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

Federal Income Tax Hellwig Fall 2017
 
Individual Tax Formula
Gross income
         –   § 62 deductions
         = Adjusted Gross Income
         –   § 63 Personal Exemptions & either Standard Deduction or Itemized Deductions
         = Taxable Income
 
            Taxable Income x Tax Rate = Gross Tax Liability
 
            Gross Tax Liability
         –  Tax Credits
         = Net Tax Liability or Tax Refund
 
From the chart:
[(Ordinary income – “above the line” deductions – personal exemptions – the greater of the standard deduction or itemized deductions) x taxpayer’s ordinary rate] + [net capital gain x taxpayer’s capital gains rate] – [credits] = tax liability
 
derivation of the basic formula:
the general formula is: tax liability = taxable income x taxpayer’s rate – credits
§ 63: taxable income = adjusted gross income – personal exemptions – (the greater of the standard deduction or itemized deductions)
§ 62: adjusted gross income = gross income – above the line deductions
§ 61: gross income = all includable income
So, gross income includes both ordinary income and capital gains for determining adjusted gross income, but since they are taxed at different rates the final formula separates them.
 
Distinguishing income tax from other taxes:
estate tax: paid on property over $ 1,00,000 – tax on the wealthy – being phased out by 2010, unless phase out repealed – originally intended to prevent huge wealth from being retained and passed on – raises very little revenue because the wealthy would rather give their money to charities
gift tax: paid on property given before death – similar to estate tax
inheritance taxes: state level – the heir is taxed on the property received
sales tax: federal sales tax is called excise tax (gasoline, liquor, firearms etc; tax is in the price) – state sales tax is a percentage imposed at the point of sale – paid by vendor on a periodic basis – customer is done with the tax once the purchase is made but does not take account of financial status of customer (poorer pay higher percentage of income in sales tax than the rich)
Value Added Tax – at each stage of production and resale, a tax is added – but refunds are issued to businesses buying for resale – each person in the chain polices the validity of the taxability of the purchase (selfpolicing tax) – withholding taxes are a good example of a self policing tax – VAT falls more heavily on the poor, like sales tax
Some items are exempt from sales tax or VAT tax
Property tax: every state and local – no federal property tax because clause in Constitution says a direct tax must be apportioned (each states share of the federal tax must be proportional to their population) – this results in a different tax rate from state to state and Constitution requires uniformity across the country – state and local taxes are assessed on value of property; same rate within the taxing authority – property taxes tend to be very politicized (especially in their relation to funding of public education)
Personal property taxes: avoided by not reporting the property or holding the property out of state
Hotel and tourism taxes: federal, state and local
Social security tax – 15.3% of all pay (7.65% by employee and 7.65% by employer) – capped at $102,000 for 2008 – for all employees but not independent contractors – easy tax to administer; no deductions, no exemptions – and no individual rights to a benefit (the essential aspect of a tax) – this is a flat tax
 
Marginal tax rate: tax on the last dollar of income – brackets of percentage of tax
Up to 10,000 pays 0%
10,001 to 20,000 pays 15%
20,001 to 30,000 pays 28%  each additional dollar pays 28cents
Effective rate is the sum of all the tax bracket effecting the tax payer
Example:
10,000 @ 0%  no tax on first 10,000
20,000 @ 50%   – half of next 10,000
total tax is 5,000
Effective tax rate is 25%
 
 
Chap 1: Orientation
I. A Look Forward
A. Understanding Income Tax
1.   More than just a numbers game, the study of tax involves both, clear reasoning and careful attention to policy considerations
a.   Why study policy?  It fosters an understanding of tax that permits lawyers to predict how unsettled matters will be resolved.
2.   Scope of Tax Law: has some effect on virtually every substantive area of the law.
3.   The Code
a.   The study of income tax begins with the Internal Revenue Code.
b.   The Code is often cryptic and difficult to understand.
B. Two Types of Tax Practice
1.   Reactive:  Tax practice can involve an application of tax principles to completed transactions.
2.   Planning:  Tax practice can also involve the structuring of proposed transactions according to tax principles.
 
II. A Glimpse Backwards
A. Law Prior to 1939
1.   The first internal-revenue tax law, enacted in 1791, imposed a tax on alcohol, while subsequent legislation imposed taxes on carriages, tobacco, sugar and other items.
a.   These taxes were abolished only a decade later – Pollock case
2.   Due to the War of 1812, taxes were again imposed in 1813, but were abolished five years later.
3.   first income tax imposed by Congress was enacted in 1862, and it taxed virtually everything.
B. Codification
1.   Tax laws enacted after 1862 were eventually codified in 1939.
2.   The Internal Revenue Code of 1954
a.   In 1954, the first major revision of the Internal Revenue Code was passed by Congress.
b.   Subsequent, less drastic revisions occurred in 1969, 1971, 1975, 1976, 1977, 1978, 1981, 1982, and 1984.
3.   The Internal Revenue Code of 1986
a.   In an attempt to simplify the tax code, in 1986, Congress replaced the 1954 Code with what it believed to

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IV. Tax Policy Considerations
Federal income tax is not neutral, for any activity that is taxed is discouraged, while any activity that goes untaxed is to some extent encouraged.
Taxation is a method used to indirectly “tinker” with the economy.
 
 
Identification of Income Subject to Taxation
Chap 2: Gross Income § 61
I. Introduction
A. Gross Income defined                         § 61
1.   § 61 defines gross income as all income from whatever source derived
B. Equivocal Receipt of Financial Benefit.        Regs 1.61-1, -2(a)(1), -2(d)(1), -14(a)
 
1.   gross income includes income from all sources, unless the taxpayer can point to an express exemption.  Cesarini v. United States.
a.  treasure trove is income
b.   claim of right doctrine: if money or property is apparently yours and yours to dispose of or spend as you will, even if there is a remote contingency that might negate that, you will be taxed on it
2.   So long as there is an economic benefit to the taxpayer, the income need not have come into his possession.  Old Colony Trust v. Commissioner.
a.   The tax was the personal obligation of the employee and the employer conferred a benefit to the employee by paying his debt to the IRS. (discharge of debt is considered gross income § 61(a)(12))
3.   Gross income is an accession to wealth, clearly realized, and over which the taxpayer has complete dominion.  (all gains are taxable income unless they are specifically excluded) Commissioner v. Glenshaw Glass Co.
a.   Punitive damages awards are taxable as gross income.
b.   Beck argues that the old definition from Macomber could apply (the gain derived from capital, from labor, or from both combined) – the treble damages are the investment of the time and labor required for the lawsuit to be pursued.
4.  Economic benefits are gross income, regardless of their source. Charley v Commissioner
a.   Travel credits (for the difference in value between a first class ticket and a coach ticket) converted into cash in a personal travel account established by an employer constitute gross income to the employee.
b.   Payments for tax purposes are characterized based on the payor’s motive and IRS can re-characterize a payment once it establishes what the payor was trying to do.