Individual Income Tax – Forman – Fall 2014
I. Applicable Tax Rates
A. Tax Rates and Progressivity
ii. The federal income tax is progressive.
1. Arguments for:
a. Progressive tax rates ensure than an individual’s tax liability is based on his/her ability to pay (declining marginal utility of money, dollar worth less to wealthy person than poor person).
b. Wealthier individuals should bear a higher tax percentage of the total tax burden because they receive more benefits from the use of those tax dollars.
c. Progressivity accomplishes some degree of wealth distribution.
2. Arguments against:
a. Progressivity necessarily makes the federal income tax system more complex.
b. Often distorts a taxpayer’s decisions. (Less incentive to work for higher tax brackets, timing.)
c. Can cause inequities between similarly situated taxpayers.
iii. Effective tax rate (average tax rate) is used to describe a taxpayer’s liability as a percentage of taxable income.
B. The Impact of Filing Status
i. Individual’s tax liability depends on two variables: filing status and taxable income.
ii. Filings Statuses
1. Married Filing Jointly
a. Married couple filing one tax return; also available to surviving spouse (see §2(a)).
2. Head of Household
b. §2(b) defines a head of household as one who both maintains his or her home as the principal residence of a dependent and is neither married nor a surviving spouse.
3. Unmarried and Not Head of Household
4. Married Filing Separately
iii. Rate Tables
1. Page 1916 of code book contains current rate tables
2. Nearly all taxpayers pay less tax under the adjusted tax tables than they would under the basic rate tables in §1(a)-(d).
3. §1(f) requires inflation adjustments to the rate tables.
4. §1(f)(*) mitigates the “marriage penalty”” effect in the lower tax brackets.
5. Congress permanently extended the marginal rate tax cuts and reinstated the 39.6% rate for high-income taxpayers.
C. Liability for Tax and the Innocent Spouse Rules
i. Taxable Income = gross income – deductions
1. Gross Income §61
2. Adjusted Gross Income §62
3. Standard Deduction §63(c)
4. Personal Exemptions §151
ii. Voluntary Assessment: individual tax payers prepare and file their own federal income tax liability (tax return).
iii. §6012(a) requires taxpayers to file and return if their gross income exceeds certain minimum levels.
iv. §6072(a) requires most individuals to file a return by April 15, and if there is a tax due payment must be included, as required by §6151(a).
v. §6013(d)(3) imposes joint and several liability for an deficiency on the return for spouses filing jointly. This means either one can be liable to pay the entire tax deficiency resulting from the error. If the spouses do not wish to share liability, they file separately.
vi. However, there are instances where an “innocent spouse” can seek relief from joint and several liability under §6015.
1. Cheshire v. Commissioner
a. Mrs. Cheshire did not satisfy the requirements of §6015(c) because she had knowledge of the transactions that led to deficiency.
b. Subsection (c) allows for relief if the spouse establishes that in signing the return he or she did not know, and had no reason to know that there was an understatement. Two types of cases:
i. Omitted Income: cases in which the tax return failed to report taxable income. Use the knowledge of the transaction test – spouse’s actual knowledge of underlying transaction that produced the income is sufficient to preclude innocent spouse relief.
ii. Erroneous Deduction Cases: cases in which an incorrect deduction results in an understatement of taxable income. Tax Court applies knowledge of transaction test her too, but other circuits have used different tests.
vii. 3 Ways to Avoid Joint and Several Liability
1. §6015(b) provides relief for all joint filers who satisfy 5 requirements therein.
2. §6015(c) allows a spouse who filed a joint tax return to elect to limit her income tax liability for that year to her separate liability amount.
a. Applies only to taxpayers who are no longer married, or legally separated, or who do not reside together for over a 12 month period.
b. A spouse who had actual knowledge of an item giving rise to a deficiency at the time that the spouse signed the return may not seek relief under §6015(c).
3. §6015(f) Innocent Spouse
a. Authorizes the SoT to grant equitable relief from joint and several liability when relief is unavailable under §6015(b) or (c).
b. Except for the knowledge requirement of §6015(a)(3)(c) (the provision disallowing election of separate liability to a spouse with actual knowledge of the item giving rise to the deficiency), the taxpayer bears the burden of proving that she has met all the perquisites for innocent spouse relief.
II. Computing Liability for Tax
A. Determining “Taxable Income” (See Tax Ladder Diagram)
i. §63(a) tells us that taxable income means gross income minus deductions allowed by this chapter.
ii. §61(a) defines gross income as “all income from whatever source derived.”
1. Anything that is “income” is potentially subject to taxation.
iii. Taxpayer must have statutory authority for every deduction.
iv. §63(b) sets forth an alternate definition
ips to the taxpayer or be a member of the taxpayer’s household
ii. The taxpayer must provide over half of the individual’s total support
iii. The individual’s gross income must be less than the exemption amount
iv. The individual must be a citizen or resident of the US, Canada or Mexico
v. The individual does not file a joint return with a spouse
b. Qualifying children are those individuals who meet the following five part test under §152(c):
i. The individual must be the taxpayer’s child or sibling
ii. The individual must be under the age of 19 (or under the age of 24 and a full-time student)
iii. With some exceptions the individual must be a citizen or resident of the US or a resident of Canada or Mexico who does not file a joint return with a spouse
iv. The individual’s principal place of abode for more than half of the year must be the same as the taxpayer’s
v. The individual must not have provided over half of his or her own support
c. Special support tests are set forth in §§152(f)(5) for students and 152(e) for children of divorced parents.
d. §152(d)(3) makes accommodation for so-called “multiple support agreements.”
vi. The personal exemption is phased out for taxpayers with the income above a “threshold amount.”
1. The threshold amount under §153(d)(3)(A) is set out by reference to the threshold amount in §68(b).
2. $300,000 is the applicable amount for phase-out now, under §68(b)(1)(A), computation in §151(d)(3)(B).