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Income Taxation
University of South Carolina School of Law
Davis, Tessa R.

Income Tax (Davis Fall 2015)

I. Preface

a. Function and Structure:

i. This book is about:

1. what items of income are taxed (and what types of expenses are deductible),

2. when such items should be taken into account for tax purposes,

3. who is the proper taxpayer to report a particular income or deduction item,

4. how different types of income are taxed.

ii. Intended to help reader understand complex law, with three passes through the system.

1. A First Glance: introduces basic tax tables and fundamental concepts of progressivity, marginal tax rates, and effective tax rates; also provides basic formula for computing tax liability of individuals.

2. A Closer Look: explores the meaning of gross income and examines federal income tax treatment of tax-payer costs.; consumes 4-5 weeks of class.

3. A Hard Stare: detailed examination of timing principles, characterization issues, personal deductions, and other more advanced topics.

iii. Suggested Study Approach

1. Skim the assigned readings in the casebook to get a sense of main topics covered in the assignment. Skimming lets you judge the time required to complete the assignment and helps you to budget that time effectively.

2. Read the assigned Code and regulation provisions carefully.

3. Read materials in the casebook, looking for connections that help explain or develop the assigned Code and regulation provisions.

4. Write out complete answers to “Problems.” Include Code, regulation, case or other authority for answers where appropriate. This forces you to articulate the rules as they apply to the fact pattern.; Also provides exam practice.

5. Go over the answers to the Problems with other people before class. Saves from embarrassment of saying something completely wrong in class and also helps you see other views of problems that you maybe missed.

II. Unit I: A First Glance

a. Chapter 1: Applicable Tax Rates

i. Organization

1. Title [26]-> Subtitles[A] -> Chapters [1] -> Subchapters [a] -> Parts [1] -> Subparts [f] -> Sections -> Subsections -> Paragraphs -> Subparagraphs -> Clauses -> Subclauses

ii. Other Sources of Authority

1. Congress writes Code, enforced by US Treasury Dept. and IRS.

2. Regulations

a. Proposed Regulations: treasury regulations drafted by the IRS and then published in Federal Register

b. Final Regulations: after comments from taxpayers, final regulation gets printed in Federal Register.

c. Temporary Regulation: effective immediately upon publication in the Federal Register; used in the meantime before the final regulation is published.

d. Interpretive Regulations: treasury regulations promulgated pursuant to the general grant of authority under § 7805(a)

i. Not subject to Administrative Procedure Act (APA)

e. Legislative Regulations: rules written by the Treasury under specific authority from Congress on technical issues.

3. Court cases

4. Income Tax treaties

5. Rulings and Pronouncements

6. Legislative History

7. When these conflict, the most recent publishing controls. (“last-in-time rule”), grouped in 3 tiers. Rule only applies to conflicts within a tier. 1 > 2 > 3.

a. Tier 1: Internal Revenue Code, Regulations, Cases, Treaties

b. Tier 2: Public Administrative Rulings, Legislative History

c. Tier 3: Private Administrative Rulings, IRS Publications

b. Tax Rates and Progressivity

i. IRC §1(a)-(d), (f)(1)-(2), (i).

1. As taxable income increases, so does the rate of tax (Progressivity)

a. Effective Tax Rate: aka average tax rate

i. Taxpayer’s tax liability as a percentage of taxable income.

b. Marginal Tax Rate: rate of tax applicable to the taxpayer’s last dollar of taxable income.

i. Makes lower tax rates on first dollars of income, therefore effective tax rate will always be less than or equal to the marginal tax rate.

c. Regressive Tax: all payers, regardless of wealth, pay the same rate of tax. (sales tax)

2. Arguments for Progressive Tax Rates

a. Ensures that an individual’s tax liability is based on his or her ability to pay.

i. Theory of the declining marginal utility of money

1. As one becomes wealthier, the satisfaction received from one dollar declines. Therefore, it is fair to tax the wealthy more than the less affluent person to whom a dollar has more value.

b. Wealthier individuals should bear a higher percentage of the total tax burden because they receive more benefits from the use of those tax dollars.

c. Accomplishes some degree of wealth redistribution.

i. Society should not allow any member to hoard all of its resources.

3. Arguments against Progressive Tax Rates

a. Progressivity necessarily makes the federal income tax system more complex.

i. Flat tax is much simpler.

b. Progressive tax rates often distort a taxpayer’s decisions.

i. Incentive not to work because more is being lost to taxes in higher tax brackets.

c. Causes inequities between similarly situated taxpayers.

c. The Impact of Filing Status

i. IRC §§ 1(a)-(d); 1(f)(8); Skim IRC §§ 2; 7703(a)

1. Filing Status:

a. Married Filing Jointly

i. Since 1948, married couples can file together as a single income, after disputes between states with community property laws and those without them.

ii. “if the couple is married on the last day of the taxable year, the couple can file a joint return for the year.” § 7703(a).

iii. Married couples with disparate incomes enjoy a marriage benefit by filing a joint return.

iv. Lucas v. Earl (1930): all wages earned by husband are attributed to husband, despite an agreement to split with his wife.

v. Poe v. Seaborn (1930): married couples may

x: the more you make, the more you owe

2. Regressive Tax: the more you make, the less you owe

3. Ability to Pay:

4. Benefit Theory: taxes provide benefits, especially used by those who make more money

5. Simplicity v. Complexity

6. Distortion: changing of rational decision-making due to tax implications

7. Vertical Equity: people who earn more should pay more, regardless of total within the household

8. Horizontal Equity: similarly situated people should be treated the same

iv. Deductions (§ 161): only deductions specifically authorized by the Code may be used to compute taxable income. Not every expenditure is deductible.

v. Adjusted Gross Income: gross income minus 18 specifically identified deductions

1. Also known as Above-the-line deductions

vi. Personal Exemptions: available to all taxpayers, and taken into account BELOW the line.

1. For the taxpayer and dependents and other spouse if filing a joint return.

2. Qualifying Relatives (five part test)

a. Individual must have one of seven listed relationships to the taxpayer or be a member of the household

b. Taxpayer must provide over half of individual’s total support

c. Individual’s gross income must be less than the exemption amount

d. Individual must be a citizen or resident of the US or a resident of Canada or Mexico

e. Individual does not file a joint return with a spouse

3. Qualifying Children (five part test) (if both qualifying relative and qualifying child are satisfied, the child controls)

a. Individual must be taxpayer’s child (biological or adopted daughter, stepson, stepdaughter, eligible foster child or any descendant of such child), or sibling (brother, sister, stepbrother, stepsister, half brother, half sister, or any descendant of such a sibling).

b. Individual must be under age 19 (or 24 and a full-time student).

c. Individual must be citizen or resident of the US or Canada or Mexico and does not file a joint return with a spouse

d. Individual’s principal place of abode for more than half the year was the same place as the taxpayer’s.

e. Individual must not have provided over half of his or her own support.

i. Support: no concrete definition, but regulations include food, shelter, clothing, medical and dental expenses, education expenses, etc.