Federal Income Tax Outline Johnson Fall 2012
Introduction
· Deductions without an actual loss are highly illegitimate. Is it lost? – First and last question to ask. Adjusted basis is what is left.
· Tax code no longer describes the wealth of the nation. Sponge with no cellulose. All holes.
· Gross Income – Common abbreviation for income is Y.
Tax Litigation
· At common law, you couldn’t get into court with a tax problem.
· Most common place to go to court is the tax court.
o Others include the district court and the claims court in DC. These courts are known as refund courts. Permission to litigate only once you pay the tax. Only court you can get into without first paying your tax is the tax court.
o IRS gives you a letter, stating the deficiency judgment. Within 90 days, you have to put a petition into the tax court, so that you may litigate without paying the tax.
· Even federal courts usually go along with their states majority political party.
o Tax court and district court is appealed to the 5th circuit. Claims court is appealed to the federal circuit.
o Tax court is comprised of people who work in tax. District court is just general litigators.
o In the tax court, if you count by numbers, government wins 90% of the time. If you count by money, people win 90%. Lots of pro se litigants and solo practitioners come with no argument, and they lose. Money figure is more important. Shows more.
· If you have a good technical case, better to go before the tax court.
· Jury may not always be your friend. Juries have trouble with tax evaders – 85% disapproval rate of tax evasion.
o Claims court has no juries. Claims court is utterly and completely isolated.
· Fair amount of forum shopping when it comes to tax litigation.
· There are many differences between the circuits, and the SC has better things to do than settle the disputes.
· A tax SC has been proposed, and all cases would eventually end up there. Would create a uniform law. But taxpayers like the game-play offered by non-uniformity.
· IRS is very generous with settlement. IRS doesn’t want to litigate cases. They have too much to do.
o But the criminal sanctions are strict and imposed often.
Capital Gains
· For many years, rates for ordinary and capital gain were the same. When Clinton raised the rate for ordinary gain, Congress reduced the rates on capital gain.
· Section 1(h) states the favorable tax rate (15%) for capital gains. Badly drafted. Congress is trying to do too much, not very elegantly.
· Corporations don’t have any capital gain provision.
o Capital gain provisions are found between sections 1201 and 1273.
§ But the tax rate for capital gains in found in 1(h).
· All gains are off until death. 1014 of the Code says that when someone dies, his children receive a basis in the investments at the amount it is worth at that time, even if it has increased in value since the time the decedent purchased it.
· Section 1211 is a loss limitation. You can’t have a loss until you’ve showed your gains. You can always use your capital losses to wipe out your realized gains. But you can’t use your capital losses to offset your ordinary income. So you have to wait until you have capital gains in order to use your capital losses to offset the gains. Capital loss carryover lasts forever for individuals. Not true for corporations.
o Simons would say that you should be able to show your loss every year.
o $3K of capital loss is okay.
· Long term gain is taxed at 15%, and short term gain is taxed at 35%.
· Capital losses for individuals allow you to use up to $3K of your loss, even if you haven’t had any gains that year. Found in section 1211.
Business Expenses v. Personal Consumption
· Income tax is only taxing the money you are supposed to keep. Business expenses don’t fall into this category.
· Investment and savings are not deductible, section 263. Expenses for personal consumption are meant to be taxed, section 262.
· Commuting expenses are not deductible. It’s your decision as to where you want to live. If you choose to move further from your work was a personal one. Can’t give you an extra bonus for not living close to your work. Would penalize those that live near work.
· Epstein would argue that depreciable personal items should account for depreciation, or personal use, even if the market value of the car goes up.
o Doesn’t make sense. For personal use of the car, depreciation is not allowed, so why should the value of the car account for depreciation.
· Even if used in business, jewelry and land are not depreciable.
· Straight-line depreciation says that value of the car goes down as time goes on.
o We have to adjust basis downward as we allow for depreciation.
· Accelerated Cost Recovery System (ACRS) allows subsidies to be given for equipment.
o You get more than $4K in early years. In year 1, you will get deductions, and the deductions increase as time goes on. Faster than straight-line depreciation.
· During WWII, in order to beat Hitler, everyone began being required to pay income tax. Tax became worse on individuals and better on businesses.
o No limit on depreciation deductions for businesses.
Repairs
· Tax system is based on whether it was a repair or a capital expenditure investment. You don’t get to choose. Depends on the facts.
· Zimmern case – Tugboat originally worth $100K, but it has depreciated down to $15K. Adjust basis. Goes down by the about of depreciation you have had. Tugboat hits a rock and sinks. To pull the tugboat up will cost you $200K, and a new tugboat will cost $180K.
o If you haven’t lost it, don’t deduct it. Treat it as adjusted basis.
o Two steps. This is a loss. Depreciation doesn’t account for rocks sinking boats. Take a $15K loss, first.
§ Second choice is two investments. Buy a new boat and leave the old one at the bottom of the lake and buy a new one. Or pull up the old one. If you allow the $200K cost of pulling it up to be treated as a repair, you get a very large deduction, which reduces the cost of pulling it up. Makes you want to pull it up for tax reasons, despite the fact that it makes no sense in any other regard.
· Buying new tugboat is an investment or a capital expenditure.
· HYPO: Building has a roof that needs to be redone every 5 years. Buildings have a 39.5-year life on straight-line depreciation. Calvin thinks roof is a different asset, with a 5-year life on depreciation.
o No. Tax court says that roof is just part of a building. You can deduct the roof costs as a repair. Roof doesn’t get you any more building than you had before. Roof falling apart is in the nature of maintenance. Repair should be a capital expenditure that expires after a little bit of time.
o Terminology of “repair” gets in the way.
Fringe Benefits
· Consumer Sovereignty – Every taxpayer knows the best way to spend his money.
· Section 162 allows deductions for meals and lodging while away from your home on business.
o Section 132 says if an employee could deduct the cost if he paid for the item, go ahead and exclude it if the employee pays for it.
§ If you had bought the meal, the $100 would not have made it down to taxable income. The employer can take advantage of that fact.
· Economists say that this system is not in equilibrium. Why would you ever go down the left hand side when you could go down the right hand side, gaining more value for
gitimate things and establish taxation.
· If the employee could deduct it, then it is okay to exclude it.
Section 132(e) – De minimis exception
· If something isn’t worth the accounting is takes to measure it, don’t bother.
o The standard deduction works much better, because proof and audits are unnecessary.
Section 132(g) – Moving Expenses
· Whether you exclude moving costs or not shall be determined by whether the employee can deduct it. Specific rules for employee deductions are found in section 217.
o Section 217 includes arbitrary 50-mile rule. If you change jobs and it requires you to drive 50 miles, you can’t deduct moving costs. If you have to drive more than 50 miles, you can deduct moving costs as a business expense.
§ If you don’t have a new job, you don’t even ask this question.
§ But we want to treat people who get their employers to pay moving costs and those who have to pay themselves the same. Both of groups can deduct moving expenses if the 50-mile rule is met.
· Commuting expenses are not deductible. Commuting is considered a personal choice. You chose to live far from your employer. But, there’s an exception!
Section 132(f) – Commuting Exception
· If, and only if, your employer pays for it, you can have $100 a month for commuting, not to be included in your gross income. You can have $175 a month, if you used mass transit.
o Environmentalists fought this battle. All commuting expenses used to be deductible. Much smaller deduction and more is given for environmentally savvy transportation.
Section 132(j)(4) – Gym Memberships
· On-premises gym facilities can be excluded. Non-discrimination Rule – Have to provide the benefit to all employees within a reasonable group.
· Cannot possible make people count gym benefits by use. The same rule applies to cafeterias.
o Section 132(e)(2) says employer-paid gyms and dining rooms are considered de minimis and are not taxable.
Barter Transactions
· We want to run a tax system based on Market Transactions or Cash
o No tax where there is no market transaction.
· Revenue Ruling 7-24: Said Barter clubs were taxable
o Reason for this ruling is because quasi-money situation became too much like real money.
Section 119
· Employee may exclude meals and lodging provided by the employer, for the convenience of the employer.
· Jones – Jones is an army lieutenant. He has a cottage provided by the U.S. army. More extravagant but he still doesn’t have a choice.
o When an employee negotiates a contract to include meals, that is different. Employer doesn’t want to provide meals.
· Section 119 has two sets of rules that are supposed to ensure that we are dealing with incidental benefits.
o Has to be for the “convenience of the employer.” Not for compensatory reasons!
§ At least for lodging, has to be a condition of employment. If you don’t accept it, you will be fired.
o Also, has to be on business purposes.
