FEDERAL INCOME TAXATION
Professor William P. Streng
Introduction to Federal
Taxation p.1
A law school subject, but
much more:
1) Black letter law
2) Relevance of other law
school course subject matter
3) Income tax
fundamentals - whom to tax; what to tax; when to tax
4) Social policy, i.e.,
tax burden distribution.
5) Economic policy (macro
& micro)
Federal Income Tax is a Statutory Course p.40
1) Primary
source of law - The Internal Revenue Code (Title 26 of the United
States Code) (assuming authority under the United States
Constitution).
2) Administration by the Internal Revenue Service (part of the U.S. Treasury Dept.).
Regulations and other
pronouncements.
3) Resolution of disputes by the U.S. Courts,
including the United
States Tax Court (an Article 1, not Article 3, court).
Constitutional History of U.S.
Income Taxation p.8
U.S. Constitution -
Art.1, Sec. 8, Cl. 1: Congress
shall have the power to lay and collect taxes; subject to the uniformity
clause.
Art. 1, Sec. 9, Cl. 4: No
capitation or other direct tax shall be laid unless in proportion to the
census.
U.S. Constitution, cont.
p.8
- Fifth Amendment – no
deprivation of property without due process of law
- Tenth Amendment – state’s
rights, except where power to Federal Government
- 16th Amendment – tax
on income “from whatever source derived” (e.g., emotional distress damages as
“income” – under the U.S. Constitution?)
Federal Taxes – History Before
the 16th Amendment
The carriage tax is not a
“direct tax.”
1894 - personal income tax
Unconstitutionally imposed
tax -
Pollock v.
Farmers Loan & Trust, p.9 -
a tax on unapportioned
real property rental income was unconstitutional.
CH 1
History of U.S. Taxation, cont.
U.S. Constitution -
16th Amendment (p.9):
Congress shall have power to lay and collect taxes on incomes, from
whatever source derived, without apportionment among the several states,
and without regard to any census or enumeration.
CURRENT TYPES OF
TAXES
1) Poll tax (head tax);
cf., ID requirements
2) Customs duties
3) Excise duties
(transaction taxes, e.g., sales)
4) Property taxes
(ownership taxes)
5) Wage taxes (tax on
labor income)
6) Gains derived from capital or trading profits (income taxes on investment)
Payroll Taxes
But, 2% reduction for 2012
Social security taxes and
Medicare taxes
Employer and employee
portions: 6.2% each on OASDI wage base ($110,100 during 2012 or $6,826.20).
For self-employed: tax @ 12.40%.
Plus Medicare
tax: 1.45% for employer and employee portion; no ceiling on Medicare tax
applicability.
Note: 2/3rds of
households pay more in Social Security taxes than in income tax.
Taxation of International (i.e.,
Cross-border) Income
How define federal “jurisdiction
to tax”?
Worldwide applicability of the U.S. income tax – to both U.S. individuals and U.S.
corporations.
Why do corporations
expatriate?
U.S. tax on foreign source
income subject to:
1) Modification by
U.S. income tax treaty
2) Foreign tax
credit (for foreign tax paid).
VALUE ADDED TAX
National sales tax, but
imposed on a staged basis, i.e., on the “value added.”
Tax on total value of
sale, less a refund to seller for prior tax paid on the item sold.
Cf., state sales tax, only
on the final sale.
An excise tax (i.e., a
“transactions tax”).
Consider the regressive nature of this tax?
Federal Revenue as a
Portion of GDP p.10
What is GDP?
Federal income taxes are imposed at approximately the 10.2 percent level of GDP. What prior
history?
What is the relevance of
this percentage?
Cf., GDP percentage in
other countries.
Cf., GDP to national debt
– what %?
Sources of Federal Revenue
GDP
What percentages of
contributions to total federal revenue?
Individual income tax
Payroll taxes (income
taxes, withheld at source)
Corporate income tax
Excise taxes (alcohol,
tobacco, gas, etc.)
Estate and gift taxes
COMPARATIVE NATIONAL TAX
BURDENS
On a comparative basis are
U.S. taxpayers subject to a high tax rate? Low tax rate?
(when compared to taxes
imposed by other national governments)
What is the difference
between (1) the nominal rate, (2) the effective rate, and (3) the marginal
rate?
Distributional Effects p.11
Do the rich
pay more (or less) proportionately? Does U.S. have a progressive
tax? (except for dividends, cap. gains & “carried interests”)
Should the rich
pay more proportionately?
Even if paying more
proportionately, are the “rich getting richer and the poor getting poorer”?
Any importance to this for purposes of federal tax policy?
Income Tax Terminology p.31
What is the “Tax Base”?
Gross income – defined, see Code
§61(a)
- Including wages, property
gains, and many other types of “accessions to wealth”
- Gain
determination necessitates identifying proceeds above cost or “tax basis” for
asset.
- Less:
Deductions – (a) “above the line” and (b) “below the line”,
-including
depreciation and amortization
Income Tax Terminology,
Cont.
Tax rates applied to
taxable income
cf., average rate
& marginal rate – p.20
Tax accounting/timing
issues: p. 34 -35 – “a penny saved is a penny earned” (B. Franklin)
Credits offsetting
tentative income tax liability: cf., refundable vs. nonrefundable credits
Why Tax Income?
How evaluate taxes, including the
income tax: (1) equity, (2) efficiency and (3) simplicity.
Tax income, consumption or
wealth?
Consider the concept of
“distributive tax justice.” Horizontal equity & vertical equity.
Why progressivity? Ability to
pay? Other reasons? What degree of progressivity is appropriate?
Basic Income Tax Principles
“Personal income” as a
concept.
Possible income
measurement systems:
- Trust accounting –
purpose?
- Financial
accounting/GAAP – purpose?
- Economic income
Haig-Simons definition of
“income” -
- 1) market value of
one’s consumption, and
- 2) change in value of
one’s property rights.
Measurement
Net wealth changes
Changes in net wealth:
increases in savings
and investment
less: debts and
liabilities
Timing: Measurement of
changes in wealth on a “transactional” basis, not on an economic basis (even though an accrual of economic value may occur over several years).
A “realization” event is required (but, not a U.S. constitutional
requirement). See discussion of “realization” at p. 35.
What degree of progressivity is
appropriate?
Flat tax vs. progressive
tax and, if progressive, what degree of progressivity?
Should progressivity be
dependent upon the receipt of governmental benefits? See the “Gini” index –
measuring the public service benefit to each taxpayer.
What is tax
regressivity? Why not make the poor contribute more (because they are a
“drag” on the economy)?
Alternative Approaches to
Taxation
Consumption taxes, e.g.,
sales taxes
Excise taxes, i.e.,
transaction taxes
Head tax (or “poll tax”)
Wage taxes or property
income taxes, or both, and, if so, in same proportions?
Wealth (ownership) taxes –
take from the wealthy and give to the poor?
Wealth redistribution
–down (or up)?
Tax Expenditure Budget p.16
What is a “tax expenditure”?
- deviations from the norm for
the measurement of economic income (both positive and negative amounts)
What is the “tax expenditure
budget”?
What is the starting point for
measuring the deviation from true income?
Appropriations without the budget
process?
What is “dynamic scoring”?
Appropriate?
Tax Expenditures, cont.
Tax Subsidies vs. “Tax-Induced
Structural Distortions”
Tax subsidies:
- Tax transfers, e.g.,
refundable credits
- Social spending, e.g., charitable deduction
What are “upside-down”
subsidies?
Tax Expenditures, cont.
Other reallocation
mechanisms:
- Energy credits
- First time home buyer’s
credit
Non-tax system
allocations:
“Cash for
clunkers” – U.S. Govt. rebates
TARP – banking
system recovery (loans or investments?)
The Tax Legislative
Process p.40
U.S.
Constitution, Article 1, § 7, Clause 1 -
Tax legislation starts in the U.S. House of Representatives (Ways & Means Comm.)
Next steps:
U.S. Senate (Senate
Finance Committee); What if a large amendment on Senate side?
Conference Committee; then
enactment.
Signed into law by the
U.S. President
Federal Tax Legislation
Internal Revenue Code of
1986, as amended
Revenue Reconciliation Act
of 1993
39.6 percent
income tax
Small Business Job
Protection Act of 1996
Taxpayer Relief Act of
1997
Economic Growth and Tax
Relief Reconciliation Act of 2001 (P.L. 107-16)
2004 Jobs Act &
subsequent (including 2010).
Statutory Interpretation
What is the Process? P.40
Relevance of legislative
history (Committee Reports and the JCT “Bluebook”)?
U.S. Treasury Dept.
Regulations
- Interpretative;
Legislative
- Temporary and Proposed
§7805(e) re “sunset” of
Temp. Reg.
What is the relevance of
the federal Administrative Procedure Act (APA)? Is IRS a “federal agency” for
this purpose?
Responsibilities of IRS
p.41
Mandate of the Internal
Revenue Service (an agency of the U.S. Treasury Department):
- Interpretations of the tax statutes and implementation of (1)
interpretive and
(2) legislative regulations
- Enforcement, including
tax reporting, collection and litigation
IRS Interpretations
p.41
Acquiescence by IRS to Tax
Court decisions
IRS Revenue Rulings (Rev.
Rul.)
IRS Revenue Procedures
(Rev. Proc.)
IRS Notices
IRS Private Letter Rulings
(PLRs)
Technical Advice
Memoranda (TAM)
Closing Agreements
IRS Determination Letters
What “Deference” to be Paid to a
Treas. Regulation? p.75
Is an IRS regulation
entitled to “deference’?
What is deference? See
Chevron (not a tax case); cf., National Muffler
What is the degree of
authority granted to IRS in promulgating a regulation?
Can an agency speak with
the “authority of law”?
Can a Treasury Regulation
be held invalid?
What is Dispute Resolution
Process with IRS? p.24
IRS review of income tax
returns –
(1) computer matching;
(2) office audit; & (3) “field audit”
Administrative appeals
process
Statute of limitations –
three or six years?
No running of statute of
limitations if (1) no return filed or (2) a fraudulent return
What potential impact of
tax penalties?
What level of delinquency
for a penalty?
Freedom of Information
Act
What amount of disclosure
is required?
Limited disclosure of tax
return information – Section 6103
Disclosure of private
letter ruling information? Yes, but crucial information is to be excerpted.
Tax Return Filing p.24
Self-assessment system;
cf., penalties?
But, subject to tax
withholding at source.
Review of income tax
returns –
quite limited
review; cf., other countries
Engage in the “audit
lottery”?
Tax return audit process –
correspondence; office audit; & field audit.
Statute of limitations – 3
or 6 years
Tax Litigation -
Judicial Review - p.25
U.S. Tax Court petition
after a “90 day letter” received from IRS (no payment).
Tax refund litigation:
U.S. District Court (suit
against U.S.)
U.S. Court of Federal
Claims
What forum shopping
opportunities?
Appeal to a U.S. Court of
Appeals
What if a “split”
in the Federal Circuits?
What is impact of
the “Golsen” case?
U.S. Supreme Court as the
final arbiter.
Possible Injunction Against Tax
Imposition?
Anti-injunction act
precludes restraint of collection of taxes
Bob Jones University (p.
369) – the “anti-injunction act” barred an action to enjoin the IRS from
withdrawing a tax-exempt status ruling letter.
What “standing” to sue in
challenging a tax statute? Or, particularly, an IRS decision to not collect tax from a “taxpayer”?
TIME VALUE OF MONEY p.37
Pay Tax Today or Tomorrow?
What is the importance of
the “time value of money” concept?
Note the compound interest
analysis:
cf., simple interest
vs. compound interest.
See table at p. 39.
How often should
compounding of value accretion occur: Yearly, monthly, daily?
TIME VALUE OF MONEY
Present Value Analysis: funds
only available in the future are worth less than funds available today.
What is the economic value
of $x to be received ten years from today?
What is the relevance of
the current market rate of interest? What is this “market”?
Asset Valuation and Financial
Analysis
The fair market value of
an asset is the sum of the present values of all future yields on the
particular asset.
These “yields” can include
interest, dividends, rents, gains, sales proceeds & liquidation proceeds.
What if the stated
interest rate does not equal the market interest rate? The face value and the
market value of the instrument are different.
Examples
How does this “time value
of money” concept relate to the payment of taxes?
• Pay the tax today.
• Defer payment for 5 years.
• Pay a 10% per annum compounded interest charge to IRS.
• What is the relevance of tax lawyers in helping to achieve tax
payment deferral?
Opinion Practice & Tax
Advice p.27
What is the function of
the “tax advisor” (as contrasted with the “tax litigator”)?
What is a “tax opinion”?
What is its purpose?
What are the
responsibilities of the advisor in issuing the opinion? What are the risks?