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1.Introduction
1.Introduction: overview of federal income taxation
A.Study and practice of tax law
B.Background to taxation
1.Brief constitutional history
a)Confederation: fed. gov’t had no authority to levy taxes
(1)Would requisition from states, which would raise specified amount
(a)But states baulked, leading to crisis resulting in Constitution
b)Constitution:
(1)Art. I, § 8, cl. 1: Congress is granted authority to “lay and collect Taxes, Duties, Imposts, and Excises” uniformly throughout US
(a)Uniformity: limits only patent or intentional discrimination based expressly on geography
(2)Apportionment cl.: art. I, § 2, cl. 3, and § 9, cl. 4
(a)Direct taxes: must be apportioned among states proportional to population
(i)Severely limits feasibility of direct tax: unless collected through mandatory requisition scheme
(ii)Direct tax: ambiguous
(a)Constitution and historical materials state that only capitation (head) and real estate taxes are direct
(b)Overridden by 16th Amend.
(3)Tax history and the idea of the direct tax
(a)Congress passed unapportioned income tax during Civil War
(i)Springer v. US (1881): SCOTUS upheld income tax as unapportioned
(a)Only direct taxes are real estate and capitation
(ii)But tax had lapsed after War: no challenged during
(b)Congress passed 2nd income tax in 1894
(i)Pollock v. Farmers’ Loan & Trust Co. (1895): SC held that tax on rental income was tax on property, tax on property was direct tax, thus unconstitutional as unapportioned, thus income tax law unconstitutional
(c)Congress passed unapportioned corp. income tax in 1909
(i)Flint v. Stone Tracy Co. (1911): SC upheld as indirect
(a)Tax was actually excise tax imposed on privilege of doing business through corp. form
(b)Excise taxes include sales, and on transfers of property (estate, gift)
(ii)But excise tax theory considered inapplicable to personal income taxes
(d)16th Amend., ratified 1913: gave Congress authority to levy income tax without apportionment
(i)Congress enacted income tax in 1913
(a)Brushaber v. Union Pac. R.R. Co. (1916): upheld tax
(i)Progressive tax structure (brackets) are valid so long as plausibly based
(ii)Challenges based on due process or equal protection
(a)Due process: takings
(i)Notion that income tax is communistic (in early period attacks)
(b)Equal protection:
(c)Cts. have consistently upheld tax against such challenges
(e)Congress reenacted income tax every year or two until codification in Internal Revenue Code, 1939
(i)Recodified in 1954, 1986
(ii)Current code: IR Code of 1986, as amended, in Title 26
2.Making federal tax laws
a)Process
(1)Art. I, § 7, cl. 1: all revenue bills must originate in House
(a)House Ways and Means Comm.: taxation, social security, int’l trade
(b)Forwarded from Comm. to full House through Rules Comm.
(2)Thence Senate: can effectively rewrite bill by amending
(a)Finance Comm.
(3)Conference comm., back to Congress, then presentment
(4)Legislation is in cooperation between Congress and Treasury, esp. IRS
b)Legislative history guides interpretation
(1)Treasury: issues regs., using legislative history
(2)Courts
3.Sources of administrative authority
a)Constitution
(1)Art. I § 8
(2)16th Amend.
b)IR Code: primary source: 26 USC
c)Regulations
(1)Two types
(a)Interpretive regulations: pursuant to 26 USC § 7805(a): Congress delegates authority to issue all regs. and rules to enforce Code
(i)Technically exempt from APA notice and comment procedure, but Treasury follows anyway
(b)Legislative regs.: substantive, pursuant to specific directives from Congress
(i)Subject to APA’s notice and comment scheme
(2)Forms
(a)Final Treasury regs.: usually given great deference by courts
(i)Inquiry into validity: Chevron USA, Inc. v. Natural Resources Defense Council (1984)
(a)Whether Congress has spoken directly to the precise question at issue in its statute
(b)If ambiguous or silent, then is agency’s regulatory answer a permissible interpretation
(ii)If reg. is ambiguous, then deference to gov’t’s interpretation but not final
(b)Proposed reg.: notice and hearing period
(i)Not binding until final
(a)But final usually retroactive to date of notice in FR
(c)Temporary reg.: binding until superceded by final reg.
d)Notices and announcements: provides information on IRS’s legal position where immediate need for guidance warrants bypassing issuing reg. or other future action
e)Acquiescences: IRS publishes in IR Bulletin notices of issues it loses in Tax Court
(1)Acquiescence: IRS will follow ruling
(2)Non-acquiescence: IRS will continue to litigate issue
f)Revenue Rulings (Published/Public Rulings): IRS publishes hypothetical situation, often based on recurring problem, with result and reasons
(1)Difference in deference paid by Tax Court and other courts
(a)TC treats as slightly better than proposed reg., other courts tend to give greater deference, but not to level of final reg.
(2)Rulings favorable to a taxpayer are internally binding
g)Revenue Procedures: set forth IRS procedures
h)Private Letter Rulings: IRS response to request from taxpayer regarding some proposed transaction, with desired tax result and reasons
(1)Taxpayer may withdraw if request would produce unfavorable result to avoid negative precedent
(a)May alert personnel to be alert for taxpayer proceeding with transaction
(2)Result is Private Ruling: can be relied on by taxpayer
(a)Not precedential but useful guidance
i)Technical Advice Memoranda: comparable in form to Private Letter Ruling, except initiated by IRS in response to matter brought to its attention
j)Closing Agreements: binding agreement between IRS and taxpayer
k)General Counsel Memorandums: justification for Published Revenue Ruling or TAM
4.Judicial jurisdiction
a)If dispute is not resolved by administrative procedures, then taxpayer has choice of going to Tax Court without paying proposed deficiency or paying and filing claim for refund with IRS followed by refund suit in Court of Fed. Claims or district ct.
b)Tax Court: nat’l jsd. to hear only income, estate, excise, and gift tax cases initiated by taxpayer petition
(1)System
(a)Judges
(i)Based in DC, but judges travel circuit in other cities
(ii)Art. I judges: app’ted to 15 yr. terms
(b)Decisions
(i)Regular: decided and written by individual presiding judge
(ii)Reviewed: selected by Chief Judge after trial for consideration by entire ct. on questions of law
(a)More precedential weight
(iii)Memorandum: decisions chosen by Chief Judge as chiefly involving factual issues or well-settled law
(a)Not published nor constitute stare decisis
(c)Appeals: regular and memorandum decisions are appealable to Circuit Ct.
(i)EXCEPT: if dispute concerns less than $50K, then taxpayer may elect expedited, simpler procedure that is not appealable
(2)Getting into TC
(a)IRS asserts taxpayer has underpaid after audit and internal appeal
(i)Sends deficiency notice (90-day letter)
(b)Taxpayer has 90 days to petition TC, which will stay the deficiency
(i)If petition not filed or not timely, then can never assert TC jsd.
(c)If taxpayer loses or didn’t file, then IRS can assess deficiency within SOL
c)DC and Ct. of Fed. Claims
(1)Juries: DCs are only forum where taxpayer can obtain jury
(2)Getting into ct.
(a)After paying assessment or filing amended return warranting refund, taxpayer can file claim for refund with IRS
(i)If IRS denies or ignores claim, then can proceed
d)Appeals
(1)CFC: appealable to Fed. Circuit Ct.
(2)TC and DC: to Court of Appeals
C.Tax policy
1.Introduction
a)Two main issues: debate is between efficiency (economic) and equity (fairness)
(1)Is aggregate tax burden (what gov’t wants to raise) too high or low
(2)How should burden by allocated across population
(a)Answer depends on two issues: who and what to tax
(i)What is the tax base
(ii)What rate is that base taxed at
(b)Determining who and what to tax
(i)How will the choice of items/activities to be taxed affect economic activity and thus overall wealth in the economy
(ii)What tools can or should be used to rationally and orderly decide how to allocate the burden among people
b)Tax policy: task of evaluating particular tax systems or provisions of the income tax using appropriate norms or criteria
(1)Federal tax code is generally quite stable
(a)Political consensus in art
(b)Mostly because rules conform to accepted principles and norms
(2)Norms
(a)Fairness norms: burden or benefit of tax on people
(b)Economic norms: how tax affects economic behavior of people
(3)Criteria
(a)Degree of complexity
(b)Degree of enforcement difficulty
(c)Viability of distinctions made in tax law
2.Modern federal tax structure
a)Types of tax structures and systems
(1)Progressive: increases burden as taxable income increases
(a)Fairness argument: fair to require richer to pay more than poorer
(b)Efficiency argument: unit of money loses value as person has more of it
(2)Flat tax (poll tax): everyone pays equal proportion
(a)Efficiency argument: consumption
(3)Income tax: taxes all inflows beyond certain deductions, regardless of expenditure
(4)Consumption tax: taxable base is only what is expended beyond business expenses
(a)Employees carry greater burden because don’t spend on business
b)Gov’t has moved closer to consumption tax
(1)Movement to abolish Code and adopt flat tax
(a)Still income tax but Code favors investors and businesses than wage earners
(b)Rates have decreased since 1970s, esp. after Reagan
(2)Favoring wealthy
(a)Deductions for investors, dividends, etc., favor them
(b)Estate and generation-skipping tax set to be repealed, 2010
(3)Harming poor
(a)Benefits to low-income are short-lived
(i)E.g., marriage penalty is repealed but only for 2 years
3.Fairness norms: equity norms
a)Threshold inquiry: Who bears burden and who captures break of tax: incidence of the tax
(1)Not necessarily nominal payor
(a)To what extent are taxes and benefits passed on to workers, owners, suppliers, consumers
(2)EXCEPT: individual income tax considered relatively immune to being passed on
(3)Two principles
(a)Horizontal equity: concept that similarly situated taxpayers should be taxed similarly
(i)BUT: issue is what is sameness
(b)Vertical equity: concept that differently situated taxpayers should be taxed differently
(i)BUT: two issues
(a)What is difference
(b)Determining how different taxpayers should be taxed
(i)E.g. progressive vs. proportional
b)Tax justice inquiry: determining the ideal tax base (which determines utility of horizontal and vertical equity) by determining the most appropriate criteria by which to apportion the aggregate tax burden among individuals
c)4 common norms of tax justice: each from differing views of gov’t vis-à-vis citizen
(1)Equal sacrifice:
(a)People are taxed equally because all benefit equally
(2)Benefit: sacrifice to gov’t according to benefits received
(a)Tax in proportion to varying benefits received: quid pro quo
(3)Utility: sacrifice to gov’t according to standard of well-being/of living
(a)Tax according to standard of living, as shown by level of personal consumption
(4)Sacrifice to gov’t according to respective abilities to pay
(a)Provide gov’t with operating funds according to economic resources under their control
4.Economic norms: debate between free mkt. and utilitarianism
a)Free-market theory
(1)Neutrality: fundamental free-mkt. norm: tax system shouldn’t interfere with free mkt. by either encouraging or discouraging particular economic activities over others
(a)Level-playing field: opposes subsidies, incentives, penalties keyed to certain behaviors
(b)BUT: neutrality not possible
(i)Substitution effect: disincentive effect of taxes on certain behaviors because of lower income
(ii)Income effect: incentive effect so as to compensate for tax loss
(iii)External factors: decision to work is unrelated to tax factors
(c)Externalities: negative and positive: use of penalties, incentives, and subsidies to combat social harms, overcome mkt. imperfections, or create social benefits
(2)Counters and variations to neutrality
(a)Gen’l theory of the second best: two wrongs in an imperfect system might make a right
(i)Change in tax law that ostensibly improves neutrality can’t practically achieve neutrality because countervailing gov’t interventions in economy would combine with change to actually aggravate non-neutrality
(a)Each tax policy change must be evaluated on context of other tax provisions and non-tax policies
(b)Optimal taxation: tax preferences and penalties are non-neutral (disturb the free mkt.) only to the extent that behavior is subject to modification
(i)Taxes should be heavier on inelastic goods, services, and behavior than on inelastic
(a)Inelastic item: has no readily available substitute to which people could turn if it is taxed: low response rate to tax
(c)Tax expenditure: neutrality norm with added political theory spin
(i)Not true tax provision: non normative: has nothing to do with deriving proper measure of income in base
(ii)Tax preferences, incentives, and subsidies that are the functional equivalents of direct spending programs
(a)Alternative form of spending used by Congress in lieu of direct spending
(iii)Corporate welfare: derogatory term when aimed at businesses
b)Welfare economics theory: allied with utilitarianism: neutrality not assumed to be controlling norm
(1)All gov’t action is analyzed from point of social gains and losses
(a)Pareto efficient: gov’t action that makes at least one person better off and no one worse off
(i)But impossible in tax scheme
(2)Kaldor-Hicks efficiency (distributive equity): most common for tax scheme: cost-benefit analysis
(a)Aggregate gains of winners, net of administrative costs, exceed aggregate gains of losers
(i)Measured by utility, not nominal dollars
(a)Equity: downward redistribution: optimal distribution
(i)Contrast with free-mkt. efficiency: maximization
5.Why the individual income tax and what is it
a)Modern individual income tax: generally compromise among standard-of-living and ability-to-pay tax justice norms, neutrality and Kaldor-Hicks economic norms
(1)Schanz-Haig-Simons concept of income: an individual’s income for a given period (usu. a year) equals any net increase (or less any net decrease) in wealth plus the mkt. value of consumption at year’s end
(a)Simons: “Personal income may be defined as the algebraic sum of (1) the mkt. value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and end of the period in question”
(b)Not in Code as such, but roughly describes federal tax base in spite of several important deviations
b)Income tax is most inclusive: taxes both net increases in wealth and personal consumption
(1)Contrast other taxes
(a)Sales (incl. VAT): only consumption
(b)Property or other transfer of wealth: only wealth
c)Conforming to norms
(1)Ability-to-pay and standard-of-living: by including both net wealth increase and consumption
(2)Neutrality: taxes only net increase in wealth in any year, not total wealth
(a)Thus taxed only once, to place on par with consumption
(3)Distributive equity: progressive rate structure, deductions off the bottom for subsistence outlays, use of tax credits rather than deductions for some items, phase-out rules for certain deductions and credits that reduce or eliminate their value at the upper end
(a)But current tax isn’t radical downward wealth redistribution: moderate
(i)Claim that whatever slight effective progressivity only cancels out regressivity found in most state/local tax schemes
6.Valuation and implementation issues in the Schanz-Haig-Simons concept
a)Issue in interpreting “net increases in wealth plus consumption”
(1)Susceptible to two readings because consumption can be either purchased on simply received in kind without charge
(a)Gross increases in wealth (inflows or receipts other than consumption received in kind) less gross decreases in wealth (outflows or outlays including consumption expenditures) plus consumption of any kind
(i)Normatively mandates taxing consumption received in kind
(ii)Compatible with standard-of-living norm
(b)Gross increases in wealth (other than consumption received in kind) less decreases in wealth, other than consumption spending
(i)Consumption is treated as only principle of non-subtraction (non-deductibility) for calculating decreases of wealth
(ii)Compatible with ability-to-pay norm
(2)Tax law reflects tension between two readings
(a)Instances where consumption received in kind is included and not
b)If CRIK is included, then how is it valued
(1)Different measures: subjective utility; fair-mkt. value; cost to providers of the related services and goods; actual cost
c)Schanz-Haig-Simons tax base requires including consumption
(1)But makes impossible to directly implement
(a)Federal tax takes indirect route: defines taxable income as current-year receipts less business and investment deductions
(i)Amounts saved or invested and decreases in wealth representing consumption costs are not deducted and remain
7.Roles of trust and business accounting
a)Trust and business acct. rules heavily influenced rules determining tax base
(1)Esp. in early years, because tax theory was not yet well-developed
(a)Early developers of income tax looked to trust/business acct. rules for guidance
b)Trusts: of especial importance in early days
(1)Trusts has already developed shard distinctions in defining income
(a)Highly concerned with preserving principle while allowing adequate return to income beneficiaries
(2)But: current Code employs broader concept of income
c)Business acct.:
(1)Attempts to convey vital info. about a business to interested parties
(a)Balance sheet describes net worth at any given time any whether it came form investments or net profit
(i)Income statement shows net profit and loss over relevant time period
(b)Because of role in conveying info., tends to be conservative: underplays good news and overstates bad to curb speculation
2.Basic principles
A.IR Code
1.§ 1: tax imposed on individuals
a)(a): married individuals filing joint returns and surviving spouses
b)(b): heads of households
c)(c): unmarried individuals
d)(d): married individuals filing separate returns
e)(h): maximum capital gains rate
f)(i): rate reduction after 2000
2.§ 2: definitions and special rules
a)(d): non-resident aliens
3.§ 11: tax imposed on corporations
a)(a): corps. in gen’l
b)(b): amt. of tax
4.§ 61: gross income defined
a)(a): all income from whatever source derived
5.§ 62: adjusted gross income defined
a)(a): gen’l rule: for individual, gross income minus listed deductions
6.§ 63: taxable income defined
a)(a): in gen’l: gross income minus deductions allowed by this chapter
7.§ 67: 2-percent floor on miscellaneous itemized deductions
a)(a): for individuals, miscellaneous itemized deductions are allowed only when the aggregate is greater than 2% of adjusted gross income