Professional Documents
Culture Documents
Analysis:
1. When trying to define a term in the Code: (ex: gift)
a. Look elsewhere in Code (nothing here)
b. Look in Regulations (nothing here)
c. Look in legislative history (nothing)
d. Try to figure out logic/structure of provision (would have been better
here)
i. Based on chart, shouldnt tax if tax already paid by transferor,
which would make both gifts taxable here
2. Two main questions:
a. What is the rule?
b. How will the IRS enforce it?
3. If get lost, follow cash:
a. What did TP get (including debt forgiveness, in-kind)?
b. What did TP pay?
c. What did TP make in the end?
Chapter 1: Income Tax Basics p. 1
1. Background
a. Individual IT brings in about as much as payroll taxes (but much more
complex)
b. Why such a complicated tax system?
i. Fine-tuned to individual circumstances
ii. Subsidy delivery mechanism (electric cars, home interest)
iii. Draws attention to itself
c. Know: basis, realization, selected Code provisions, reading and applying
Code
2. Calculating tax liability
a. Basic formula: Tax liability = tax base (taxable income) x tax rate
b. Calculating taxable income
i. Calculate GI (61; see also 71-140) exclusions
1. What money even goes into pot?
ii. Calculate AGI (62) above-the-line deductions
1. Subtract any deductions referenced in 62
2. Dont compete with standard or other itemized deductions
iii. Calculate taxable income (63) below-the-line deductions
1. Include personal/dependency exemptions + itemized OR
standard deduction(s) cant have both
iv. Use taxable income to calculate tax liability (1 rates)
3. Adjustments (taxpayer-favorable):
a. Two questions:
i. Now or never? (permanently excluded?)
ii. Timing? (taxable, but when?)
b. Exclusions never included in GI
i. Value of exclusion = Amount of exclusion x MTR
ii. Dependent on source of funds (usually more generous)
1
b. Marginal tax rates (MTR) = rate that applies to last dollar of income
i. Includes hidden 0% tax rate up to personal exemption +
standard deduction
ii. More useful for tax planning
iii. Increases for additional income, but can decrease for deductions
1. Could be blended if spans 2 rates
c. Ex: Assume tax rate schedule: 0-30,000 = 10%, 30,000+=30%
i. X has wages of 30,000, so tax = 3000 (at 10% rate); should X earn
1000 more?
1. Last 1000 taxed at 30%, so $300 and 3300 total tax
6. Phaseouts useful for helping Congress avoid political heat
a. Personal exemption reduction for affluent taxpayers (151(d)(3))
i. Hard to understand/plan for (hidden MTR hike)
ii. Lose 2% of exemption for every $2500 by which AGI exceeds p/o
threshold
1. Completely phased out at $125,000 over threshold
a. MTR drops back down to 35% (but had to pass through
p/o paying higher rate to get there, so ATR still higher)
b. Ex: $200,000 AGI, MTR = 35%; 5 people x $3000 personal exemption =
$15,000 exemptions before p/o (at $200,000); should TP make another
10%?
i. 151(d)(3)
1. $210,000 AGI 200,000 p/o threshold = 10,000
2. 10,000/2500 = 4 x 2% = 8% reduction in exemption
3. 15,000 x 8% = 1200 increase in TI (lost exemption)
4. 10,000 additional income + 1200 lost exemptions = 11,200
5. 11,200 x 35% (MTR) = 3920 tax on last 10,000
a. Combo of additional income + lost exemptions
7. Tax principles:
a. Tax base: based on income and ability to pay
i. Income tax with consumption tax features (dont tax unrealized
appreciation or retirement savings)
b. Tax expenditures: special income tax provisions (have to be classified as
such) that favor the TP (exclusion, deduction, credit, deferral, preferential
rate)
i. Negative tax expenditures: less favorable treatment to TP
(executives, lobbyists)
c. Sources of law
i. Constitution Statutes (Code) Regulations (legislative or
interpretive) Revenue rulings and procedures Committee
reports (bluebooks)
d. Tax litigation
i. Choice of forum
ii.
Juris.
Tax Ct
Dist
Ct
Fedl
Cl.
Jury
?
Appeal to?
Likely
precedent?
Deficienc
y
Taxpayers
circuit
Most likely
Refunds
Taxpayers
circuit
Least likely
Refunds
Federal Circuit
In between
Notes
Travels, bench
trials, can invoke J
w/i 90 days if
dont pay; 90%
sue here
Pay and sue for
refund
Pay and sue for
refund
e. Policy
i. Progressive v. flat tax
1. Progressive tries to raise most money with least loss of
utility to TPs
2. Balance between:
a. Declining marginal utility of money ($$ worth less after
have a lot of it) and
b. Disincentive effects of high tax rates (people stop
earning)
3. Try to avoid cliff effects
a. Cliff effect = small change has major consequences
b. Instead progressive higher tax rates affect income
only after max out previous rate
ii. Distributive justice
1. Is tax redistributing income? How? In which direction? Is that
good?
2. Think about how government is spending the money
3. Make sure there is consistency in metrics (rate v. money)
4. Still look at overall effect (is it progressive enough??
5. Ex: Tax schedule 0-20,000 = 40%, 20,000+=10% (so
regressive MTR)
a. 2 types of people: Rich ($100,000) and Poor ($20,000)
i. Poor = $8000 tax (20,000 x 40%)
ii. Rich = $16,000 tax ((20,000 x 40%) + (80,000 x
10%))
b. Govt collects $24,000 in taxes, and spends:
i. $10,000 to Poor (gains $2000)
ii. $14,000 to Rich (loses $2000)
iii. SO Poor gains $2000 from Rich (progressive
redistribution)
1. Result of mixed metrics (regressive rate but
progressive redistribution of money)
it:
Tax imputed income (unlikely)
Allow deduction for imputed income
Have system where marriage irrelevant
(avoids stacking effect)
4. Imputed income from property also not taxed on imputed
income from owner-occupied property (implicitly within 61;
no exchange)
a. Big tax break is in imputed income exclusion, not home
mortgage interest deduction
b. Ex: $500,000 fmv (unmortgaged)
i. With $25,000 net imputed rental value untaxed
economic benefit (understatement of income)
c. Ex: $500,000 fmv (fully mortgaged)
i. $25,000 interest deduction (gain)
ii. 25,000 net imputed income (gain) 25,000
interest (loss) = $0 net economic benefit (NO
ECONOMIC GAIN)
iii. 0 tax 25,000 interest = (25,000) loss
1. Just transfers tax break to salary (much
more visible)
d. Ex: Swapping houses for jobs would be a barter and
rent value is taxable income
i. Maybe not enforced, but if report income, could
also get rental deductions (maintenance, 168
depreciation)
ii. Unrealized appreciation
1. Implicitly excluded from GI
2. Not permanent exclusion just a deferral
a. Unless hold to death and stepped up under 1014
3. Policy: valuation and liquidity problems
a. Not always true (stocks excluded but easily valued, but
in-kind exchanges included and not easily
valued/liquidated)
c. Statutory exclusions based on non-cash nature of
benefit/required use of cash
i. ER-provided health insurance
1. Most significant tax subsidy in entire Code: 106, 105
2. Both ER-provided health insurance benefits and premiums
excluded
a. 106(a) excludes value of ER-provided health
insurance coverage/premiums from GI of EE
i. Plus for spouse and dependents (regs)
ii. Including Cadillac coverage (far from basic)
iii. Doesnt deal with unmarried partners (so cant be
excluded)
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a. Annual tax accounting period sacred (dont like to go back and amend
returns)
i. Need some period of tax finality; chose yearly
1. Nothing that happens after close of tax year affects what
happened in that tax year
a. If seemed right then, dont amend it
i. So if just made mistake (mistake from get-go and
should have known), amend return if SoL hasnt
run
ii. But if becomes a mistake with benefit of
hindsight and later events, dont amend
b. Instead, offsetting income inclusion in later year
i. So can look back (like for basis)
ii. But cant leave a year open pending
developments
c. Congress can override, of course
i. 219(f)(3) IRA contribution deductions
ii. 1033 involuntary conversion of property
ii. Most fundamental backward-looking rule: 1001 realization rule
(look back for basis)
iii. How know which year to take income/loss/deductions into account?
1. Individuals cash method
a. Follow cash flows (simpler)
b. Subject to cash/barter non-distinction
c. Subject to constructive receipt
2. Businesses accrual method (more accurate)
a. Follow obligation/right to pay or receive
b. Instances of annual accounting
i. Loss carryover provision: 172
1. TP with net operating loss (NOL) in business activities can
use NOL to offset positive income in 2 preceding years or 20
years following
2. Evens out unstable income a bit, but
a. Still limitation on # of years can move losses, and
b. 172 applies only to business losses
3. Ex: Income bunching can inflate MTR C and D each get
10,000 standard ded/person exemption (assume businesses)
a. C makes 15,000 in Y1 and 15,000 in Y2:
i. Y1 & Y2: 15,000 10,000 = 5000x2 = 10,000 TI
b. D makes 0 in Y1 and 30,000 in Y2:
i. Y1 = 0; Y2 = 30,000-10,000 = 20,000 TI
ii. EITC: 32 (most important instance) see pg. 57 also
1. Fully refundable
2. Favors regular income (not bunched), esp. as interacts with
child care credit because can take more of credits each year
a. Progressive MTR
b. Personal exemption and standard deduction dont
create NOL
c. Refundability of child care credit
d. EITCs sweet spot plateau is much more generous
16
3.
4.
5.
6.
7.
23
iv.
v.
vi.
vii.
viii.
iv.
v.
vi.
vii.
iii. Courts often split the different between parties claims (which
incentivizes unreasonable positions)
iv. Frequently at issue
1. Even if dont sell, may need to for depreciation, home office
deduction, purchase of small business, or different tax
treatment may apply for different parts even if maintain
ownership
b. Gamble v. Commissioner (TC 1977)
i. P bought horse in foal at bargain price of 60,000 and after foal
born, sold foal for 125,000; claimed 30,000 as b of foal (big stud
fee); G said no basis
ii. Court found basis of foal is 20,000 (what P claimed on insurance)
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45
50
1.
2.
3.
4.
ii. Exempted vehicles over 3 tons (most SUVs) probably intended for
trucks for business reasons (1984), but then everybody started
buying SUVs (bad policy)
iii. Congress reduced ceiling to 25,000 to SUVs under 179(b)(6), but
still there
iv. Ex: 2013 and want either luxury sedan or heavy SUV for 60,000
1. Sedan: limited to 280F; Y1 deduction only about 3000
2. SUV: 25,000 179 + 35,000x20% ACRS (=7000) = 32,000
deduction
7. What Costs Must Be Capitalized? p. 623
a. Capitalization = spread out cost of long-term asset through depreciation
(usually prefer deductions as early as possible)
i. Tangible, physical property capitalize almost everything
ii. Intangibles separate and distinct test allows avoidance of
capitalization
b. Self-produced property: 263A (1986)
i. Anytime TP self-produces property, have to capitalize (not currently
deduct) not only obvious direct costs (EQ, wages), but also indirect
ones (depr on all facilities used to construct, all wages allocated to
it, rent and utility expense)
1. Codifies and expands Commissioner v. Idaho Power Co. (US
1974) where Court said that TP business who used own
resource (crane) to do maintenance and also create new
capital asset had to capitalize the value into basis of new
asset (more like an investment than an expense); if also use
for other repairs then apportion value accordingly
a. Ex: Crane (100,000 orig b; 168 S-L depr over 10
years); powerlines (40-year S-L ACRS recovery)
i. So 10,000/yr S-L, which is added to basis of
powerlines
ii. So 250 over 40 years (instead of 10,000 over 10
years)
2. If self-producing inventory, recover inventory costs (which
include overhead, like rent) when sell inventory
a. If sales come sporadically or are uncertain, cant
always claim deductions currently
b. Ex: M produces 1 piece of jewelry/month, has expenses
1200/mo in rent + utilities; sells 8 out of 12 last year
i. Under 263A, gets CGS deduction for 9600
(8x1200)
ii. But nothing for 4 (4800) still in inventory
(4x1200)
ii. BUT writers, artists, photographers not subject to rules and can
deduct inventory costs currently even if not sold: 263A(h)
1. Artist = general definition, then look at uniqueness and
aesthetic value over utilitarian value
2. LH says in general, people who make jewelry, furniture, or
pottery are not artists under this provision
54
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Chapter 8: Tax Preferences, Tax Shelters, and the Alternative Minimum Tax
p. 697
1. Tax Preferences and Implicit Taxes: The Case of Municipal Bonds p. 698
a. Tax preference = any deduction or exclusion that results in TI
understating TPs true economic income (usually ACRS)
i. Usually attribute of asset (planes ACRS), but with Roth IRA, its all
tax-free because of TP attribute (earned $, age)
1. So can buy investments with no implicit tax and put into Roth
IRA and avoid all tax on interest
b. Economics of the exclusion
i. 103 says interest on municipal bonds (MB) excluded from GI
1. So if same rate as corporate bond, will buy MB (full after-tax
return)
2. So MB rate will drop (can offer cheaper), and federal
government essentially subsidizes through exclusion
a. Implicit tax = reduced pre-tax rate of return in
exchange for tax preference
3. But cant discriminate on price, so cant drop bond rate all
the way to highest bracket limit because lower brackets
wouldnt buy and may not have enough buyers in top bracket
a. Which leads to delivery efficiency
i. Federal government still gives full tax break as if
were in top bracket, but not all of the benefit
goes to state/local government (some goes to TP)
ii. Ex: Tax system with 3 brackets (30%, 20%, 10%) and $100 MB and
$100 corporate bond (CB) at 10% interest
1. If price MB at 7%, can match CB; like $3 federal subsidy
(delivery efficiency)
a. MB = 100 x 7% 0 tax = $7 after-tax return
b. CB = 100 x 10% $3 tax = $7 after-tax return
2. But if not enough TPs in top (30%) bracket, then have to raise
rate to 8% so TPs in 20% bracket will buy too (cant
discriminate), then inefficient delivery:
a. Feds still out $3 (would get $3 if bought CB and paid
tax), but only $2 goes to state/local govt and $1 goes
to TP
c. Bond = obligation of state or local government
i. Exclusion intended to benefit state, not just give windfall to TP
ii. See US Trust Co. of NY v. Anderson where court held that interest
payments from state on condemnation award are not excludable
because LH indicates wouldnt apply where there was no
bargaining or implicit tax (just windfall for TP)
d. Delivery efficiency = when federal governments revenue loss from a
subsidy ends up in the pockets of the intended beneficiary (here,
state/local government)
2. Tax Shelters
a. Tax shelter = investment that produces artificial tax losses that can be
used to eliminate tax on income from unrelated sources
i. Artificial loss money not really gone
57
a. With patch:
i. 200,000 78,750 = 121,250 x 26% = 31,525
1. Technically, 30,059 regular tax + 1466 AMT
2. Base smaller than regular base, but AMT
rate is higher than regular blended rate
b. Without patch:
i. 200,000 45,000 = 155,000 x 26% = 40,300
1. Pay 30,059 regular tax + 10,241 AMT
c. AMT and its discontents
i. Amt was intended to make sure rich people paid their share of
taxes
ii. But because not indexed for inflation (and Bush tax cuts) means
more and more people being affected
1. Especially if Bush tax cuts extended
63
a. Negative tax
3. Plateaus until p/o starts at 17,090
a. Take excess over this threshold x
21.06% to get reduction in max
credit
4. P/o ends at 41,952 for 2+ kids (21.06%
reduction/dollar earned)
a. Positive tax (in effect increase in
MTR)
iii. No-child TPs: small credit
1. Functions as rebate of payroll tax on first
6070 of earned income
2. Phased out at AGI of 13,660
v. Ex all credits: single parent with 2 kids with EI of 25,000
1. Tax liability:
a. Pre-credit tax = 25,000 8700 HoH standard ded
11,400 (3 personal exemptions) = 4900 TI x 10% 1(b)
rate = $490
2. 24 child tax credit
a. 1000 x 2 = 2000 available tax
b. 490 non-refundable part takes tax liability to 0
c. Refundable part?
i. 25,000 3000 threshold (earlier number?) =
22,000x15% = 3300 ceiling on refundability
1. 2000 max credit 490 already got = 1510
refundable remainder of 24
2. < 3300 ceiling so get entire 1510
refundable
3. EITC:
a. 25,000 17,090 p/o threshold = 7910 excess of
threshold
i. 7920 x 21.06% reduction = 1666 reduction
ii. 5236 max credit 1666 reduction = 3570 EITC
credit
4. 1510 24 refundable credit + 3570 refundable EITC = 5080
refundable credits (check from government)
2. Income Tax Treatment of Marriage p. 767
a. Current law
i. In two lowest brackets, marriage bracket is double single bracket
(pro-marriage; like single penalty)
ii. In middle brackets, single bracket more than half marriage bracket
1. Could produce Boyter marriage penalty (1969 system)
2. Could also produce marriage bonuses
iii. In top brackets, single and marriage brackets are the same (big
marriage penalty)
b. Historical development
i. Pre-1949 marriage didnt matter; tax assessed individually
1. Earned income must be taxed to the earner
67
ii.
iii.
iv.
v.
c. Cant
i.
ii.
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