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Federal Income Tax
University of Toledo School of Law
Tierney, James Edwin

Federal Income Tax

James Tierney

Spring 2011


I Constitutionality of Federal Income Taxation

A Constitutionality

1 Income Tax NO longer Un-Constitutional

i 16th Amendment to US Constitution gave Congress power to levy taxes on income but à provisions w/in the IRC may be found to be unconstitutional for other reasons

II Sources of Tax Law

A Primary Sources

1 Internal Revenue Code (“IRC”)

i Definition:

a = codification of Federal Income Tax laws passed by Congress AND codified in Title 26 of USC

(i) Code Ü LAW

2 Case Law

i Definition:

a = case precedent used by courts in subsequent tax cases

(i) Cases Ü LAW

B Secondary Sources

1 Regulations

i Definition:

a = interpretations of the IRC sections & provisions by the IRS

(i) Regulations Ü NOT Law, but are made to aid TP’s “understanding of” & “compliance w/” tax laws

(ii) However, IRS Regulations in existence in 1986 (@ time the new code was adopted) à are given full force & effect by courts

1. Courts believe Congress adopted new tax code w/ these Regulations in mind à if Congress had disagreed w/ their interpretations, they would NOT have included them

2 Revenue Rulings

i Definition:

a written declaratory opinions made by the IRS at the request of a TP regarding a forthcoming tax issue

(i) Revenue Rulings Ü NOT Law (“non-binding”) but can be used as persuasive authority

1. Ex: If I take a deduction for this & this on my tax return, will this violate tax code?

III Federal Income Tax System

A General Principles

1 The more $$$ TP makes à the more TP’s $$$ will progress through the tax system

i There are 6 layers/brackets of taxation

2 Kiddie Tax

i If a child under 18 has unearned income in excess of [a floating threshold], the excess will be taxed at the higher rate btw the child’s personal tax rate and the child’s parent

B Progressive & Marginal Tax Rate System

1 Progressive

i = applies increasingly higher tax rate in correlation to increases in income levels

2 Marginal

i = the increasingly higher tax rate is only applied to portion of income which exceeds certain $$$ amounts

a Only those dollars in the higher tax brackets are subjected to the higher marginal tax rate

(i) Ex: Married couple who has a taxable income of $14,000 would be taxed $1,400

1. However, if they earned $14,100, they will pay Ü

a. $1,400{14,000 x 10% } + $15{100 x 15%} = $ 1,415

3 Effective Tax Rate

i = the actual tax rate at which a TP’s tax liability is calculated

a Effective Rate is always less than the Marginal Rate

(i) *can decrease taxes by making “1 big pile of income” into “2 smaller piles of income”

1. Ex: TP can lower tax liability by à

a. having his income paid over a number of years

i. “deferred compensation”


b. having income paid out to a number of other TPs

i. “split income between spouse & children”

C Tax Year

1 For Individuals

i = tax year of individual TPs coincides w/ the “calendar year”

2 For Corporations

i = corporations can choose to correlate their “fiscal year” w/ their “tax year”

a Single Requirement à

(i) corporate tax year must begin on 1st day of some month AND end on 31st of some month

D Deductions (a.k.a. exemptions) / Exemptions v. Tax Credits

1 Generally, a taxpayer is better off having NO deductions at the end of the year b/c TP must spend $$$ in order to gain the deduction

i Deductions are only available for $$$ already spent– TP will not save more than your marginal rate

a Ex: if TP’s tax rate is 15%, every dollar the TP can deduct from his taxable income will only save him $0.15

2 Exclusions do not save TP any more than deductions, but the $ is excluded from the beginning when the $ is removed from the income pool (still save at marginal rate)

3 However, tax credits provide TP with the $$$ back w/out spending anything AND they give back the entire amount of the allowance

i Ex: if TP owes $25 in tax but gets a tax credit of $5, he gets the full $5, not just a percentage

IV Jurisdiction, Audits, & Tax Court

A Statute of Limitations

1 If TP Files a Tax Return à

i = 3 years from filing-date

2 If TP’s Tax Return Omits More Than 25% of Total Income OR when deductions taken are greater than 25% of TP’s total income à

i = 7 years from filing-date

3 If TP Fails to File a Tax Return à

i = Statute of Limitations never begins to run

B Audit Process

1 Commencement

i If TP receives a letter from the IRS requesting an audit AND TP disagrees à audit process begins

2 Preliminary Notice of Deficiency (“30-day letter”)

i If the IRS chooses to proceed with process à they will send TP written notice of the deficiency known as the “30-Day Letter”

a Essentially, this letter shows that the IRS is NO longer just investigating à they are moving towards legal proceedings

(i) *deficiencies can result from a TP’s talking improper deductions, hiding income, OR mathematical errors

3 Protest

i After TP receives “30-Day Letter” AND “amount of deficiency” from the IRS:

a If the amount exceeds $ 2,500 AND TP wishes to pursue administrative remedies Ü

(i) TP must “file a written protest” for an administrative hearing

ii Requirements of Protest:

a If “deficiency amount” is greater than $2,500, TP must Ü

(i) file a “written protest” seeking an “administrative hearing” w/in 30 days of receiving “notice of deficiency” from IRS

b If “deficiency amount” is less than $2,500, TP is automatically granted an “administrative hearing”

4 Administrative Hearing

i Most cases resolved at the admin hearing (a.k.a. appeals office conference)

ii If issue not resolved, proceed to 90-day letter

5 Statutory Notice of Deficiency

i 90-day letter = statutory notice of deficiency

ii 3 things occur:

a 90 day protection from IRS attaching property, putting liens on property, or freezing accounts

b 90 days within which to petition the US Tax Court

(i) w/out petition, not getting into Tax Ct

c if case not moved into Tax Ct or settled, then property will be attached, frozen, etc.

(i) TP can pays the tax, TP loses the right to go to Tax Ct, but TP can file for a refund

6 Court

i Whatever the route taken into court, TP is the petitioner/plaintiff and carries the burden of proof

7 Appeals

i Following US Dist Ct, US Claims Ct, or US Tax Ct – TP can appeal to US Ct of Appeal as of right

ii Not many cases appealed b/c heavily fact-drive

C Flowchart (“Getting into Court”)

Taxes paid on self-assessment tax system

TP Pays

30-Day Letter sent to TP by IRS

Audit Process

-IRS determines TP’s tax deficiency

NOT income until sold b/c à NOT clearly realized

4 Imputed Income

i Definition:

a Flow of satisfaction from goods & services that arise from a TP’s own efforts

II Reporting & Tax Calculation of Gross Income

A Who is Subject to Fed Income Tax & in What Amount?

1 Must have Ability to Hold Title to Property à

i Individuals (human beings)

ii Corporations

iii Trusts

iv Estates

2 Entities that can NOT hold title AND NOT subject to Income Tax?

i Partnerships

B Tax Imposed – § 1

1 Married Individuals Filing Joint-Returns AND Surviving Spouses – § 1(a)

i Requirements for Married Individuals:

a Married Individuals can “elect” to file jointly for a particular tax year, if they are à

(i) married on the last day of the tax year

1. i.e. December 31st


(ii) both spouses consent to joint filing

2 Heads of Households – § 1(b)

i Definition:

a = unmarried person who is NOT a surviving-spouse under § 1(a) who maintains a household in which there is at least 1 dependent

3 Unmarried Individuals – § 1(c)

i = any individual who is NOT married OR a surviving-spouse

4 Married Individuals Filing Separate Returns – § 1(d)

5 Estates AND Trusts – § 1(e)


I General Rule

A Gifts & Inheritance – § 102(a)

1 Rule

i gross income does NOT include the value of property acquired by à

a gift,

b bequest, devise, or

c inheritance

d (b/c already taxed at front end of transaction)

2 Exception – § 102(b)

i If the “gift, bequest, inheritance, or devise” is composed of income from property à

a = must be included in gross income

(i) Ex: Creating an income trust for child w/ right to income for life

1. the right itself is in the trust corpus, which is excluded, but the income paid to the child each year by the trustee must be included in the child’s gross income

II What is a Gift?

A Two Methods of “Gift” Determination à

1 Common Law

i Present Intention to give AND Delivery to donee AND Acceptance by donee

2 By IRS for Income Tax Purposes

i Requirement:

a Donor’s motive to make the gift must arise out of a disinterested & detached generosity

b No expectation of compensation

IV Employee Gifts

A General Rule – § 102(c)

1 Employers cannot make gifts to employees; all transfers considered compensation/gross income

B Other Instances of Gift v. Employee Compensation

1 Tips = gross income

2 Gifts from businessperson to businessperson = gross income (no disinterested/detached generosity)

3 Retirement Gifts

i In situations where an EE retires & is given gifts à must look at “Who is giving the gift” AND “Why they are giving?”