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

Federal Income Taxation

Professor Hellwig

Spring 2011

GENERAL CLASS INFORMATION

A. Note that this is a new casebook.

B. Ignore provisions in the statutory regulations book that talk about the law after 1/1/2011, because they were assuming the Bush Tax Cuts wouldn’t be extended.

C. The only thing allowed on the exam is the statutes and regulations book; no writing in the book, but you may tab. It will be a number of short answer questions (~15-20 questions). You can bring in a calculator.

D. Supplements–

1. Hellwig will put some information on reserve. The teacher’s guide to the textbook (with answers to the questions) will be on reserve.

I. Chapter 1: Introduction to Federal Income Taxation

A. Background–

1. Federal Income Tax comprises of approximately 1/2 of the federal government’s income stream.

a. Currently less because of the downed economy and stock sales write-offs.

b. The income tax revenue is approximately equal to employment tax, currently. Employment tax includes the medicare and social security, which is 15.3% total; half from the employee, half from the employer.

c. Note that while it nominally is half on the employer and half of the employee, realistically, it’s pretty much all born on the shoulders of the employee.

d. Note also that the social security tax is capped at ~$100K, while there is no cap on medicare.

2. The taxing power originates in the Constitution, Article I, section 8, clause 1 (“Congress shall have the Power to lay and collect Taxes, Duties, Imposts, and Excises . . . but all Duties, Imposts, and Excises shall be uniform throughout the United States.”).

a. Duties, Imposts, and Excises must all be uniform. Equality in taxes are only subject to the political system.

b. Direct taxes, i.e., taxes directly to individuals, must be apportioned amongst the population (Apportionment requirement).

i. Early cases held that income tax was a direct tax on property as it applied to income received from property (e.g., rent).

ii. However, the 16th Amendment specifically gave Congress the power to lay and collect taxes on incomes, without apportionment.

B. Sources of Law–

1. Code– The Internal Revenue Code (IRC, Code) is one of the major sources of tax law (ch. 26 of the USC)

a. E.g., §61 – Gross income is all income from whatever source derived (not exactly clear, somewhat circular)

2. Regs– Next source, after the IRC is the Treasury Department Regulations. These are basically numerated as “1.[IRC code §] – X.” E.g., Treasury Regulation § 1.61–14.

a. There is an extreme deference to the regulations from the Treasury Department; almost as binding as the IRC. You can bring a challenge, but it is next to near impossible.

3. Revenue rulings– These are issued by the IRS, and address hypothetical situations and provides their analysis of that situation in light of the tax law.

a. These generally come up when issues are about to be litigated or they are about to audit someone and they think there are likely many people that will be affected.

b. The difference b/w revenue rulings and Treasury Dept. Regulations is that the regulations do not have to go through a public comment period, etc.; it is just the gov’t’s position. The only thing persuasive about it is the government’s analysis.

i. You can file taxes contrary to a revenue ruling, however you would probably have to litigate your stance.

4. Revenue proceedings– basically the same as revenue rulings, except deals with procedures.

5. Private letter ruling– When you ask the government to give their interpretation of how the tax law applies to a proposed transaction. You have to pay the government and have no precedential value outside of that specific taxpayer.

a. Although they have no precedential value, they still would show how the IRS interpreted a certain set of facts; may not have anything better.

b. The IRS, however, is not estopped from changing their position

6. Technical advice memorandum– This is basically the same as a private letter ruling, except it is requested by the government, e.g., what the headquarters is telling their IRS agents.

C. Tax Controversy Flowchart (Sources of Judicial Law)

1. The source of every tax controversy starts when you file your return.

a. We have a “voluntary system,” meaning you don’t wait for the IRS to send you a bill, you file your taxes voluntarily. For probably 98%+, filing taxes ends here.

2. The next step is the audit.

a. There is generally a 3 year statute of limitations (starting from the due date) to assess a deficiency in taxes.

b. Red flags for audits might be large deductions, extremely large offsetting losses (e.g., $150 million in capital gains and $150 million in offsetting losses), “Schedule C” income (if you are an independent contractor, not an employee, e.g., a lawn mower), etc.

3. A local IRS agent will send you a letter with the disputed taxes.

4. You can then either go to the IRS Appeals Office or pay the deficiency. Note that this whole time, they must keep in mind the 3 yr. statute of limitations.

5. A notice of deficiency (90-day letter) must be issued prior to the 3 year SOL. The SOL is tolled for 90 days.

6. You must file your challenge in the US Tax Court within 90 days or the Tax Court looses subject matter jurisdiction.

a. If you want to contest the tax without paying the deficiency, you MUST do it in the Tax Court. That

s less and less delicious.

i. This is the theory behind the progressive scale of taxes.

b. Whether or not the tax system is fair or not is essentially a political argument.

c. Transparency- How clear it is how much money you owe.

4. Time Value of Money-

a. The timing on paying money affects its worth. A $100 check right now is worth $100; a $100 check payable in 10 years does not have a present value of $100.

b. Conversion from IRA to Roth IRA; Government wants to do this so they can get the tax money now.

i. In order to incentivize people to do this, the gov’t has allowed you to pay half of the taxes in 2011 and half in 2012. This is an incentive because you are effectively decreasing your tax liability.

c. DELAYING TAX IS DECREASING YOUR TAX LIABILITY!

i. Ex., Equations for value of money, with tax paid in year 1, versus the value with the tax paid in year n. C = income in year 1; r = rated of return; t = tax rate.

1) Value [tax paid in y1] = C x (1 – t) x (1 + r) ^ n.

2) Value [tax paid in yn] = C x (1 + r) ^ n – C x (1 – t).

5. Why income tax?

a. Efficient (won’t curve behavior much [give up labor for leisure], not much deadweight loss, substitution effect),

b. Fair (doesn’t really single out any specific group of persons, income is a good proxy for wealth)

E. Overview of the Tax System–

1. Gross Income– all income from whatever source derived – §61.

a. Exclusions from Gross Income – Income not included in Gross Income – §§101-139A

b. Must be both realized and recognized–

i. Realized – The amount T receives on a sale or exchange in excess of her adjusted basis (gain) or less than her adjusted basis (loss) – § 1001(a).

ii. Recognized – the amount of gain or loss that is included in gross income for the year, certain gains and losses are subject to nonrecognition provisions in the code . The default is that the income is recognized – § 1001(c).

2. Deductions– Decreases taxable income, the value of a deduction depends on the marginal rate of tax.

Credits– Decreases the amount of tax owed, so a $1000 credit is worth $1000 (so long as T owes > $1000 of tax, unless the credit is refundable).