FEDERAL INCOME TAXATION
Fall Semester 2017
Professor William P. Streng
Introduction to Federal Taxation
A law school subject, but much more:
1) Black letter law.
2) Relevance to subject matter of most other law school courses.
3) Income tax fundamentals - whom to tax; what to tax; when to tax; how to tax.
4) Social policy, i.e., tax burden distribution.
5) Economic policy (macro & micro).
Federal Income Tax is a Statutory Course p.24
1) Primary source of law - The Internal Revenue
Code (Title 26 of the United States Code) (assuming authority under the United States Constitution).
See Code §§1 and 11 – the tax imposing provisions.
2) Administration of tax system by the Internal
Revenue Service (part of U.S. Treasury Dept.);
Regulations and other pronouncements. P. 24-25
3) Resolution of disputes by the U.S. Courts
including the U.S. Tax Court (an Article 1, not
Article 3, court). P. 19-20.
Constitutional History of U.S. Income Taxation p.22
U.S. Constitution - Art.1, Sec. 8, Cl. 1: Congress shall have the power to lay and collect taxes; subject to the uniformity clause. P.22
Art. 1, Sec. 9, Cl. 4: No capitation or other direct tax shall be laid unless in proportion to the census. What is a “direct” tax? P. 23
U.S. Constitution, cont.
- Fifth Amendment – no deprivation of property without due process of law.
- Tenth Amendment – states’ rights, except where the power is granted to the Federal Government.
- 16th Amendment – tax can be imposed on “income from whatever source derived” (e.g., are emotional distress damages to be treated as “income” – under the U.S. Constitution?)
Federal Taxes – History Before the 16th Amendment
1894 - personal income tax was enacted.
Supreme Court holds: Unconstitutionally imposed
tax - Pollock v. Farmers Loan & Trust (1895), p.23
a tax imposed on unapportioned real property
rental income was deemed a tax on property and tax
was not apportioned (by population); therefore, this
tax was an unconstitutional tax (Art 1, § 9).
Subsequent History of U.S. Taxation - 1913
U.S. Constitution - 16th Amendment (p.23): 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.
Thereafter: enactment of the Revenue Act of 1913, and all subsequent legislation (for 100+ years).
CURRENT OTHER TYPES OF TAXES
1) Poll tax (head tax); the simplest tax?; cf.,
ID requirements at the polls (Texas).
2) Customs duties (inbound goods).
3) Excise duties (transaction taxes, e.g., sales)
4) Property/wealth taxes (ownership taxes).
5) Wage taxes (tax on labor income).
6) Gains derived from capital or trading
profits (income taxes on investments).
Payroll Taxes p.3
Social security taxes and Medicare taxes -
Employer and employee portions: 6.20%
each on OASDI wage base ($127,200 during
2017 or $7,886.40).
For self-employed: S.S. tax @ 12.40% ($15,772.80).
Plus Medicare tax: 1.45% for both employer &
employee portion; no ceiling on the Medicare tax.
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 govt.’s “jurisdiction to tax”?
See Code §1.
Worldwide applicability of the U.S. income tax – to
both U.S. individuals and U.S. corporations.
Why do U.S. 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
Most Common Tax in World
National sales tax, but imposed on a staged
basis, i.e., on the “value added” at each level
Tax on total value of sale, less a refund to
seller for prior tax paid on the item sold.
Cf., state sales tax - imposed only on the final sale.
An excise tax (i.e., a “transactions tax”).
Consider the regressive nature of this tax?
Federal Revenue as a % of
GDP See chart p.7
What is GDP (gross domestic product)?
Federal income taxes are imposed at
approximately the 10 percent level of GDP.
Total federal taxes = 18 percent of GDP.
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 the total federal revenue? P.6
Individual income tax
Payroll taxes (income taxes, withheld at source)
Corporate income tax – why % decline?
Excise taxes (alcohol, tobacco, gas, etc.)
Estate & gift taxes (each is a “transfer tax”)
COMPARATIVE NATIONAL TAX BURDENS
On a comparative basis are U.S. taxpayers
subject to a high tax rate? Low tax rate?
(when compared to total taxes imposed by
other national governments)
What is the difference between (see p.1 & p.31):
1) the effective rate, and
2) the marginal rate?
Cf., nominal tax rate.
Distributional Effects p.12
Do the rich pay more (or less) proportionately?
Does U.S. have a progressive tax/regressive tax?
(cf. taxes imposed on dividends, cap. gains & “carried interests”)
Should the rich pay more proportionately (because
of their “ability to pay”)? P.12
Even if paying more proportionately, are the “rich
getting richer and the poor getting poorer”? Is this
important for purposes of “federal tax policy”?
What degree of progressivity is appropriate? P.12
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 (assuming they are a “drag” on the economy)?
Income Tax Terminology p.26
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” (p.28).
Less: Deductions – (a) “above the line” (i.e., expenses for generating the income?), including depreciation and amortization, and
(b) “below the line.” p.26
Income Tax Terminology, Cont.
Tax rates are applied to taxable income.
cf., average rate & marginal rate – p.32
Tax accounting/timing issues (i.e. deferral):
p. 30 – “a penny saved is a penny earned”
(B. Franklin) or “time value of money” p.254.
Credits offset the tentative income tax
liability: cf., (1) refundable vs. (2) nonrefundable
credits. E.g., EITC (p.2) & withholding.
Why Impose Tax on “Income”?
Tax (1) income (receipts), (2) consumption (rewarding savings), or (3) wealth (ownership)?
How evaluate taxes, including the income tax:
(1) equity, (2) efficiency and (3) simplicity.
Consider the concept of “distributive tax justice.” Horizontal vs. vertical equity. P.12
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
- Income taxation
Haig-Simons definition of “income” – p.554
- 1) market value of one’s consumption, and
- 2) the change in value of one’s property rights.
Measurement of net wealth changes
Changes in net wealth (“accretion to wealth”):
increases in savings and investment
less: debts and liabilities
Timing for tax: 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 tax/calendar years).
A “realization” event is required (but, this is not a U.S. constitutional requirement). See discussion of “realization” (vs. recognition) at p. 28.
Tax Expenditure Budget
p.27 (& see web materials)
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 economic income?
Are these expenditures actually appropriations without the budget process occurring?
What is “dynamic scoring”? Appropriate to use?
Tax Expenditures, cont.
Tax Subsidies vs. “Tax-Induced Structural Distortions”
- 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
U.S. Constitution, Article 1, §7, Clause 1 -
Tax legislation starts in the U.S. House of
Representatives (Ways & Means Comm.). Why?
U.S. Senate (Senate Finance Committee); What if a
large amendment occurs on the Senate side?
Conference Committee; then enactment.
Last: Signed into law by the U.S. President.
(What is the “budget reconciliation” process?).
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; then 110 more tax acts; then the American Taxpayer Relief Act of 2012 (or 2013?).
& subsequent legislation through 2016 (114th Cong.).
What is the Process? P.24
Relevance of legislative history (Committee
Reports and the JCT “Bluebook”)?
U.S. Treasury Department “regulations”
- Interpretative; Legislative
- Temporary and Proposed Regs.
§7805(e) re “sunset” of Temp. Regulations.
What is relevance of the Federal Administrative
Procedure Act (APA)? Recent Altera case (2015).
Is the IRS a “federal agency” for purpose of APA?
Responsibilities of IRS
Mandate of the Internal Revenue Service (an
agency of the U.S. Treasury Department):
- Interpretation of the tax statutes and implementation of (1) interpretive (explanatory) regulations, and (2) legislative regulations (subject to APA requirements).
- Enforcement, including tax reporting, collection
What “Deference” to be Paid to Treas. Regulation? p.24,fn
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?
IRS Interpretations p.25
Acquiescence by IRS to Tax Court decisions
IRS Revenue Rulings (Rev. Rul.)
IRS Revenue Procedures (Rev. Proc.)
IRS Private Letter Rulings (PLRs)
Technical Advice Memoranda (TAM)
Chief Counsel Advice (CCA)
IRS Determination Letters
Tax Return Filing p.17
Self-assessment system is imposed for all taxpayers;
cf., penalties? But, subject to tax withholding at
source on wages & outbound (from U.S.) payments.
Review of income tax returns – quite limited review; cf., other countries. Tax return audit process – correspondence; office audit; & field audit.
Does a “tax collection gap” exist?
Ethics of engaging in the “audit lottery”?
What is Dispute Resolution Process with IRS? p.17
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 is filed or (2) a fraudulent return is filed.
What potential impact of tax penalties?
What level of delinquency for a penalty?
Freedom of Information Act (FOIA)
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 excised before release.
Note: 2013 FOIA filing by Tax Analysts re the 501(c)(4) (issue re tax exemption status for certain organizations).
Tax Litigation -
Judicial Review -
U.S. Tax Court petition after a “90 day letter” is received from IRS (no payment required). P. 19
Tax refund litigation:
U.S. District Court (a suit against the U.S.)
U.S. Court of Federal Claims.
What “forum shopping” opportunities?
Appeal to a U.S. Court of Appeals P.20.
What if a “split” in the Federal Circuits?
What is the impact of the “Golsen” case? P.20.
U.S. Sup. Ct. is final arbiter (e.g., re Obamacare).
Possible Injunction Against Tax Imposition?
Anti-injunction act precludes restraint of collection
Bob Jones University (p. 638) – the federal “anti-
injunction act” barred an action to enjoin the IRS
from withdrawing a tax-exempt status ruling letter.
What “standing” to sue is required in challenging a
Or, particularly, concerning an IRS decision to not
collect tax from a “taxpayer”?
TIME VALUE OF MONEY p.254 Pay Tax Today or Tomorrow?
Tax planning objective is deferral: (1) Delay income & (2) accelerate deductions.
What is the importance of the “time value of money” concept?
Note the compound interest analysis:
cf., simple interest vs. compound interest.
How often should compounding of value accretion occur: Yearly, monthly, daily?
TIME VALUE OF MONEY
Present Value Analysis: funds which are only
available in the future are worth less than funds
which are available today.
What is the present economic value of $x amount 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
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.
How does this “time value of money” concept
relate to the payment of federal income taxes?
1) Pay the tax today.
2) Defer tax payment for five years (no interest).
3) Pay a 10%(?) per annum compounded interest charge to IRS on a delayed tax payment.
What is the advisory role of tax lawyers in helping to achieve deferral of income tax payment?
Opinion Practice & Tax Advice
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 tax opinion?
What are the professional practice risks in this context?