Review Week 1

Tax is based on the Code: codified laws. Two basic questions:

What does the code say?

What does the code mean?: Regs. and Cases

Differences between Tax and Financial Accounting

law meets accounting: words and numbers

adversarial, not driven by "fairness"

not conservative

political as well as technical sources of tax rules

1. US Income Tax: Constitutional foundation

Art 1 Sec. 8 power to tax

16th Amendment: Power to Y tax w/o apportioning by population

1913 response to atrocious 1895 case holding the "Marxist" income tax not constitutional, because taxing land rent was "direct" and had to be allocated by population

Plenary Extent of Congressional power

Only 2 supreme court cases have since invalidated any aspect of a tax enactment by Congress

Eisner v. Macomber (1920): stock dividends not income because no realization. Continuing validity of Macomber dubious, but not come up as long as Sec. 305 in the code

Gore v. Evans: the "diminishment" clause for federal judges. Can't subject sitting federal judges to new tax (but can raise rates).

 

2. Tax Code Interpretation

Legislative history

A kind of fiction: they don't really read the stuff

Key usually the House, senate, conference reports

For relatively recent stuff, this is about the only guidance

IRS administrative rulemaking: levels of authority

Agency regulations

General regulatory power Sec. 7805, and sometimes specific delegated power, eg. consolidated returns

Only occasionally overturned by courts as unsupported by the Code

IRS Procedures & Rulings: how to do it, and statements of position on hypotheticals

Letter rulings: non-precedental transaction approvals

Info Publications: Can't officially rely, but solid guidance

Federal Court System

Supreme court. Discretionary review (rarely hears tax cases)

Circuit Courts of Appeal. Below Supreme. Fair ## of tax cases

Appeals from trials in district court

And in tax court: specialized, nationwide court

The law of the circuit

Each follows its own precedents, unless the Supremes have spoken. Means that a variety of different interpretations can creep in

Dist courts follow their controlling circuit

Tax court golsen rule: to what circ would this be appealed

IRS can relitigate issues in different circuits. May indicate intent to do so by "nonacq."

3. Tax Calculations

Overview

Most rules involve classifying transactions to determine what is income and what deductions are allowed to offset it.

The technical terms for the algorithm are: Adjusted gross income (total, w/o excluded items and less cost of getting it)- itemized (mostly traditional, non-costs of Y) or "standard", less "exemptions" equals taxable income

Brackets and Progressivity

Tax rates progressive: tax rises faster than Y

Brackets: rates change as the total amount of taxable income increases.

15% - 28% -31% -36% -39.6%

Example: 1997 tax for single person

Exemptions and Status

For indiv's, 2 sets of "family responsibility" adjustments (on top of basic premise that tax is individual by individual)

"exemptions"

an income subtraction of @2,650/yr for T and certain people who "depend" on T. Mostly minor children. Test for support, relationshiop, residency, Dep's income and child/student modification.

Additional special rules for multiple support, divorce, etc.

Filing status

 Different rate schedules reflect different family arrangements

Single, MFJ, MFS, H of H.

Marriage penalty issue

 if Y's equal; bonus if not = =.
because some states had comm prop, some not
50K MFJ is 8,644
MFS rates are the worst. Avoid!

Two difficult twists in the tax calculation.

Erosion of itemized deductions and exemptions

If AGI over cetain levels, itemized deductions and personal exemptions erode away: to raise more revenue at same rates by misdefining Y

Capital Gains

To extent TP's txbl Y consists of certain "net capital gains", property held over one year, special rates apply

Cap gains not taxed separately. Amalgamated in income and then separated out for speical rates.

1997 changes are a quantum leap in complexity
 

4. Tax Credits

Subtractions from tax. Some only current year, some have excess carry to other years, some refundable

Prepayments

Wage withholding

E'ee estimates withholding level on a W-4. Employer or payroll uses a lookup table

W-4 is confusing: translate itemized deductions into "equivalent" amounts of dependent exemptions

Also a 2-earner couple problem; W-4 tends to treat each as the primary earner who uses the lowest tax bracket. -- so they are underwithheld

Estimated Tax payments

a time value "penalty" if w/holding plus amounts paid in = quarterly installments don't cover the tax

note there's a 2 mo quarter and a 4 mo quarter

safe harbors: last years tax, 90% of current. (Exception for high income)

Payment to other jurisdictions: foreign tax credit

Payments by other entities. here, only a few RICS and Tip Cr for partner/owners in restaurants . Very common in european system

Subsidies run thru tax system

Business: R&D, Gasahol (former ITC)

Low income earners: EIC

Child Care

New: taking effect in 1998, for 4/15/99

Child

Education: Hope, Lifelong learning

5. Defining income

Section 61

Code defines by example: includes w/o limitation
Most topics in Sec. 61 are fairly clear
Q is how to handle things at the margin

"Economic income": Haig Simons defined (@ 1930's)

Clever identiry: flows in less costs equals current consumption plus/minus change in net worth

Academic economists love it, but it's unworkable for tax

Need to value assets at market annually
• Consumption value of personal assets:
•   eg. house rental value less depreciation
• Family sharing, gov't transfer payments

Accounting income

Realized periodic revenues minus systematically allocated costs

Can't handle related parties, and question of how to systematically allocate

how adapt to millions of non-accountants?

Taxable income as a legislative/administrative/judicial mix

Frequent references in early cases to constitutional issues, due to history of income tax enactment

Relics of these issues today: municipal bonds, 280E

Example: Cesarini v. Commissioner

Facts: Tp found old currency in a used piano bought at auction years before

Procedure: refund suit (?why? -- no penalty, or forum choice?)

Issue: is it Y. Holding: Yes.

Also Issue: when? Issue: Cap gain?

Reasoning: Sec. 61 broad, Rev Rul, Reg. Re treasure trove

 

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