Federal Income Tax Outline

Federal Income Tax-Morisson- Fall 2011

CHAPTER 1: Introduction

A. Article I § 8 allows Congress to lay and collect taxes, duties, imposts and excise.

a. Limited in 3 ways:

i. Direct taxes must be apportioned among the states

ii. Raising revenue must originate in the House of Reps

iii. Taxes must be uniform throughout the US

b. 1913 the 16th Amend. has allowed Congress to tax incomes without apportionment

B. Internal Revenue Service

*Major function is to see that taxes are collected

a. *“Letter rulings” in response to taxpayer requests for rulings on contemplated transactions are made public, but they are not meant to have precedential value.

b. *A ruling request must contain a complete statement of the facts relating to the transaction in question and copies of relevant documents.

C. Tax Controversies: Taxpayers are required to file returns and pay the taxes due. If there is a controversy w/ reportable income, the following procedure is implemented:

(1) Action by the IRS: Most are settled by agreement b/t the taxpayer and Revenue Agent. If not, the IRS will send a 30-day letter explaining its determination/position.

•If no action is taken w/in 30 days by the taxpayer a deficiency notice, or 90-day letter will be sent.

•Taxpayer now has 90 days to pay up or file a petition w/ tax court. If neither is done, the IRS will assess the tax and demand payment by certain date, and then seize assets if that order is not complied with.

(2) Action by the Taxpayer: Possible avenues for the taxpayer in a dispute. Taxpayer should, depending on sum of the dispute, do research to determine the best possible course of action and/or venue.

(a) Contest liability in tax court (cannot be availed if taxpayer has paid the tax in full, b/c tax court is Art. I court, only having deficiency jxd) No jury, tax-court judge. Appeal would go to the circuit court of appeals, then to SC, which rarely grants cert. in tax cases.

(b) If you have money, pay it, then sue for refund in the federal district court.

Refund Cases— Probably good if you are weak on the Code. You will get jury.

(b) & (c). Gov is (c) Pay money, sue for a refund in court of fed. claims, appeal to the federal circuit in D.C.

rep. by the DOJ

*Taxpayer has a free choice of forum in tax cases, and b/c tax decisions of courts other than the SC are not always binding on other courts, questions of tax law often remain unsettled from many years.

•COA decision binds DC in that circuit

•Court of fed. claims must follow decisions of the COA for the Fed. Cir.

•Tax Court, must follow (per Golsen Rule) decisions of the court of appeals to which the case before it is appealable.

•Tax Court is an Article I court, which only has “deficiency” jurisdiction, and cannot be availed by a taxpayer who has paid the tax in full.

(3) Statute of Limitations: Time in which IRS must come after you and assess tax

(a) 3 Years: S.O.L. from the date on which the return was filed

(b) 6 Years: If return omits an item of gross income greater than 25% of the gross income shown on the return

(c) NO S.O.L: No Return filed, or files on in which that is false or fraudulent, with intent to evade tax.

D. Tax Payers and Tax Rates

a. Progressive Rate System: Income-tax rates for individuals and corps have almost always been progressive—i.e., tax on a high income is a larger percentage of the income than the tax on a lower income.

i. Proportional (not used): A tax on the same percentage of all income, i.e., 20% of all income. (A-100K, B-20K, after tax A = 80K, B =16K, A still has 5X the amount of income as B)

ii. Regressive (not used): A tax on the larger percentage of lower income than of higher incomes, i.e., a tax of 20% of the first 100K, plus 10% of the amount of income over 100K.

iii. Marginal rates: using the progressive rate structure to tax at incomes over a certain threshold at higher percentages as the income level goes up.

1. Top rates now are 35% for individuals

2. Non-corporate taxpayers who have “long term capital gains” are usually taxed at a maximum rate of 15%

3. Some capital gains are taxed at max. rates of 25-28%

4. Dividends received on corporate stock are usually also taxed at a max. rate of 15%

*After the progressive rate system is implemented, as a general rule, if A’s before tax income is higher than B’s before tax income, A’s after tax income will also be higher than B’s.

*A variety of tax provisions subject various kinds of income to lighter than normal taxation, to further non-tax policies favored by legislators

E. Tax-Rate System as defined: The tax-rate schedules of § 1 apply to the taxpayer’s taxable income.

a. Taxable income is computed by subtracting from the taxpayer’s gross income (See § 61) any allowable deductions.

b. §61 Gross Income Defined—encompasses only the gross amount of wages, dividends, interest, rent, etc…received by the taxpayer undiminished by any deductions attributable to such income

HYPO: (Progressive Structure) A, single male, has $100K of taxable income.

Rate schedule—Over $53,500 but not over $115, 000…is taxed at $10,815, plus 28% of the excess over $53,500.

•$10,815 is automatic

•With 100K, A is $46,500 over $53,500. This amount is taxed at 28%

(46,500 x .28) and equals $13,020 of additional tax.

•Tax Liability of A: $23, 835 ($10,815 + $13,020)

•A’s marginal tax rate is 28%

•A’s average tax rate is 23.83% (divided by 100K)

HYPO: A earns $50K a year, for ten years. B earns nothing in yrs. 1, 3, 5, 7 and 9 and 100K in yrs 2, 4, 6, 8.

Rate Schedule—0% of the first $25K a year of income plus 10% of the amount by which the taxpayer’s income exceeds $25K

•A, each year is taxed $2500. $25K for ten years

•B, is taxed nothing in 1,3,5,7,9. But in years 2,4,6,8,10 is taxed at a rate of 10% on the $75K. $7500 per year, or $37,500K total for years 2,4,6,8,10

CHAPTER II: The Concept of Income

A. Basic Tax Computations

a. §61 Gross Income Defined—encompasses only the gross amount of wages, dividends, interest, rent, etc…received by the taxpayer undiminished by any deductions attributable to such income. There are 15 types of income included.

* Taxable Income: Calculated by subtracting the taxpayer’s deductions from gross income. (If gross income is 200K, and deductions are 50K, taxable income equals 150K)

(1) Individual Taxpayers: Calculations of taxable income involves two steps

(a) Deductions (from § 62—above-the-line deductions) are subtracted from gross income, yielding a figure called adjusted gross income (AGI)

i) §62 encompasses all business expenses (except most employee business expenses), investment expenses pertaining to rents.

ii) Called “above the line deductions”

(b) Next, the taxpayer subtracts deductions for personal exemptions (not tied to actual outlays) and either (i) itemized deductions or (ii) standard deduction from AGI to determine taxable income. (If your itemized exceeds your standard, you deduct the itemized. If your itemized is less than the standard, you deduct the standard)

*All taxpayers will deduct their above-the-line deductions and their personal exemptions.

*Itemized deductions: deductions other than above-the-line deductions, personal exemptions and the standard deductions, i.e., charitable contributions, home mortgage interest, state and local income taxes, property taxes

*Standard deductions: Statutory Amount (usually 5K for married couple, 3K for individual)