Individual Income Tax
Professor Thimmesch
Fall 2015
THE TAX CALCULATION
Gross Income (§ 61)
(Above the Line Deductions)
§ 62(a)(1)-(20)
Adjusted Gross Income
Less: Either
(Standard Deductions – § 63(c)) or
(Itemized Deductions)
(Personal Exemptions – § 151)
Taxable Income
*Tax Rate*
Tax Due
Apply Credits, if available
UNIT 1
TAX BASICS
TAX RATES
Progressive Rates Structure
Increases the rate of tax as income increases. Equalizes the “pain of paying.”
Built-in disincentive to earn the next dollar.
Effective Tax Rate
Applicable to taxable income as a whole.
Marginal Tax Rate
Applicable to the last dollar of taxable income.
Hypo: $1 to $100 = 10%. $101 and up = 50%. Income of $110.
Tax on the first $100 = $10
Tax on the next $10 = $5
Total tax = $15
What is this person’s tax rate?
Effective Tax Rate: $15/$110: 13.6%
Marginal Tax Rate: 50%
TAX EXPENDITURES
Tax expenditures are defined as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.”
Tax expenditures include any reductions in income tax liabilities that result from special tax provisions or regulation that provide tax benefits to particular taxpayers. Entitlements to those who meet the established statutory criteria.
This idea captures those items of deduction, exclusion, or credit that are really promoting some social policy goal rather than just trying to measure net income
Note: § 162 is not a tax expenditure provision because it is necessary for the income tax to be a tax on net income, and does not further some other goal.
Example: Home mortgage interest deduction. Congress intended to promote home ownership.
Deductions v. Credits: Deductions reduce income, while credits reduce tax liability.
A dollar of tax credit saves a dollar of taxes, while a dollar of deduction saves a fraction of that amount (depending on the TP’s tax bracket)
Hypo: $100 deduction for a TP in the 25% tax bracket saves $25 in taxes, whereas a $100 credit saves $100 in taxes.
ORDER OF AUTHORITIES
Internal Revenue Code – Title 26 U.S.C.
Treasury Regulations
Entitled to deference – persuasive to the court, but not binding
Treasury’s interpretation of the Code
Revenue Rulings
IRS saying this situation has come up, here is our analysis, and here is our decision.
Binding on the IRS
Good guidance for a practitioner
Private Letter Rulings
Private ruling just for the taxpayer – these cost $$$
TAX APPEAL PROCESS
IRS Audit
Internal IRS Appeal
Court
Pay and file a refund claim
District Court (appeal to circuit court of appeals)
Federal Court of Claims (appeal to Court of Appeals for the Fed. Cir.)
Deficiency Jurisdiction (not pay)
Tax Court (appeal to circuit court of appeals – Golsen rule)
The law from your circuit court of appeal will be applied
Bankruptcy Courts
GROSS INCOME
Different Formulation For Determining Income
Haig-Simons: Formula: Income = consumption + savings OR Income – consumption = savings.
Under this conception, almost everything under the sun is included in income
BUT: This is not sufficiently practical to be administered by the IRS.
This is not income under the Code.
Gross Income under § 61
(a) Except as otherwise provided in this subtitle, gross income means all income from whatever source derived including (but not limited to) the following items:
(b) Items specifically included in gross income, see part II, § 71. Items specifically excluded from gross income, see part III, § 101
Glenshaw Glass
“Undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”
COMPENSATION FOR SERVICES
§ 61(a)(1) – Compensation for services, including fees, commissions, fringe benefits, and similar items
§ 1.61-2(a) – In general, (1) Wages, salaries, commissions paid salesman, compensation for services, tips, bonuses, termination or severance pay, rewards…
§ 1.61-2(c) – Payment to charitable organization on behalf of person rendering services. The value of services is not includable in gross income when such services are rendered directly and gratuitously to an organization described in § 170(c). (i.e. pro bono services).
However, pursuant to an agreement, services are rendered to a person for the benefit of an organization described in § 170(c) and an amount for such services is paid to such organization by the person to whom the services are rendered, the amount so paid constitutes income to the person performing the services.
Remember: § 170 – Charitable deduction
Substance over form
§ 1.61-2(d) – Compensation paid other than in cash (i.e. paid for in property). Must be included in income as compensation.
Pay the Tax on the Tax
Old Colony
Facts: Company decides to pay the President’s taxes on his behalf.
Issue: Did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee? Yes
Rule: Under the Code, even the payment of your taxes constitute gross income.
This is an accession to wealth. TP is better off because of it.
Horizontal Equity: Two TP in the same situation should be taxed the same.
§ 1.61-14 – Another person’s payment of the taxpayer’s income taxes constitutes gross income to the taxpayer unless excluded by law.
Total amount the company would have to pay to ensure that the employer did does not have to pay tax?
Formula: Income / (1 – tax rate)
Ex: Watch = $1,000. TR = 25%.
$1,000 / (1 – .25) = $1,333
§ 1.61-14 – Treasure Trove. Treasure trove…constitutes gross income for the taxable year in which it is reduced to undisputed possession.
FRINGE BENEFITS
In kind benefits transferred to an employee
Generally, this is gross income under § 61(a)(1), but Congress has chosen to specifically exclude certain fringe benefits under § 132.
§ 132(a) – Gross income shall not include any fringe benefit which qualifies as a –
(1) No Additional Cost Service
(2) Qualified Employee Discount
(3) Working Condition Fringe
(4) De Minimis Fringe
No-Additional Cost Service – § 132(b): ELEMENTS
Service
Provided by an employer to an employee (See § 132(h))
Offered for sale to customers in the ordinary course of the line of business of the employer in which the employee is performing services
The employer incurs no substantial additional cost (including forgone revenue) in providing such service to the employee
Ex: Airline employees take an empty seat on an airplane that’s flying anyway
Note: If you can’t meet the elements of § 132(b), run through a § 132(c) analysis.
Qualified Employee Discount – § 132(c)
Employee discount?
§ 132(c)(3) – The term “employee discount” means the amount by which –
(A) the price at which the property or services ar
er-Provided Meals – § 119(a)(1)
By or on behalf of the employer for the: Convenience of Employer
§ 1.119-1(a)(2): Must be furnished for a “substantial noncompensatory purpose”
See (2)(b), (2)(c), (2)(e)
Generally being “on call” after business hours establishes they are for the convenience of the employer.
Implicit that it is noncompensatory, but must be reasonable
Business Premises
§ 1.119-1(c): Generally means the place of employment of the employee.
In certain circumstances it might be broader.
Question: Is this where work is done?
De minimis Fringe of Meals and Meal Money
If we fail § 119 – look to § 1.132-6(d)(2):
De minimis fringe benefit- occasional meal, or meal money provided to an employee is excluded as a de minimis fringe benefit if the benefit provided is reasonable and is provided in a manner that satisfies that:
(A) Occasional basis
(B) Overtime
(C) Meal Money
Employer-Provided Lodging – § 119(a)(2) & § 1.119-1(b)
By or on behalf of the employer for the: Convenience of the Employer
“substantial noncompensatory purpose”
Business Premise
Required for Employment
This means that as a practical, realistic matter – you have to be there in order to perform your job/duties. (i.e. hotel manager, on-call duty)
Employee could not perform the services required of him unless he is furnished such lodging. (See § 1.119-1(b))
Bengalia v. Commissioner: The manager of 2 Hawaiian hotels was given a room at the resorts for him and his wife. This was solely because he could not otherwise perform the service required of him since duty was continuous.
§ 1.119-1(e): MUST BE IN-KIND, NOT CASH.
The exclusion provided by § 119 applies only to meals and lodging furnished in kind by or on behalf of an employer to his employee. If the employee has an option to receive additional compensation in lieu of meals or lodging in kind, the value of such meals or lodging is not excludable from gross income under § 119.
Note: Cash payment or cash reimbursement to an employee is not excludable under § 119
§ 119(b)(3) – Fixed Charges For Meals
§ 119(b)(3)(A): If an employee is required to pay a fixed charge on a periodic basis for meals, and the meals are furnished by employer for convenience of the employer the amount equal to the charge is excludable from gross income.
§ 119(b)(3)(B): (A) shall only apply whether the employee pays the fixed charge out of his stated compensation or out of his own funds, and only if the employee is required to make the payment whether he accepts or declines the meals.
Hypo:
Employer A pays $95 and provides $5 meal under §119. Employee is taxed on the $95.
Employer B pays $100 and makes employee pay $5 for meal whether they want them or not. § 119(b)(3)
The two are in the same economic position.
