Issues arise b/c of progressive taxation –people want to push income to low bracket taxpayers
2004 Consumer Price Index Adjustments- [TC, ix] Much of law in this area is case law or administrative (Rev. Rulings) not statute
It is difficult to shift income without giving up the property
You cannot shift income received from services received under same agreement.
The one area where income can be shifted, is divorce or separation (alimony).
The Taxable Unit
Taxation of the Family
o “Marriage penalty” is a tax penalty on 2-earner married couples by taxing them at a higher rate than unmarried individuals earning the same amount.
o Policy that a married couple must file a joint return unless they elect to file separately (limitations apply with MFS)
o Difficult if not impossible to treat everyone alike with progressive system that requires married individuals to combine their incomes – therefore the tax system is adjusted to make it more or less advantageous to being married vs. unmarried
o Assumption under IRS is that married individuals share their income, 2 people earn together less .
o 2001 Tax Relief Act – attempt to relive “marriage penalty” starting in 2005 and completely eliminated in 2008 or 2009
Marriage penalty does NOT constitute a direct legal obstacle on decision to marry therefore it does not violate the Constitution.
· Assistant US attorney challenged the constitutionality of rate structure that gives disadvantage to marriage
· D computed their tax based on MFS even though they were married
· D claimed that marriage penalty is unconstitutional b/c it unfairly discriminates against working married couples in violation of the Equal Protection Clause of the 14th Amendment
· Right to marry is considered “fundamental,” but reasonable regulations that do not SIGNIFICANTLY INTERFERE with the decision to marry may be imposed
· Marriage penalty is not a direct legal obstacle therefore does not significantly interfere and survives rigorous scrutiny
2003-85, 2003-49 IRB 1184 [TC, xi]
‘Remedying’ the ‘Marriage Penalty’
MFJ- If only one is earning the income, you get the same benefit as if each earned half the income and then filed separately. Designed to eliminate the ‘Marriage Penalty’ with respect to the 10% bracket (and anyone over it)
o NOW there is discrimination against single people. Where one TP is unmarried with taxable income (TI) of $58K. The other is married, also with a TI of $58K, with a spouse who has no income. The married person has less of a tax burden than the single person.
o Why the difference? Theoretically, the married people share resources. This is a lame argument, because look at two people living together under a lease (legal agreement about sharing expenses, much like marriage); they share resources much like the married couple, yet they get no tax break
o Note: once you get to the highest income bracket (above $319K), there is no difference in tax for these individuals
Difference in Standard Deduction [xi] o MFJ $9700
o MFS $4,850
Kiddie Tax: I.R.C. §1(g)
Children under 14 are taxed on “net unearned income” at the parent’s top marginal rate (e.g. interest, dividends).
Designed to eliminate a perceived abuse – that parents would put assets in names of children and therefore income would be taxed at children’s rate or not at all if under standard deduction and personal exemption
Represents a major step toward taxation based on family income
Amount taxed is that in excess of $650 reduced by greater of $650 or amount of allowable deductions that are directly connected with the production of the unearned income.
o Minimum of $1,600 of child’s unearned income is NOT subject to the kiddie tax and is taxed at the child’s marginal rate
o Anything over $1,600 is taxed at parent’s marginal rate
o “unearned income” is interest, dividends etc.
Parents may elect to treat children’s income as their own. If child’s income is between $500 and $5,000, parent can choose to report child’s income on return but rate structure is different then under kiddie tax. First $650 is not taxed, next $650 is taxed at 15% and anything over is at the parent’s marginal rate. The advantage is that the children do not have to file returns if this is their only income.
The $8,400 of net unearned income would be taxed at the parents’ rate, the remaining $1,600 would be reduced by the §63(c)(5) $800 standard deduction: If child’s income is between $500 and $5,0
id in state of residence will be recognized for purpose of determining deductible alimony payments. (Superseded by Rev. Rul. 67-442, below)
Facts: Couple were separated in 1965 and entered into a separation agreement. Husband obtained an ex parte divorce in Mexico. Wife was served in CT but never appeared in Mexico. Husband remarried. Ex-parte divorce in Mexico was ruled invalid. Husband continued to live with wife #2 and make separation payments to wife #1 under the agreement.
Issue: Are payments recognized as payments incident to a divorce?
Held: Yes. 2nd Circuit held that the payments were deductible as payments “incident to… a decree of divorce” even though the divorce was held invalid.
Rev. Rul. 67-442: 
Divorce will be held invalid if not recognized by state court.
IRS will not allow a deduction when a state court with jurisdiction declares a prior divorce to be invalid. Couple is considered still married.
This view was upheld in 9th Circuit and 2nd Circuit has limited the Borax finding to the alimony issue alone.
Davis (now codified in § 1041)
Facts: TP had property with AB of 60k and FMV of 100k. TP transferred property pursuant to a divorce decree for 100k.
Court said that, when transferred land, she was discharging a legal obligation, and therefore had a 1001 transaction, so she had $40K gain. (???)
Issue: Is this a realization transaction?
· If so, then he has $40k of gain. Remember tax results depending on what state you live in and what way you hold the property.
· It depends on if you live in a community property state (No realization, just a division of commonly owned property, even if divide right down the middle) or non-community property state, and it depends if you own property jointly.
Congress enacted § 1041 to prevent similar results like Davis