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Federal Income Tax
West Virginia University School of Law
Lathrop, Robert G.

                                                           Federal Income Taxation
 
I.                      PERSPECTIVE
 
A.      Impact and History of Income Tax – Tax Expenditures – probably not on exam. See notes
B.      Tax Terms and Rates
1.       Above the Line: Gross Income – § 62 Deductions = AGI.       
2.       Below the Line: AGI – Personal/Itemized/Standard Exemptions and Deductions = TI
3.       Progressive Rate Structure – increments of TI taxed at higher rates
a.       Marginal Rate – rate charged on last dollar of income
b.       Effective Rate – actual % of your income paid in tax taking into account all the different rates that you could pay in tax.
c.       Higher MR = Higher ER, BUT ER will NEVER equal MR b/c it’s the average of an ever increasing rate
 
Example – $30 k income –         1st $10k taxed at    5% = $500 in taxes                MR = 20%
                                    2nd $10K taxed at 10% = $1k in taxes                 ER = 3,500 = 12%
                                    next $10k taxed at 20% = $2k                        30000
 
C.     Capital Gains – gain from the sale/exchange of a capital asset
1.      capital asset includes stock, personal assets, home, jewelry – usually non- business assets
2.       capital asset does NOT include dividends, interest, bonuses, rents, royalties, or business assets
3.       long term – property held for more than one year – usually taxed at a lower rate than ordinary income
4.       short term capital gain – property held for less than one year – usually treated the same as ordinary income
5.       different rates apply to CG – if your MR is 15%, your CG rate is 10% – if your MR is above 15%, your CG rate is 20%
D.     Nature of Gross Income –
1.       GI – § 61 (a) (2) – all income from whatever source derived except as otherwise provided by statute e.g. wages, salaries , interest, dividends, and rents
a.       realization requirement
b.       receipt of an income benefit
2.      Exclusions from GI
a.       Proceeds of life insurance
b.       Gifts and inheritances
c.       Interest on state and local bonds
d.       Compensation for Injuries or Sickness and Damages
e.       Income From Discharge of Indebtedness i.e. bankruptcy/solvency
f.        Educational Provisions i.e. qualified scholarships/tuition reduction, educational assistance programs, US savings bonds
g.       Meals and Lodging Furnished To Employees in Certain Circumstances
h.       Other – adoption, foster care, military, etc. – see outline
 
E.     Computing Gross Income
1.       Step 1:        GI (all includable income) – (business related deductions) = AGI
Step 2:       AGI – (Personal exemptions i.e. dependents + standard deductions OR itemized deductions) = TI
Step 3:       TI x (Applicable Tax Rate) = Tax Liability
Step 4:       Tax Liability – Tax Credits = Tax Due
2.       credit is preferable to deduction b/c credit subtracts the dollar amount from TI whereas a deduction reduces the amount of income you pay tax on i.e. $30 credit is $30 less tax to pay, $30 deduction is like if you had just earned $30 less
 
F.     Deferral and Present Value
1.       AR – AB = Gain
a.       AR = amt. T

’er deducts contribution to plan, e’ee pays no tax until retirement
b.       MUST be nondiscriminatory – § 401 (a) (4)
c.       MUST be offered to employees w/in one year of service or upon reaching age 21 – § 410 (a) (1)
d.       vesting rules – § 411. E’er paid benefits must vest w/in five years. E’ee paid contributions must vest immediately
e.       mere promises to pay in the future are not taxable or deductible until year of payment
 
Benaglia v. Comm. – NOW OR NEVER? – P worked and lived at hotel w/free food and lodging. D tried to tax him on those benefits. Ct. said no b/c it was for the benefit of the employer, too difficult to value, and forced consumption. Now codified in §119 – excludes value furnished to e’ee, spouse, and dependents when for the benefit of the e’er.
Dissent – P’s meals and lodging wee compensation and an economic benefit
 
3.      § 119
a.       for the benefit/convenience of employer – must show a business necessity
b.       meals must be furnished on the business premises – e’er can’t give you money to go grocery shopping
c.       lodging must be on premises as a condition of employment
d.       must be for substantial non-compensatory business reason, not just to boost morale
e.       controversial b/c it leads to inequity problems