1. Intro and History
A.Authority comes from 16A and Internal Revenue Code
B.Pros of income tax:
i. It’s based on ability to pay.
ii. It has horizontal (folk with similar incomes pay similar amounts) and vertical (poorer folk pay less) fairness.
iii. It’s an efficient major fund raiser: it raises funds w/o disrupting what’s going on in the marketplace.
There are two types of efficiency: admin (IRS) and compliance. These total about 8.5% (ie it takes 8 cents to get every $1 in revenue. Most of this (8%) is due to compliance (ie tax cheats)
D. It’s a countercyclical device: you lose your job, and your taxes go down. You probably get a refund, and you can use that cash.
i. Gross Income (GI): all income from whatever source derived.’ Cash, wages, services, capital gains, winnings, discharges of indebtedness all count
a. Imputed income: ‘income’ gained by TP doing services for himself (ie housewife doing daycare/home upkeep). This is not included in gross income.
ii. Adjusted Gross Income (AGI): Income less certain deds:
a. Ed expenses
b. Moving expenses
c. Self-empment expenses
e. It is also used to calculate other deds (ie medical expenses)
iii. Taxable income (TI): the amount of income on which you pay tax
a. Computed as AGI less below the line deds and personal exemptions
iv. Gains: amount received in selling less the cost basis.
v. Loss: if the basis exceeds the sale price
a. Both are only owed when they are realized (ie incurred when the property is sold).
b. Both can be capital or ordinary. Capital gains are taxed more favorable than ordinary income, but capital losses are generally limited in the extent they can be deducted
vi. Cost basis: what was paid for property adjusted upward or downward to reflect subsequent expenditures or tax benefits attributable to the asset.
vii. Exclusion: an item of income that does not have to be included in gross income
a. Property acquired by gift
b. Property acquired by inheritance
viii. Deductions: Costs incurred that can be subtracted form income
a. Above the line: deds subtracted from GI to compute AGI
i. Everyone can take these
b. Below the line: deds subtracted from AGI to compute TI
i. Only available to those who itemize
ii. Std ded can be used by those who don’t itemize
c. Standard Deduction: fixed amount set by statute for each filing status:
i. S and MS: 5350
ii. MJ: 10,700
iii. HH: 7850
ix. Personal Exemption: An amount used to reduce TI, which are phased out with rising AGI. Each TP gets one, plus one for spouse (MJ) and dependents
x. Credit: a dollar-for-dollar reduction of tax owed
a. Refundable: can bu used to get you cash back after tax liability has been reduced to 0
i. Example: EIC
b. Non-refundable: can only be used to reduce tax liability to 0
xi. Tax Rates: There are four tables, which vary according to marital status.
a. The rates are progressive–they get higher as income increases.
b. Average rate: amount of tax paid on income (ie, 25% on the first 20k and 50% thereafter gives an average rate of 40% on an income of 50K. There will be 20k in tax owed, and 20k is 40% of 50k)
c. Marginal rate: The rate paid on the last dollar of income (in the above example, this would be 50%, as that what is the highest rate paid on the last dollar of income).
D.General figuring of tax:
i. Calculate gross income
ii. Subtract ‘above the line’ deds to get AGI
iii. Subtract below the line deds (ie, itemized or std deds) to get taxable income
iv. Apply tax rate schedules to get tax liability
v. Apply tax creds to reduce liab.
E. Legis Process: Although congress has power to lay and collect taxes, most tax policy and admin decisions are made by exec. Pres will delegate to SecTreas, who will delgate admin to IRS and policy to Undersec for Tax Policy.
i. All bills originate in House, generally in Ways and Means Com meeting. SecTReas will frequently be the first witness. If approved, the bill is sent to House floor, generally w/ a limit on debate and amendments.
ii. Bills passing House go to senate, where they are looked at by Senate finance com. If approved, they go to floor, with no restrictions on debate or amendments.
iii. Conference com of House and Senate is called to reconcile differences in bills passed by each house.
iv. When approved by conf com, bills go to the floors again, and cannot be changed.
v. If passed, pres can sign or veto.
F. Admin Resolution of Disputes
i. SOL is generally three years. IRS can audit and correct up to that time from when return was filed, and taxper has that time to change the return. If there is fraud, there is no SOL, and taxper can agree to waive SOL.
ii. Role of Judiciary
a. District Court: on notice of deficiency, taxpayer (TP or tp) may pay it, then claim a refund of the amount paid, and then bring a suit to enforce that claim in ct (which can, theoretically, go all the way to scotus)
b. Claims Court: Same as above, but filed in the ct of federal claims.
c. Tax Court: tp may refuse to pay and (w/in 90 days) file w/ tax ct for review. This may be appealed to scotus, unless it is a small claim (under 50k). Those rulings are neither precedential nor reviewable. These opinions often have a lot of minutiae in the factual findings, but this stuff is generally necessary to distinguish cases (ie skip at your own peril). If a ruling is not issued form the bench, it will be referred to a conference of the tx ct judges who will then issue a decision. Appellate cts cannot reverse findings of fact unless the are clearly erroneous.
d. Golsen Rule: Tx cts are bound by precedents in Circuit cts of Appeal when TP would be able to appeal to that ct (ie 9th Cir would govern tax ct for tp in CA, but not one in NC).
2. Tax policy
A.Goals of a tax:
i. Equity: The tax burden should be shared fairly, and if tax policy is used to achieve other objectives, it should be done in a manner that minimizes interference with equity.
a. Horizontal Equity: Notion that people across the same economic strata should be taxed the same. Two people making 100,000/yr should have the same amount of tax due.
b. Vertical Equity: People in the top and bottom should have to pay fair and similar proportions of their in tax.
ii. Efficiency – If the benchmark is the allocation of goods and services that would occur in a market economy without taxes, taxes should not cause interference with economic decisions in these otherwise “efficient” markets. Further, tax structure should support economic stabilization and growth objectives.
iii. Simplicity – The tax system should permit fair and non-arbitrary administration, and should be understandable to the taxpayers, and administration and compliance costs should be as low as possible.
B.Types of Tax Structures
i. Head Tax: One tax, the same amount, on each person in the US. Just find out how many people are in the country,
a. But, this system would be a regressive tax system, placing a heaver burden on the poorest, because they pay a larger percentage of their income, violating the notions of vertical equity, where the tax system should be fair across economic levels.
ii. Consumption Tax: Placing a tax on what the populous spends
iii. Income Tax: Placing the tax base on the amount of money that each person “takes in” in a certain period of time.
a. Ability to Pay: tends to be the relative measure of fairness for this system.
b. Marginal Rate: The rate can change according to the bracket, so
C.Theories of income:
i. Bringing in of pleasure: This is the correct one, but it is not used as it is too hard to figure out the value of this stuff to tax it.
ii. Haig-Simon: Income = consumption +/- change in net wor
b. Offered for sale in the ordinary course of business of the employer;
c. Airlines letting empees ride on unsold seats
ii. Qualified Empee discounts: These are excluded if the discount does not exceed emper’s gross profit percentage. Services can also be included in this, so long as the discount is not more than 20% of the selling price of those services. The stuff must be the same as is provided by emper to the public at large
a. Real property and personal property commonly held for investment do not qualify under this rule (ie are excluded from being excludable).
iii. Working conditions fringes: Stuff that empee could deduct if he had to pay for them
iv. De minimus Fringes: Stuff that is so minimal considering cost and frequency it is provided so as to make accounting for the tax on it impractical (personal copies, occasional parties, etc.). Subsidized eating facilities are included in this if they are on or near the business premises, they make more than the operating costs, and non-discrimination reqs are met. Gyms are allowed under this is they are provided and operated by emper for empees.
v. Qualified tuition Expenses: for education below graduate level provided to empee, spouse, or kids, and non-discrimination reqs are met
vi. Qualified transportation fringe: monthly bus passes, etc
vii. Qualified moving expenses fringe
viii. Qualified retirement planning fringe
ix. Qualified military base realignment and closure fringe
b. Non discrimination reqs: All these must be offered (on substantially the same terms) to all empees, regardless of salary or title, not discriminating in favor of officers, etc. It has nothing to do with gender, race, etc.
i. This only applies if the FB is not useful for empees job (ie tax profs get a free copy of WSJ, and it is not discrimination not to give that to janitors).
c. Valuation: The taxable amount is the FMV, regardless of the cost to emper. R1.61-2d.
iv. S125: Cafeteria plan: employee may choose among a variety of non-cash non-taxable benefits or may choose to take cash (taxable):
a. w/o this plan, employee would be taxed on cash that he could have taken, even if non-taxable option were chosen (constructive receipt)
b. Allows employer to provide nontaxable fringe benefits to those who want them without disfavoring employees who have no need for them.
c. Offerings limited to group-term life insurance (up to $50K), dependent care assistance, adoption assistance, excludable accident/health benefits, and 401(k)
d. Use-it-or-lose-it: if you elect $5K child-care reimbursement, if you don’t use all of the $5K by the end of the year, you can’t cash out the rest.
v. U.S. v. Gotcher: H and W went on an expenses-paid trip to Germany to see VW up close as a precondition to buying into a VW dealership. H toured the factory and talked business, W did some sightseeing. Neither claimed it as income.
a. This is not income for H. If the dominate purpose of the trip is business, it is not income, even if some fun time is scheduled.
b. This is income for W, unless she had to be there for H to transact business.