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Income Taxation
University of South Carolina School of Law
Hellwig, Brant J.

Chapter 1: Introduction

Title 26 is the primary source of tax law
Administrative Authorities includeà

1) Treasury Dept. Regulations
2) Revenue Rules- Rev. Rules
3) Private letter ruling- no precedential value, only binding for the particular taxpayer

Case law- how does a tax controversy get into the courts?

Start w/ filing your return (since we have a voluntary tax system)
How are issues raised?

Pay too little tax, audit performed (less than 1% of returns) – SEE Option A
Request a refund of tax- SEE Options B

RAR 30-day letter- time allowed to seek administrative appeal hearing w/ IRS
Administrative Appeals conference w/ IRS
Formal Notice of Deficiency letter- 90 day letter-

Time allowed for seeking redetermination w/ Tax Court- if you miss that date, then have to pay deficiency and go to other two courts;
Have to send the letter to toll the 3-year statute of limitations on litigating deficiencies

A. Tax Court- Refuse to pay the tax

Taxpayer commences action without paying asserted deficiency
Most expertise
Constitutional (Article 1) status (can punish for contempt and issue writs)
Cases before one judge, no jury, opinion goes to chief judge, CJ can allow to stand or send to full court for review (most weight)
HQ in DC, but hold court in big cities
Appeals heard by Federal Court of Appeals of US

TC bound by squarely on point precedent from federal court district where appeal can be brought- Golsen v. Commissioner

B. Federal District Courts- pay tax, claim for refund

Tried before juries
Individuals- bring cases in district where reside, or Corporations- in PPOB
Appeals heard by district’s Ct. App.
Better for dubious legal claims b/c there is less expertise w/ tax law

B. US Court of Federal Claims- pay tax, claim for refund

No jury, residence doesn’t matter
Appeals heard by US Ct. App. for Federal Circuit

Reasons to choose one over another:

Finances
Jury trial
Expertise
Past record

Functions of Income Tax

1) Raising revenue
2) Allocates the cost of public goods and services among Americans on an ability-to-pay basis (designed to track after tax investment in a particular piece of property)
3) Social policy
4) Economic policy

Analyzing Tax Liability

Question 1- What is the applicable tax rate?
Question 2- What is the tax base, What is the tax rate applied to?

Tax Rate depends on taxable income
Taxable Income w/ non-itemized deductions =

Adjusted Gross Income – Standard deduction – Deduction for personal exemptions in § 151

Taxable Income w/ Itemized deductions =

Gross Income – Deductions allowed by C1, Subtitle A – and Deduction for personal exemptions
Claims Below the line deductions

Gross Income, § 61- Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following:

1) Compensation for services
2) Gross income derived from business
3) Gains from sale or disposition of property
4) Interest
5) Rents
6) Royalties
7) Dividends
8) Alimony and separate maintenance payments
9) Annuities
10) Income from life insurance and endowment Ks
11) Pensions
12) Income from discharge of indebtedness
13) Distributive share of p’ship GI
14) Income in respect of a decedent
15) Income from an interest in an estate or trust
Reg. 1.61-1(a)- Gross income includes income realized in any form whether in money, property or services
Reg. 1.61-2(d)(1)- If services are paid for in exchange for other services, the fair market value of such other services taken in payment must be included in income

Assignment of Income doctrine- prevents higher income taxpayers from transferring income value to lower income related taxpayers (like mother’s house being painted in exchange for son’s services, son has to report as his income)

Assumes that income would have been received by taxpayer had he not arranged for it to be paid to another.

Adjusted Gross Income, § 62- Gross income minus specified deductions (Usually business expenses)

NOT A DEDUCTION GRANTING PROVISION!
Used as interim measure to determine standard deduction (in lieu of making itemized personal deductions which are administratively burdensome)

Credits- taken against the TAX, §§ 21-53, reduces tax dollar for dollar

§31- credit for employee’s withholding tax for employers- Most Common

Deduction- reduces taxable income, thus reducing tax that is dependent on tax bracket

Reasons for deductions:

Permitted for the costs of producing income
Social and economic policies that aren’t integral to tax system

Currently deductible- entire amount at once
Capitalized deduction- Accounted over time- amount deducted over period of time
Process:

1) Is it deductible? Find Code section
2) Is it above the line or below the line? Look at § 62
3) Is the deduction subject to the 2% floor?

Two categories of deductions

1) Above the Line- Deductions listed in §62 for calculating AGI
2) Below the Line- Deductions applied after AGI computed

Gross Income
– §62 Deductions (above the line)
= Adjusted Gross Income
Then decide,
Standard Deduction OR
Itemized Deductions (below the line)
Then decide, is it subject to the 2% floor on Misc. Itemized Deductions

Taxable Income
Taxable income depends on whether Taxpayer Itemizes or uses Standard Deduction

against employee by employer directly to IRS counts as taxable income for employee because the taxes are consideration for services.

Payment of the tax was in consideration for services renderedà is a gain by the employee for his labor

Form of payment makes no difference
Discharge by 3rd person of tax obligation is equivalent to receipt by person taxed

Not a gift (which would be exempt)- even though gratuitous payment, still for services rendered (taxes due on stock given to employees- Noel v. Parrott)

GI may be realized in any form, whether money, property or services
If services are paid for in property, the FMV of the property is the measure of compensation; if paid for in the form of services, the value of the services received is the amt of compensation (compensation for services rendered)
Windfalls are taxable
Payment of employee’s income taxes or debts by employer increases employee’s taxable income

3. Source Matters when Congress says source matters: Statutory Exclusions

a. Gifts and Bequests
Code: §102; 274(b)(1); Regs: 1.102-1(a) to -1(c)

§102 excludes gifts as well as property acquired from a decedent through bequest, devise or inheritance

102(a) does not describe what a gift is thus we will see litigation

Ask whether the property/amount received is characterized as a gift, bequest, devise or inheritance?

INTENT of donor is critical in characterization
Statutory gift ‘proceeds from a detached and disinterested generosity out of affection, respect, and admiration, charity or like impulses

Two options for business in giving gifts:

1) Can transfer property to person, characterize as compensation, and get business deduction

Will mean no exclusion for person
But, get no deduction for gifts to individuals in excess of $25 per § 274(b)

2) Can report person’s characterization as excludable gift, losing deduction

Limitations on §102:

Gifts v. compensation: no gift exclusion for amounts transferred by an employer to, or for the benefit of, an employee. (§102(c)(1))
No deduction for gifts made by businesses to individuals > $25 (§274(b))(applies only to items excludable as gifts)

Statutory Limitations on the Exclusion – §102(b)

Two limitations on the gift exclusion:

All income derived from a gift is taxable to donee