things that could be achieved through social expenditures
· Example: have the federal government provide day care or give tax brakes to parents needing day care
· Good Example: homeowners exception
o In Canada, no deduction for homeownership—means more people rent
o In US, deduction for homeownership—means more people own
§ Equity and Simplicity often conflict w/ one another

Single

· Pay highest tax rate
· Get to 35% faster if single then do if you are married (standard deduction $5,150)(itemize 3300)(number under 8,450 don’t have to file a return.)

Married Filing Jointly

· Gets the lowest rates
· Means both spouses sign form and both are responsible legally

Married Filing Separately

· Pays highest tax rates
· Means file own separate return, are only liable for own return

Head of Household

· Generally single parent
· 2/3-1/2 of the way between married filing jointly and being single in terms of paying most v. least
· TEST: unmarried individual, who pays more then ½ the cost of maintaining a household where they live w/ a dependent(qualifying child or qualifying relative)
o Exceptions
§ Child does not have to be your dependent
· Dad pays child support so he claims child as dependent, mom would claim head of household
· If mom who is unmarried, and daughter (age doesn’t matter) who is broken up w/ her husband and moves back in w/ mom, mom can claim head of household
· If the child is married then must be a dependent
§ Dependent parent does not have to live w/ you
· Often kids take care of elderly parents, could take mom as a dependent even though she doesn’t live w/ you as long pay ½ of moms living expenses—qualifies if mom is living in nursing home
o Abandoned Spouse—you are married w/ a child and your spouse had not been a member of the household for the last 6 months of the year (July-December)
§ Spouse walks out in May and can’t find to sign joint return—can file H of House
§ Spouse walks out in October and Can’t find to sign joint return—can’t file
§ Must have a child who is a dependent

Qualifying Widower

· Sometimes called surviving spouse—means that you qualify for the married filing jointly (lowest rates)
· If you have a married couple and there is a death, in the year of death you can file a joint return, (doesn’t matter if you have kids or not), the next year if you have no dependent children they you are single (unless remarried), special status qualifies if you have dependent child (2 tests: dependent and child)—then for 2 years qualify for joint rates
o Example:
§ In 2004 spouse dies: get to file joint return
§ In 2005 and 2006: get to file as qualifying widower as long as have dependent child
§ In 2007 and beyond: get head of household as long as have dependent child, then would go to single

Test for Filing Status

· TEST: what were you on the last day of the year
· If you get married on Dec. 31st, you were married all year
· If you get divorced on Dec. 31st, you were single all year

Defense of Marriage Act

· For federal law defined marriage as begin between one man and one woman—even if state has exception for homosexuals, doesn’t apply for federal purposes

Dep- Earened income=labor
a. don’t have to file if your earned is less than 5,150
Unearned income=investment- only have to file if more than 850
Business-if you have your own business, if you earn over 400 you have to file.
· Deductions
o Can do standard deductions or itemize
§ Standard deductions
· Single $5,150
· Married Joint $10,000
· Over 65 get an extra $1,250
· Blind get an extra $1,250
§ Itemize (1/3 of people do this)
o Personal deductions and dependents
§ For yourself get $3,200
§ Get $3,200 for each dependent
o AGI—Standard deductions—personal exemptions—dependent exemptions = taxable income
o Dependents
§ Is either a qualifying child or a qualifying relative (Handout)

Test For Dependency Exemption

Qualifying Child
(used for tax statutes too)

Qualifying Relative
(don’t have to apply to child under 18, but once turn 19 have to apply)

Relationship
1. Child (adopted, step, includes taxpayers brothers and sisters and their dependents)
2. Other blood relationship (cousins don’t count though)
3. Unrelated “member of household”

1. Yes

2. No

3. No

1. Yes

2. Yes (parents, grandparents, no cousins etc.)

3. Yes

Age
1. Child under age 19?
(under age 24 if

employees
§ Impossible to win in these cases
§ IRS goes after riches and easiest person to collect from
· Cases
o Chambers case
§ Tax court special court whose only job is to try cases (federal tax cases only)
§ Tax court decisions divided into two categories
· Regular opinions
o Important cases
· Memo opinions
o Are decisions the court decides aren’t that important
§ Facts: guy tried this case pro se (w/o a lawyer)—guys got wages garnished and decided he should only have to pay taxes on the amount of income he received, and not on the amount that was garnished (argued that b/c he never received the money so he shouldn’t have to pay taxes)
§ Court decided that he did have to pay taxes
o Schuster case
§ Clinic and there is a religious order and you take a vow of poverty, a nun belonging to the order worked for the clinic as a nurse and order wrote a letter to the clinic asking to have the checks made out to them b/c they were tax exempt, clinic wrote back and said they would make the checks out to nun
§ Order claimed that nun was the agent on their behalf collecting the money and therefore it was tax exempt
§ Court determined that it was taxable and that the nun could claim charitable donation exemption (maximum is ½ of salary) and then the rest is subject to taxes
· Forming own personal corporation—Self incorporation
o Must be very careful to always use letterhead and stationary w/ the incorporation name on it
· Accounting methods
o Cash basis—Revenue – Expenses = Profit

Cash Basis Method

Income—have income whether actual or constructive receipt

· Actual Receipt
o Have the check and have deposited it your account
· Constructive Receipt (1.451-2)(made available)
o General Rule: income although not in taxpayers possession, is constructively received when it is made available
o Defense in this situation would be if there was a substantial restriction or substantial limitation
§ 60 mile round trip is enough
o if IBM were to say if you stop now and meet these criteria we will give you a $20,000 bonus—not constructively received b/c there is a condition of quitting your job
o if at a new years eve party and client offer to pay you then and you say no wait till next year—must pay taxes b/c it was constructively received b/c it was made available
o if check bounces not constructively received b/c it was not available
o when there is still a price to be paid not constructively received b/c have to work for it—Ex: negotiations

Agents

· Delivery to the agent is delivery the principle and income is recognized even if handed to agent
· Doesn’t matter when the principle deposits/cashes the payment just when received it

Deductions

· Only actual payment qualifies (461)
· When you write and deliver a check—it is a deduction
· Mailbox Rule: only time tax law favors cash method
o Your client is a LL and T puts check in mail in Dec. and LL doesn’t get the rent till Jan. when does T deduct rent
§ T can deduct rent in Dec. when they wrote the check, the post office is deemed to the agent of the LL
o When the check is large make sure send by certified mail b/c IRS could want to make sure it was mailed
· If pay by credit card—you deduct when you charge it
o Logic is that when you charge something you are essentially taking a loan from the bank

Prepaid Income