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Federal Income Tax
Washington & Lee University School of Law
Hellwig, Brant J.

Fed Income Tax of Individuals
Fall 2013
·         SOURCES OF LAW
o    16th Amendment (1916) – source of the power of Congress to lay and collect taxes from whatever sources they are derived, without apportionment among the states and without regard to any census or enumeration
o    Internal Revenue Code  (IRC) Title 26 of the U.S.C., subtitle A is income tax
§  Tax law remand in effect until it is repealed or amended
§  Changes to the tax code are usually done through Congress and are called the Revenue Acts ( before 1939, a Revenue Act referred to the amendments, before the entire tax law)
§  Most current code à 1986
o    Treasury Department Regulations
§  Title 26 of the C.F.R.
·          “legislative regulations” are regulations issues under a specific grant of authority
o    Mayo Foundation for Medical Education in Research v. United States stated that Chevron deference applies to interpretive and legislative regulations
§  Treat regulations as binding authority
§  Interpretative Regs: treasury interprets what is passed by Congress
·         to challenge, TPer must show that it was beyond the scope of the power given to the treasury
o    as long as the interpretation is deemed reasonable, it will stand
§  Procedural Regs: regulations dealing with the administrative tax system à ie: where to file forms when are the deadlines
§  Proposed Regs:  regulations will be put out for comment before they become final
o    Rulings
§  Rev. Rulings: IRS will put out a fact pattern and then will say how the IRS would rule
§  Rev Procs.: will include procedural items that should be known
§  PLRs: a TPer can write the IRS for a fee and ask if you do X, what would the result be à only upheld in court for the TPer writing it
·         TAX RATES AND PROGRESSIVITY – IRC §1(f)(1)–(2),(i). IRC §1(a)–(d)
o    Federal Income tax is progressive à increase in income = increase in rate of tax
§  The greater the tax base, the greater the average tax rate will be
§  Each add’l amount of money is taxed at the next level
o    Tax Rates
§  Average tax rate: take total tax divided by the total tax base. (total federal tax paid divided by taxable income)
§  Effective Tax rate – a taxpayer’s tax liability as a percentage of taxable income
§  Marginal Tax rate – the rate of tax applicable to the taxpayer’s last dollar of taxable income
§  Effective tax rate ≤ marginal tax rate
·         Hidden marginal tax increases happen where one starts losing deductions due to increase income
·         2013: 5th bracket 33% à 36%, 6th 35% à 39.6%
§  Capital Gains – Preferential rates
·         If normal income tax rate under 25% à 5% (0% after 2007) §1(h)(1)(B)
o    This will go to 5% after 2013
·         If normal income tax rate 25% or higher à 15% §1(h)(1)(B)
o    This will go to 20% in 2013
·         Qualified dividend income is NCG and gets preferential rates §1(h)(11)
§  Regressive – all taxpayers pay the same rate of tax
o    Arguments in favor of progressive tax rates
§  Ensure that an individual’s tax liability is based on his or her inability to pay
§  Wealthier individuals should bear a higher percentage of the total tax burden because they receive more benefits from the use of those dollars
§  Accomplishes some sort of wealth distribution
o    Arguments against progressivity
§  Makes the federal income tax system more complex
§  It distorts taxpayer decisions
·         Such as incentive to work for more money or not to work at all, etc
o    More work for same amount of money
§  “Income Effect” (operates opposing substitution effect)
o    Less work bc the marginal dollar isn’t worth it à Mankiw
§  Mankiw – Op-ed
·         If taxes are raised, then at some point, the marginal dollar is not worth it to work for and he would choose leisure or other activities instead
o    “Substitution Effect”
§  Many people in the U.S. don’t have the option to tailor their jobs that much, so it may not be a good case for all of society
·         Encourage activity to avoid tax in the first place
·         Also might change the timing of income (time value of money)
§  Might cause inequities between similarly-situated taxpayers
·         Tax Liability – function of filing status and taxable income
·         FILING STATUS – IRC §§1(a)–(d); 1(f)(8). IRC §§2; 7703(a)
o    Married Filing Jointly § 1(a) – married couples are allowed to add their incomes together – tax table §1(a)
§  §7703: if a couple is married on the last day of the taxable year, the couple can file a joint return for the year.
§  Poe v. Seaborn (1930)
·         community property state, and the husband gets all of the income and the wife stayed home
·         in a community property state, they can divide the income equally
o    it is beneficial bc there would be less amount in the marginal tax brackets
·         SCOTUS ruled that dividing the income is ok, even if not in community prop state
§  Available for “surviving spouse” §2(a)
·         An individual whose spouse died in either of the two prior years and who maintains a home that is also the principal residence of his or her child or stepchild
§  Not available for Same-Sex Couples
·         IRS can levy taxes on domestic partners who live in community property states
o    subject to the same “income-splitting” as married couples Poe
§  Community v. Non-Community Prop. States
·         Community property States: divide income equally between spouses
o    As a matter of state law, for every dollar that comes in, it is owned by the spouses equally
·         Non-Community property States: Income is taxed in totality b/t spouses
§  Marriage Penalty – each spouse generates income
·         Sometimes MFJ actually causes one to pay more taxes than individual because more of the income is being taxed in the next marginal tax bracket
·         MFJ  tax brackets are adjusted to eliminate this
§  Marriage bonus – one person earning income in the family and they file jointly à only pay half of what the individual would pay
o    Head of Household §1(b) – one who both maintains his or her home as the principal residence of a dependent and is neither married nor a surviving spouse – tax table §1(b)
§  Must maintain the home for one-half of the year
§  “Dependents” includes children, stepchildren, grandchildren, step-grandchildren
o    Unmarried and Not Head of Household §1(c) – unmarried individuals that cannot claim head of household or surviving spouse  – tax table § 1(c)
o    Married Filing Separately §1(d) – married couples may file separately – tax table §1(d)
o    NOTE: Revenue Procedure – adjusts basic rates in the tax tables for specific years
§  Taxpayers pay less tax under the adjusted tax tables than they would under the basic rate tables in §1(a)–(d)
·         §1(f)(1) requires inflation adjustments to the rate tables
o    Based on the CPI of the previous year
·         §1(f)(8) mitigates the “marriage” penalty effect in the lower tax brackets
o    Requires that the ceiling of the 15% tax bracket for joint return filers be adjusted relative to the ceiling of the 15% tax bracket for unmarried taxpayers
o    Unmarried taxpayers can suffer a “singles penalty bc they are not married
·         §1(i)(1) introduced the 10% rate bracket (there are 6 brackets)
o    §1(i)(1)(B) sets fixed bracket amounts for the lowest rate, but §1(i)(1)(C) requires inflation adjustments to those amounts
·         §1(i)(2) provides for rate reductions applicable to the four highest tax brackets for all taxpayers
o    §63 à Two Methods for Computing Taxable Income
§  Taxable Income Formula §63(a) gross income – deductions allowed by this chapter (other than the standard deduction)
o    USE: if itemized deductions > std deduction
·         Gross Income §61(a) – all income from whatever source derived including, but not limited to, 15 examples set forth
·         Deductions – §161 à taxpayer must have statutory authorization for every deduction
·         Misc Itemized Deductions§63(d) – all deductions other than “above the line” deductions and personal exemptions
o    “below the line deductions”
o    §§67,68 impose limitations on the amount of itemized deductions that a taxpayer may claim in a taxable year
§  §67(a)  “miscellaneous itemized deductions” –  all itemized deductions other than the 12 deduction

y realized (3) complete dominion
§  Realization – taxpayer has received something severable for his benefit
·         E.g. acceptance of cash, but not appreciation of stocks
·         NOT borrowing on property or giving a gift
·         Finds/Treasure Trove
o    1.61-14(a) – taxpayer discovered an item and took possession of it
o    Cesarini v. United States (N.D. Oh. 1969)
§  Rule: Finding something of value that you reduce to undisputed possession is income. This was definitely income; the cash was not what they bought. 
·         This is something they didn’t have before, they are wealthier than the instant before when they didn’t have it.
·         Rev. Rul. 61, 1953–1
o    The finder of a treasure trove is in receipt of taxable income to the extent of its value in U.S. Currency
·         Barter EXCHANGE
o    Barter Exchange §1.61-2(d)(1): If services are paid for other than in money, FMV of the property or services taken in payment must be included in income. 
o    When enforcing: IRS doesn’t go after individuals mostly, but Barter Clubs
§  Courts look to timing
·         how close were the exchanges
o    if further apart, may begin arguing that they are gifts
·         intent  (did they expect something in return)
o    Are services being paid in exchange for other services?
§  Yes- the FMV of such services taken in payment must be included as compensation
·         IF a stipulated price, then that will be presumed to be FMV unless found to the contrary
o    Are services being paid in property?
§  Yes- then the FMV of the property taken in payment is included in income
·         Illegal Income
o    James v. United States (1961)
§  Rule: Illegal income must be included in gross income
·         Compensation for Services
o    Payments to Third Parties §61(a)(1)
§  §61(a)(1) – all forms of compensation for services must be included in gross income
·         Does not have to be received directly by the taxpayer
§  Old Colony Trust v. Commissioner (1929)
·         Facts: The Commissioner notified a president of a company that he was deficient in taxes.  It turns out that his company was paying the IRS what he would pay in taxes on his salary and then giving him his full salary.
·         Held: Pmts should be included in gross income
·         Rule: A  discharge by a third person of an obligation to him is equivalent to receipt by the person taxed
o    The taxes paid by the employer were consideration in lieu of services rendered and not a gift
·         Policy: The amount must be included in gross income, if ppl could get their employers to pay all of their expenses and taxes directly, everyone would
§  McCann v. United States (U.S. Ct. of Claims 1981)
·         Facts: The McCanns went on a trip to Las Vegas for a seminar paid for by Mrs. McCann’s company.  The McCann’s went on the trip because of Mrs. McCann’s selling insurance above and beyond a certain amount
·         Held: The trip was compensation and must be included in gross income.
o    The all expenses paid trip was an economic benefit to the McCanns for Mrs. McCann’s good sales techniques
o    The reward was not in the form of money but was compensation and within the meaning of income termed in §61(a) of the Code
o    §74(a) includes amount reserved as prizes and awards
o    Could also have been considered a barter exchange