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Income Taxation
University of North Carolina School of Law
Thomas, Kathleen DeLaney

 
Income Taxation
Professor Thomas
Spring 2015
 
 
 
Structure
Tax liability calculation
  
 Gross Income (§ 61)
–  § 62 Deductions (“above the line” deductions)
= Adjusted Gross Income (“AGI”) (§62)
 
   AGI
– [Itemized Deductions (§ 63(d)) OR the Standard Deduction (§ 63(c)) ($6,200 in 2014 unmarried individuals, $12,400 married taxpayers filing jointly, $9,100 heads of households)], whichever is greater
– Personal Exemption (§ 151) ($3,950 in 2014; one for each of the following: (i) taxpayer; (ii) taxpayer’s spouse; (iii) each of taxpayer’s dependents. §151).
= Taxable Income (§ 63)
 
Taxable Income * Rate (§§ 1, 11) (progressive rates; rate applicable to last dollar of income earned is marginal rate; effective rate is tax liability for the year divided by taxable income (like average rate); implicit zero tax rate if income does not exceed some of personal exemption and standard or itemized deductions)
= Tax Imposed
 
Tax Imposed – Credits (§§ 21-53)
= Tax Liability
 
 
General
·         After going through above for tax liability, note that there is also an alternative minimum tax for individuals, set forth in §55
·         Ability to pay is the touchstone for allocating tax burdens
·         Goals of tax system: (1) fairness (goes to ability to pay); (2) administrability; and (3) efficiency (how will tax influence behavior?)
o   Horizontal Equity: Goal of fairness met through horizontal equity, where those making same amount pay same amount. $100k is taxed same, whether lottery winnings or wages
o   Vertical Equity: Ability to pay goes to vertical equity. Greater ability means pay more. Progressive or proportional rate structures accomplish this. Regressive doesn’t
·         If question on test asks about character, just know one year or less is short term, longer is long term. Can be long term capital gain/loss or short term capital gain/loss
·         For actual test, first thing prof. should see is the answer. Then show work. Bold/underline, whatever. Just make noticeable. Work helps for partial credit if answer is wrong
 
 
Deferral and its Value
FV = PV (1+r)n
Ex: C wants to know what is saved by pushing $10k tax five years into the future, assuming rate of 8%. 10k (1.08)5 = $6,805
 
Gross Income
 
What is income?
·         In SCOTUS case Eisner v. Macomber (1918) (now not good law), Court said income is “gain derived from capital, labor, or both combined”
o   In that case, stockholder got new stock certificate in mail as dividend (instead of cash)
·         Haig-Simons: Another possibility is Haig-Simons, which is consumption plus change in wealth
o   One problem with this is that change in wealth would be recognized whether you actually realize it or not
o   Also, change in wealth is not administrable. It would require a constant valuation of everything you have every year
o   Another problem is ability to pay. Having property of value doesn’t mean you have liquid cash to pay
o   Efficiency is an issue too. People would have to sell property more often. Might also get things that depreciate in value, like cars
·         The Code defines gross income in §61, which says “all income from whatever source derived”
o   Includes in §61 things like wages, interest, dividends, rents, and gains from dealings in property. §§71-140 helps lay out inclusions and exclusions
o   Commissioner v. Glenshaw Glass: Supreme Court set forth the new test in Commissioner v. Glenshaw Glass, where it defined income as “[1] accessions to wealth, [2] clearly realized, and [3] over which the taxpayers have complete dominion.”
§  In that case, Glenshaw won $800k in lawsuit, $324k of which was punitive damages. Glenshaw did not report that part of the amount as income
§  Accession to wealth is just change in wealth. Simple
§  Clearly realized is whether you realize the gain (liquidity)
§  Complete dominion just asks whether there are any strings attached
 
 
Noncash Benefits, Fringe Benefits
·         What if someone is paid with items (or services) instead of cash? (Objective FMV). Say, Professor Thomas paid with a car instead of cash? Is this income?
o   As reg. §1.61-1(a) says: Gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services.
§  There are exceptions, alluded to later, like stock-for-stock transactions. This is general rule though
o   If not, there would be horizontal equity problem. Person getting cash would receive less (after taxes) than person getting car. Also may hurt those who need cash (don’t have enough liquid) and not items like cars
o   Ex: A makes $5k month, pays $1k in rent. Employer offers to pay her $4k month, and pay her $1k in rent for her. Is that rent payment income? Yes. Payment in property/services is income
o   How much is property payment taxable?
§  Objective fair market value. Reg. §1.61-2(d)(1). Subjective value doesn’t matter. Even if Professor Thomas valued the car at $15k because it’s an ugly color, if the car cost the University $20k, that’s what is taxable as income
§  Same for services (fair market value)
§  Ex: Revenue Ruling 79-24
§  Situation 1, lawyer provided legal services in exchange for housepainter painting lawyer’s personal residence. No cash exchanged. This is includable in income because if services are paid for other than in money, FMV of property or services taken in payment must be included in income
§  Situation 2, apartment building owner allowed artist to live rent-free for six months in exchange for art. Gross income, same reasoning
·         BUT if something is not compensation, a court can make the determination as to its subjective value (how the recipient would value it) instead of using only objective fair market value
o   In Turner v. Commissioner, where person won cruise tickets from radio station, tickets were not transferable, had other restrictions, and selling them would cost time/money, so petitioners took the trip. Court determined the value to petitioners was $1.4k, even though face value was $2.2k. Fringe benefits, §61(d), go to compensation for services. They use fair market value. Non-compensation, like prizes or something, uses subjective value
·         What about fringe benefits (noncash workplace benefits)? Fringe benefits are noncash employer-provided benefits provided at no cost or below market price to an employee. Examples are meals, lodging, medical care, life insurance, discounts

ndent children (§132(h)). And retired/disabled employees
§  Reciprocal written agreements among employers operating similar business can qualify too (so, for example, one airline can let employee fly on another airline at no cost, so long as same requirements are met)
§  10. Qualified employee discounts (§132(a)(2); §132(c))
§  If employee is purchasing goods/property at a discount, employee can exclude the discount up to the employer’s gross profit percentage. §132(c)(1)(A)
o   For example, employer sells goods for $100k. Employer’s cost of goods is $60k. So gross profit percentage is 40%, which is $40k. Employer could offer its employees tax-free discounts of up to 40%
o   Gross profit percentage equals (aggregate sale price of goods sold [minus] aggregate cost of goods sold) [divided by] aggregate sale price of goods sold)
o   BUT discounts for property held for investment (as well as real property) are not excludable at all. §132(c)(4)
§  If employee is using services at a discount, employee can exclude the amount that does not exceed 20% of the price at which the services are being offered by the employer to customers. §132(c)(1)(B)
o   So 20% or less is deductible. Massage parlor offers massages for $100. If employee pays $80 or more, all deductible
§  Employee must work in line of business of the employer in which the item is ordinarily offered for sale to customers
§  Again, highly compensated employees can’t be favorably discriminated. §132(j)(1)
§  May be provided tax free to employee’s spouse, surviving spouse, or dependent children. §132(h)
§  11. Working condition fringe benefit (things that would be deductible if business bought it) (§132(a)(3); §132(d))
§  Defined generally as an property or services that could be deducted as a business expense under §162 or §167 if paid directly by the employee
o   §162 allows taxpayers to deduct all “ordinary and necessary” expenses paid or incurred during the taxable year in carrying on any trade or business
§  So deducting cost of professional journal if employee bore those costs herself is not taxed if employer supplies the journal free of charge
o   §167 allows taxpayers to take depreciation deductions on property used in a trade or business and held for the deduction of income
§  Examples are business use of company car, free subscription of magazine related to employee’s job, even private jet (if for business)
§  12. De minimis fringe benefit (§132(a)(4); §132(e))
§  Defined as any property or service the value of which is so small as to make accounting for it unreasonable or administratively impractical. §132(e)(1)