Federal Income Tax Outline

Federal Income Tax
Professor Morrison
Fall 2003

CHAPTER 1: Introduction
A. The Constitution and the Income Tax

A. Tax Payers and Tax Rates

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 would have 80K, while B would have 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.
*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

B. Tax-Rate System: The tax-rate schedules of § 1 apply to the taxpayer’s taxable income. Taxable income is computed by subtracting from the taxpayer’s gross income (See § 61) any allowable deductions.
§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 $11,493, plus 30% of the excess over $53,500.
•$11,493 is automatic
•With 100K, A is $46,500 over $53,500. This amount is taxed at 30%
(46,500 x .30) and equals $13,950 of additional tax.
•Tax Liability of A: $25,443 ($11,493 + $13,950)
•A’s marginal tax rate is 30%
•A’s average tax rate is 25.433% (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

C. Internal Revenue Service
*Major function is to see that taxes are collected
*“Letter rulings” in response to taxpayer requests for rulings on contemplated transactions are made public, but they are not meant to have precedential value.
*A ruling request must contain a complete statement of the facts relating to the transaction in question and copies of relevant documents.

D. 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 written protest or payment), a deficiency notice, or 90-day letter will be sent.
•Taxpayer