Individual Tax Outline | ID 77203 | University of Nebraska School of Law

BACKGROUND TO INCOME TAXATION

I. 16th Amendment (1913): Modern Income Tax
The Federal Income Tax is imposed on the income of:
–       Corporations
–       Trusts and Estates
–       Individuals

The Federal Income Tax is NOT imposed on the income of entities taxed as:
–       Partnerships
–       LLCs
–       LLPs
–       Income is passed through to the individual owners

             I.      TAX LAW APPROACHES
a.      Accurately measure income
b.      Pursue public policy goals outside of income
                                                              i.      Ex: Give tax breaks for various things

          II.      5 Steps to Computing an Individual’s Income (pg. 22)
a.      Figuring out Individual’s Income
                                                              i.      This literally means ALL your income
                                                            ii.      Gross income is defined in the IRC § 61
b.      Adjusted Gross Income
                                                              i.      Defined in IRC § 62
                                                            ii.      Get AGI from GI by subtracting deductions from GI (personal deductions)
c.       Taxable Income
                                                              i.      Defined in IRC § 63
                                                            ii.      AGI minus certain other deductions (below the line) is TI
                                                          iii.      This is the amount that we actually pay tax on
d.      Apply a tax rate to the TI
                                                              i.      IRC § 1 defines tax rates
                                                            ii.      Apply tables to compute a tentative tax
                                                          iii.      Ex: 15% x $5,0000 = $750 tax
e.       Apply any credits
                                                              i.      Tax law applies various credits

       III.      8 Questions to ask in connection w/ analyzing any tax problem:
a.      Is Income Generated?
                                                              i.      Do we have gross income?
1.      analyzing what is happening in a transaction to see if income was generated (what in substance is actually happening)
2.      Substance over form doctrine—Can’t just label something; what was actually done matters (i.e. can’t have someone mow your lawn and you just claim it was a gift)
b.      Is it ordinary income or capital gains?
                                                              i.      Deciding what is taxed at a more favorable rate
                                                            ii.      Congress currently has a lower top tax rate on capital gains than regular income (regular income top rate is 35%, and top rate on capital gains is 15%)
1.      Incentive to characterize income as capital gains
c.       Does a specific statutory exclusion from gross income apply?
                                                              i.      Income excluded from gross income
d.      Even if there is income, is there an offsetting deduction?
                                                              i.      What type of deduction (above or below line)?
e.       When is income reportable?
                                                              i.      Deals with timing
f.       Whose income or deduction is it?
                                                              i.      Parents may have incentive to transfer income to kids b/c they are in a lower tax bracket, for example
g.      What is the applicable tax rate?
h.      Do any credits apply?

       IV.      ORGANIZATION
a.      House of Representatives: Ways and Means Committee comes up w/ proposals and then referred to House of Reps.
b.      Then it goes to the Senate finance Committee and it needs to be approved by the Senate
c.       There are usually disagreements between the houses, so a Created Conference Committee to help w/ disputes. Then it goes back to House and Senate for subsequent approval, and then it goes to the President
d.      Joint committee on Taxation: Plays an advisory role only—made up of tax experts. Generally it provides an explanation of tax law to the rest of Congress

          V.      IRS IMPLEMENTATION (Tax Administration)
a.      Key department is the Treasury Dept., and the IRS is within that department
                                                              i.      In general, the treasury dept. as a whole does a study of tax law, and makes proposals of tax law
                                                            ii.      Since President is in charge of tax law, in a sense he is in charge of reforms of the law
                                                          iii.      Treasury dept. also interprets the revenue IRC, through treasury department regulations
                                                          iv.      The IRC and the regulations are the primary sources of authority

       VI.      Sources of Tax law:
a.      IRC (primary)—BINDING LAW
b.      Treasury Department Regulations (these have the force of law, although they are promulgated by the treasury dept.) (primary)—BINDING LAW
c.       Revenue Rulings—statements by the IRS of a factual situation, and how the IRC and regulations are applied to that factual situation
                                                              i.      Much more limited source of authority than regulations, but they can be useful guidance on the IRS’ understanding of the issue (that doesn’t mean the IRS is right though)
d.      Revenue Procedures—provide procedures for taxpayers to follow (general procedural guidance to taxpayers)
e.       IRS notice—Notice where the IRS says what they intend to do on an issue
f.       General Counsel Memoranda—Memos written by the IRS’ legal counsel on an issue. Often these include recommendations on how the IRS stands on an issue (freedom of information act requires these be made public)—these provide interesting insight on how the IRS will decide an issue
g.      Technical advice memorandum—written by members of the IRS National Office. These actually are usually initiated by a taxpayer, who says they want guidance, and then the auditor will get guidance from the National Office
h.      Field Service Advice—Informal
i.        Private Letter Ruling—request by a taxpayer to get guidance on their specific transaction in advance. Looking for assurance it will be taxed by the IRS the way they want it
                                                              i.      Significant part of tax practice involves these requests on behalf of clients. Very important for big transactions, where the client doesn’t want any chance that the IRS will audit them
                                                            ii.      Ex: Nursing home originally for charitable uses, and then there is a remodeling process where the nursing home wants to make more money, and they want to provide it for more upper-class people. Letter ruling may be necessary b/c taxpayers funds/bonds are being used, so want to clarify this is still considered charitable

    VII.      PROCESS OF FILING A RETURN
a.      Unique aspect of our tax system is we rely on a voluntary assessment system (gov’t trusts us to calculate our own tax liability)—file by April 15th
b.      Honest reporting is critical—Congress has adopted penalties if you don’t honestly report income
                                                              i.      Negligence Penalty—Equals 20% of tax not paid attributable to 1) negligence or disregard of rules or regulations or 2) substantial understatement of income tax liability or 3) valuation misstatement
1.      Avoid this penalty by fully disclosing how you computed your income, OR if you have substantial authority for the position you are taking, then you may be able to avoid this penalty.
2.      If taxpayer can prove reasonable cause for that portion of underpayment and that taxpayer acted in good faith, then they are probably okay.
                                                            ii.      Tax Shelters
1.      What: Schemes devised to pay an inappropriately low amount of tax through abuses of the rules.
a.      Congress has tried to regulate these.
b.      Now to be a tax shelter, then you have to register to be one, and then you are subject to stiffer penalties
                                                          iii.      Fraud
1.      What: Willfully and intentionally failing to report income you should have.
2.      Not only do you face criminal penalties, there are also civil penalties of 75% of what you should have paid
c.       Your return may subsequently be audited
                                                              i.      Only a small % of returns are selected for audit
                                                            ii.      Audit must commence within 3 years of due date of return
                                                          iii.      If you discover you made a mistake on your return and are entitled to more money, then you have 3 years to commence an action
                                                          iv.      The IRS has 6 years to come after you if fail to admit on your return a substantial income item (more than 25% of your return)
                                                            v.      Notice of Proposed Deficiency—given 30 days to respond: either agree to pay the tax, or appeal (you can appeal within the IRS)
1.      If the IRS appeals officer disagrees with you, you receive a notice of deficiency, where you have 90 days to respond and either pay the money or contest it in court
STATUTE OF LIMITATIONS:
      1. 3 years from the filing of a tax return to send a 90-day letter (6501(a))
      2. 6 years If Taxpayer omits and amount from FI that exceeds 25% of gross income w/o disclosure.
      3. NO SOL: If either 1) no return filed or 2) fraudulent with intent to evade tax

tirement allowances
b.      Form of Receipt:
                                                              i.      Any form of payment of taxation is included in GI
1.      Courts will not look to contract law to determine if something is a gift or services
2.      ISSUE: Courts will focus on INTENT of PAYOR to determine whether something is a gift or service- was it given to be compensatory for something received?
                                                            ii.      Old Colony Trust v. Commissioner:
1.      Facts: Wood was president of a company, and the company not only paid him salary, but they paid the income tax on his salary as well.
2.      Issue: whether the payment of the income tax by the company was additional income to Wood.
3.      Old Colony’s Argument: The Company was not intending to compensate the President for services. This was a gift.
4.      HOLDING: Supreme Court held that the payment of the taxes was valuable consideration paid in consideration for the services the President rendered as an employee.
a.      Court said it was income—under IRC § 61(a)(12) the company was discharging Wood of indebtedness.
b.      Payment of taxes was also clearly intended as compensation for services under IRC § 61(a)(1), as decedent only agreed to employment upon agreement to pay income taxes.
5.      Another example: OPRAH—giving away of cars example
6.      Today the law requires employers to withhold the amount of tax liability from an employee’s paycheck
a.      Employee = Primary obligation to pay taxes
b.      Employer = Secondary obligation to pay taxes
c.       IRC § 74. PRIZES AND AWARDS
                                                              i.      Prizes are taxed as income
d.      TAXATION OF FRINGE BENEFITS: Generally taxable income, UNLESS there is a specific statutory section excluding them
Fringe Benefit-in-kind benefits transferred to an employee, they may be additional compensation or essential to the performance of the employee’s job. They are transferred because the employee has performed a service for the employer and thus have a compensatory element, but they also are often for the benefit of the employer.
                                                              i.      IRC § 61(a)(1) says fringe benefits are generally taxable income
                                                            ii.      Many exclusions to fringe benefits as taxable income
1.      Rationale: The reason a lot of fringe benefits are not taxed is b/c they are forced on the employee—no control or dominion idea from Glenshaw Glass
                                                          iii.      TREASURY REG. §1.61-2(d) Compensation Paid other than in Cash: Confirms that the fair market value of fringe benefits must be included in your income (unless otherwise excluded)
1.      Services ßà Property: If services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation.
2.      Services ßà Services: If services are paid for in exchange for other services, the fair market value of such other services taken in payment must be included in income as compensation.
3.      Services ßà Price: If the services are rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary.
4.      HYPO: Employer subsidizes the rental cars for its employees. The normal rate is $500/week. The subsidized rate is $200/week. The FMV of the fringe benefit is $300.
                                                          iv.      Issues regarding fringe benefits:
1.      Equity: Implied that some employees may wind up paying less tax than others even though they received the same tax benefit (i.e. taxed on receiving $5K extra in salary; not taxed on receiving $5K extra in fringe benefit)
2.      Efficiency Concerns: Lead employees/employers to lean towards providing compensation in forms of tax-free benefits, even if employee would prefer cash