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Income Taxation
University of North Carolina School of Law
Bryan, Patricia L.

Income Tax Outline
 
1)      Chapter 1: Introduction
a)      Income as Tax Base, Tax Terms and Computation
i)        Why tax income?
(1)   Want to tax “ability to pay” and income tax is thought to be best indication of ability to pay that is also easy to administer. (others: property tax, sales tax, consumption?)
(2)   Goals of Tax: revenue and encourage certain social and economic activities; Transfers money to benefit us all
(3)   Ex. encouraging retirement savings or home ownership.
(4)   Way to encourage people to spend their money; to provide incentives for people to choose to give to charity rather than go on vacation
(5)   A way of promoting social/public policies/goals → lowering people’s taxes if they choose to make those choices
ii)      Who to tax?
(1)   Based on some grounding of ability to pay
(a)    Notions of equity
iii)    Tax Expenditures: Policies that are encouraged – similar to saying it is gov’t spending by giving up revenue that it could have collected
(1)   Charitable contributions
(2)   Education credits
(3)   Home ownership – interest is tax deductible
iv)    Terms
(1)   Above the line: The amount reduced from gross income before AGI
(2)   Exclusions: Amounts “excluded” from gross income
(3)   Deduction: Amounts deducted from your AGI
(a)    This only saves you money on your rate
(4)   Credit: Amount taken off of your taxes
(a)    Credit is BETTER than a deduction because you get a complete saving of that amount
(b)   A dollar for dollar savings
(5)   Income = Receipts – Cost of Producing them – Certain other Deductions
v)      Computation
(1)   Tax Base x Tax Rate = Tax 
(a)    Federal only has an Income Tax
(b)   Measured based on your increase in economic power over the year (pt. 1 to 2)
(i)     Includes Savings and Consumption (Personal living and family uses)
(ii)   Consumption + DNet Worth
(iii)Person who spends all of $200k salary and person who spends half and saves half is for income tax purposes taxed the same amt.
(2)   Gross Income (GI) § 61 à AGI § 62 à Taxable Income (TI) § 63
(3)   §61: Gross Income is “all income from whatever source derived” (economic benefit)
(a)    3 Things to know
(i)     Not limited to cash
(ii)   Timing – there must be a realization event (i.e. stocks, property); wait until you sale and compare to what you paid
(iii)There are lots of Exclusions (i.e. gift from parents)
(b)   Except:
(i)     Gifts and Inheritances: § 102 (excludable)
1.      Limited exclusion for gifts of $12,000 applies for gift tax purposes
2.      Donor has to pay a gift tax if he gives more than $12,000 – independent of the income tax
3.      Unlimited exclusion for the recipient
(ii)   Interest on State and Municipal Bonds: § 103 (excludable)
(iii)Fringe Benefits: §§ 119, 132 (excludable)
(4)   Gross Income – Business Expenses [§62] = Adjusted Gross Income
(a)    § 162ordinary and necessary business expenses
(b)   Alimony
(c)    Reimbursed employee business expenses
(d)   Above the line deductions – better than below the line
(5)   AGI – [Itemized Ded. or Std. Ded.] – Personal Exemption) = T.I.
(a)    Itemized Ded. are below the line
(b)   Standard Deduction – leads to ease of use; helps some people who don’t have many itemized deductions for example if they are renting;
(i)     If you take the St. ded. then you do not get the benefit of even a small amt. of itemized deductions
(c)    Choose the greater between itemized deductions or the standard Deduction
(i)     Itemized deductions
1.      Mortgage Interest
2.      State and Local Taxes
3.      Casualty Losses (above 10% of AGI)
4.      Medical Expenses (above 7.5% of AGI)
5.      Charitable Contributions
6.      Misc. Itemized Deductions – MID (above 2% of AGI)
a.       Unreimbursed employee business expenses
b.      Tax return preparation fee
7.      § 262: No deduction for personal, living, or family expenses
(ii)   Standard deduction: relieves people of hassle of keeping track of outlays
(iii)Corporation has no itemized deductions
(d)   Personal Exemptions are also subtracted from AGI
(6)   Taxable Income x Tax Rate = Taxes
(7)   Taxes – Credits = Tax Liability
(a)    Ex. EITC, Child Credit, amounts already paid/withheld by employer
(b)   Credit v. Deduction
(i)     Credit is a dollar for dollar savings on your tax
(ii)   Deduction is a percentage savings
(8)   Tax Liability – Payments = Money to the IRS or Refund  
vi)    Alternative Minimum Tax: Does it apply? § 55
(1)   Tax in lieu of, and payable if greater than, the tax computed under normal rules
b)      Tax Rates
i)        Policy
(1)   Horizontal Equity: We want people who make the same amount to pay the same
(2)   Vertical Equity: Progressive Rate Structure, which is achiev

much better off you are depends on the interest you can earn. (called interest rate or discount rate)
(a)    If interest rate is greater, amount you have to set aside is smaller (more benefit)
(b)   As term lengthens, PV decreases b/c have more time to let it grow (more benefit)
(3)   Example
(a)    If $10,000 is put into a retirement account an accrues 10% interested over 10 years the investor will have $25,937, which will then be taxed at say 40%, leaving him with $15,563
(b)   If the $10,000 could not be deferred, the investor would only have $6,000, and if he invests it for 10 years at 10%, he will only get a 6% rate because of the tax, and be left with $10,745, though already taxed, would be 69% of the deferred money
(4)   Importance
(a)    The issue is not whether the amount should be included, instead when it should be included in tax
(b)   When the government wants to encourage certain investments, they provide for deferral of taxes through vehicles such as IRA
(c)    If you can defer the tax without deferring the economic benefit, you benefit the taxpayer
ii)      Present Value of Money
(1)   Table 1.3 on Page 31
(2)   $6,805 is the present value of $10,000 in the future at 8% in five years
(3)   Discounting to present value determines the present value of money in the future
(4)   Rule of 72
(a)    Money doubles in X year if you dividing 72 by the interest rate
(i)     Example: At 12%, $1 will be worth $2 in 6 years (72/12=6)
 
iii)    Formula
(a)   PV = FV/(1+r)n     or        PV=FV *(factor)
(b)   FV= PV(1+r)n       or        FV= PV/(factor)
 
Gross Income (Wages, Salaries, Dividends, Rents, Interest, Gain from Sale)
                       (Excluded are Alimony, Discharge of Indebtedness)
–                      Deductions (Business Expenses, Charitable Contributions)
=          Adjusted Gross Income (Taxable Income) (minus any Statutory Credits)