Knoll_Federal Income Tax_Spring_2012
Federal Income Tax – Key Provisions
Code Section
§61
Gross Income Defined – all income from whatever source derived
§61, 71-89
Items Specifically Included in Gross Income (not a comprehensive list)
· §71 – Alimony
· §72 – Annuities
· §74 – Prizes and Awards
· §79 – Group term life insurance purchased for employees
· §82 – reimbursement for moving expense
· §83 – Property Transferred in Connection with Performance of Services
· §85 – Unemployment Compensation
· §86 – Social Security and Tier 1 railroad retirement benefits
§101-134
Items Specifically Excluded from Gross Income (not a comprehensive list)
· §101 – Certain Death Benefits
· §102 – Gifts and Inheritances
· §103 – Interest on State and Local Bonds
· §104 – Compensation for injuries or sickness
· §104 – Amounts received under accident and health plans
· §106 – Contributions by employer to accident and health plans
· §108 – Income from discharge of indebtedness
· §117 – Qualified Scholarships
· §119 – Meals and Lodging furnished for the convenience of the employer
· §121 – exclusion of gain from sale of principal residence
· §125 – cafeteria plans
· §127 – educational assistance programs
· §129 – dependent care assistance programs
· §132 – certain fringe benefits
· §135 – Income from United States Savings Bonds used to pay higher education tuition and fees
§62
Adjusted Gross Income Defined – look here for above the line deductions
· 62(a)(1) – Trade and business deductions
· 62(a)(2) (A) – Reimbursed Employee expenses
· 62(a)(3) – Losses from sale or exchange of property
· 62(a)(4) – Deductions attributable to rents and royalties
· 62(a)(6) – pension plans of self-employed
· 62(a)(7) – retirement savings
· 62(a)(10) – alimony
· 62(a)(15) – Moving expenses
· 62(a)(16) – medical savings accounts
· 62(a)(17) – interest on education loans
§63
Taxable Income defined – look here for below the line deductions
· 63(c) – Standard deduction – for non itemizers
· 63(d) –Itemized deductions
· 63(e) – election to itemize
§151
Allowance of Deductions for Personal Exemptions
· In 2001 – personal exemption is $2900, in 2000, was $2000
· §151(d)3 – personal exemption gets phased out once reach certain income level (about 200,000)
· §151(d)4, companion provision, inflation adjustment — in the case of any taxable year, the dollar amount shall be increased based on the cost of living adjustment
§152
Dependent Defined – taxpayers also entitled to exemption for each dependent (includes children, grandchildren, parents and other relatives, and unrelated members of taxpayer’s household, more than ½ of whose support for taxable yr provided by taxpayer);
§162
Trade or Business Expenses – there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business . . .
· deduction may be above the line or below the line
§163
Interest – There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness
· deduction is limited
· may be above the line or below the line
§212
Expenses for Production of Income – In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year
· for the production or collection of income
· for the management, conservation or maintenance of property held for the production of income or
· in connection with the determination collection or refund of any tax
· deduction may be above the line or below the line
§67
2% Floor on Miscellaneous Itemized Deductions – In the case of an individual, the miscellaneous itemized deductions for any taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds 2% of any adjusted gross income.
· If your expense is not on the list in §67, by default it is a miscellaneous itemized deduction and thus subject to the floor.
· Deductions not subject to the floor include (not comprehensive):
o interest – § 163
o casualty losses — §165(a)
o taxes – § 164 (state, local, and property)
o charitable contributions — §170, §642(c)
o medical expenses – § 213
o moving expenses – § 217
o annuity mortality losses – § 72(b)(3)
§64
Ordinary income defined – any gain from the sale or exchange of property which is neither a capital asset nor property used in a trade or business.
§65
Ordinary loss defined – any loss from the sale or exchange of property which is not a capital asset.
I. INTRODUCTION
a. History & Overview of US Taxation
b. Choice of Tax Base
i. marginal tax rates
1. limit disincentive to move into a higher bracket
ii. types of tax systems:
1. proportional: takes constant % of income
2. progressive: takes increasing % of income
3. regressive: takes decreasing % of income
iii. progressive tax rates
1. pros
a. utility comparison
b. tax revenues may increase as get more income from rich
c. * gov may use system to redistribute income / reduce inequalities
d. fairness: ppl who have more $ receive more from gov/society
e. protect consumer base by protecting base income for the poor
f. * essential to tax based on ability to pay
2. cons
a. disincentive to move to higher brackets; discourage work
b. fairness: poor may get more from gov than the rich / why penalize hard work (ew)
c. marginal rates may encourage manipulation
d. discourages savings
e. adminstrability / complexity
f. limit gov revenue to control its size
iv. facts: top 5% earn 17.6% income; wealth distrib even more uneven
v. criteria for evaluating taxes
1. equity: those w/ greater ability to pay should pay more
2. efficiency: interfere as little w/ ppl’s economic behavior
3. simplicity: minimize compliance, transactional, rule complexity
c. Computation of Tax Liability
i. income tax = ( taxable income [gross income – deductions] x tax rate ) – tax credits
ii. determine gross income (§61)
1. § 61 is non-exclusive list of sources of $ incl in gross income
2. incl compensation, fringe benefits, dividends, royalties, annuities, income from insurance, discharge of indebtedness income, pensions, income from an interest in an estate or trust
3. if it’s incl in GI, will be found in § 61, 71-89 of code
4. does not incl excluded categories listed in § 101-134 of code
iii. subtract above the line deductions (§62)
1.
married couple w/ total income $16,400 has no tax liability ($10k std ded + $6400 personal exemptions)
from gross income to calculate adjusted gross income
2. these deductions include: (above line)
a. ordinary + necessary business expenses – §162
b. reimbursed business expenses – § 62(a)
c. expenses from performing artists – § 62(b)
d. losses from sale or exchange of property – §161 + §62(a)(3
e. alimony by payor – §21
f. other: performing artists, pension plans, unemployment comp, jury duty, moving expenses, etc
3. it’s above the line if in §62. with §162, 212, 163 it depends
iv. subtract personal deduction in form of either itemized deductions or standard deduction in order to get taxable income (§63)
1. deductions for personal exemptions – for TP/spouse/dependents (§151)
a. $3200/person, $6400/married couple
b. §151(d)(3): personal exemption gets phased out once reach certain income level (adds to progressivity of the Code – the phaseout is a hidden increase in marginal rates)
c. §151(d)(4): companion provision, inflation adjustment – in the case of any taxable year, the dollar amt shall be increased based on cost of living adjustment
2. std / itemized deductions:
a. standard deduction (§63(c)):
i. $5000/person, $10,000/married couple
ii. policy: administrability, no need for TP’s records)
b. itemized deductions (§63(d)):
i. subject to § 67 2% floor of AGI
1. aggregate of misc itemized deductions must be > 2% to allow itemization
2. only excess over 2% floor is deductible
ii. subject to § 68 phaseout
1.
§151 + §68 phaseouts = hidden marginal rate increases
all deductions (misc + other) capped
2. exceptions that have own cap: (§ 68(c))
a. med expenses
b. investment interest
c. casualty losses
3. 3% haircut:
a. for every $ of AGI over threshold amt, lose 3% of deductions!
b. (another hidden marginal rate increase)
iii. non-miscellaneous itemized deductions (not subject to 2% floor) §67(b)
1. interest – §163
2. casualty losses – §165(a)
3. taxes – §164 (state, local, property)
4. charitable contributions – §170
5. medical expenses – §213
6. moving expenses – §217
7. annuity mortality losses – §72(b)(3)
wise employers would pay employees’ debts, etc in lieu of “income” to avoid taxes
c. Employee Fringe Benefits
i. non-cash, in-kind compensation from employer
ii. any fringe benefit not qualifying for statutory exclusion (§ 132(a)) expressly includible in income (subject to tax)
1. employer motive to compensate employee only (no employer benefit) = fringe incl in income
2. BUT something provided to employee for primary purpose of business + employer’s convenience will NOT be included in income
a. TEST: employer’s primary/dominant purpose/motive? lack of employee control over expenses? (Gotcher)
i. incidental personal benefit will not alone mandate inclusion
iii. employer can always deduct whole cost of fringe
1. b/c still business expense to employer (regardless of whether employee used it for business or personal)
iv. rationale for taxation
1. taxes serve as proxy for ability to pay – fringes part of ability to pay b/c free up $ which would otherwise be spent on supplied benefit
2. horizontal equity: similar jobs should be taxed similarly (radically diff non-taxed fringes would mean wide disparities)
3. vertical equity: better jobs usually more fringe benefits – w/out taxation, rich would get richer while poor have greater % of their income taxed
4. efficiency: if didn’t tax fringes, would lead employees to take compensation in forms that they don’t want b/c would be cheaper than cash at higher tax rates (don’t want to distort consumption decisions)
v. rationale for exclusion:
1. administrative burden of accounting not worth overall benefit to the system
2. want to encourage ppl to buy certain goods (health care)
3. political/historical reasons – certain fringes were initially de minimis and voters take it for granted that are excludable (change not worth potential political costs)
4. difficult to estimate value of fringe to employee
5. fringes partly non-compensatory as employer derives benefit from them
vi. work-related fringe benefits NOT included in gross income: (§ 132)
1. * non-discrimination RULE!
a. can’t favor officers, highly compensated employees, etc (132(h))
2. no additional cost service (132(b))
a. a fringe provided to TP that is 1) offered for sale to customers in ordinary course of line of business in which employee is performing svcs, and 2) creates no substantial additional costs to employer
b. if employees allowed to reserve in place of paying customers, will not qualify b/c revenue will be foregone
c. ex: empty seat on plane IF residual spaces
3. qualified employee discounts
a. savings by employee not taxable – only up to 20% off retail (svcs) or employers wholesale cost (goods)
4. working condition fringe (132(d))
a. * prop/svcs provided to employee that would be deductible as trade/business expense under 162 or as depreciation expenses under 167 if employee had paid for them out of own pocket
b. does not incl any amt that would be deductible for trade/business other than that of working for THIS employer
c. if employee uses fringe for both persona/business use: must substantiate what % used for business + only exclude that portion (274(d))
5. de minimis fringe (132(e))
a. excluded if value considering frequency so small as to make accounting impractical
b. employer-provided eating facility is de minimis if located on business premises + revenue exceeds/equals operating costs
c. 1.132-1, 1.132-6: incl things like meals for overtime employees, use of vehicle to get home after hours, etc
6. qualified transportation fringe…
7. parking (tradition rationale)
8. gyms (if on premises, operated by employer, non-discriminatory)
9. tuition assistance
