Chapter 1: Intro To Income Tax Planning Flashcards
Income Tax
What are the functions of the income tax system
-produce revenue
-manage the economy (effectuate fiscal policy & encourage desired behavior)
-social function (redistribution of wealth)
-regulatory function (discourage undesirable activities)
What is the tax structure
Tax base, tax rate & incidence of tax
Tax base
Amount to which tax rate is applied
Tax Rate
Applied to Tax Base to determine tax liability:
-proportional
-progressive or
-regressive
Incidence of Tax
Degree to which total tax burden is shared by taxpayers
Proportional Tax Rate
Same rate for everybody
Progressive Tax Rate
The higher your income, the higher your tax rate, up to a 37% rate.
Regressive Tax Rate
Flat tax rate, and then the more income you make, the tax rate comes down
Example: social security tax rate
Types of taxes
-transaction (usually state tax)
-estate & gift tax
-generation skipping transfer
-income
-employment
-property (ad valorem)
-other (sales, road, lodging)
Estate Planning Taxes
-estate & gift tax
-generation skipping transfer
Income Tax Planning
-income
-employment
What types of taxes make up 80% of the revenue that the government receives
Income & employment taxes
Whats the first day of the year that you get to keep the money based on your annual payment of taxes
Between April 15th & May 1st (Tax Freedom Day)
What are the 3 separate US Federal Tax Systems
-Income Tax
-Estate & Gift Tax
-Generation-Skipping Transfer Tax
Internal Revenue Collections
Individual Income Tax accounts for 55.8%
Employment Tax accounted fro 30.6%
Roughly a total of ~80% of revenue collected
Basic Rules of Income Taxation
- All accretions of wealth, from whatever source derived, constitute income
- For every deduction taken, there must be an inclusion on income
What are the “Exceptions” to Rule #1 in regards to the Basic Rules of Income Taxation
Rule #1: all accretions to wealth, from whatever source derived, constitute income.
Exceptions:
-realization principle
-capital recovery doctrine
-Public policy exclusions
What are the “Exceptions” to Rule #2 in regards to the Basic Rules of Income Taxation
Rule #2: For every deduction taken, there must be an inclusion on income
Exceptions:
-qualified retirement plans
-charitable planning
What are the “Implications” to Rule #2 in regards to the Basic Rules of Income Taxation
Implications:
-to claim a deduction on a tax return, that amount must hav been included in income
-every deduction claimed by one taxpayer should constitute income to another taxpayer
Triads of income taxation
Come in 3’s:
-tax systems
-types of income
-types of tax accounting
-key tax principals
-components for classifying gain
-types of assets
-types of rental real estate
-methods of tax planning
-anti-abuse provisions
-administrative rulings
-final regulations
-courts to resolve disputes
Think big picture for taxes in terms of general rules & the exceptions
There are general tax rules and exceptions to the general rule and sometimes there are exceptions to the exceptions
3 types of income
- Active (ordinary)
- Portfolio
- Passive
3 types of tax accounting
- Cash method
- Accrual method
- Hybrid method
3 key tax principles
- Doctrine of constructive receipt
- Economic benefit doctrine
- Doctrine of the fruit and the tree
3 components for classifying gains
- The type of asset that was held
- The use to which the asset was put
- The holding period (how long the asset was held)
3 types of assets
- Capital assets
- Ordinary income assets
- IRC Section 1231 assets
3 uses of assets
- Can use it for personal purposes (Personal use assets)
- Can use it in the active conduct of a trade or business (business assets)
- Can use it for the production of income (production of income assets)
3 types of rental Real Estate
- Tax-free rentals activities
- Ordinary rental use activities
- Mixed use activities
3 methods of tax planning
- The advisor and client can legally avoid taxation. In addition, the advisor may be able to help clients:
-shift incoem to related taxpayers in lower income tax brackets, or
-realize income in a form that is taxed at lower tax rates (ling-term capital gains or qualified dividends) - The advisor and client can deduct expense to reduce taxable income and take tax credits to reuse taxes due
- The advisor and client can deer in elm and thus defer taxation
3 anti-abuse provisions
- The alternative minimum tax (AMT)
- The at-risk rule limitations
- The passive activity rules
3 types of administrative rulings
- Revenue rulings
- Private letter rulings
- Determination letters
3 types of final regulations
- Procedural regulations
- Interpretative
- Legislative regulations
3 Courts to resolve disputes
- US tax court
- US district court
- US court of federal claims
What are the 3 sources of tax law
- administrative action
- Judicial decisions
- statutory law
3 sources of tax law in order of highest priority to lowest priority
1 being the highest & 3 being the lowest
- statutory law
- judicial decisions
- administrative action
what is their authority
Statutory law
the Legislative Branch
congressionally derived law through legislative power provided by the 16th amendment to the US constitution
wha is their authority
Administrative Action
the Executive Branch
- Treasury Department: Executive authority of law enforcement delegated to the Treasury Department
- Internal Revenue Service (IRS): Tax collection authority delegated by the Treasury Department to the IRS
what is their authority
Judicial Decisions
the Judicial Branch
juducial authority to determine if tax laws enacted by Congress and enforced by the President are constitutional
what is the law
Statutory Sources of Law
Internal Revenue Code of 1986, as amended
Administrative Sources of Law
Treasury Regulations:
* proposed regulations
* temporary regulations
* final regulations
IRS Determinations:
* Revenue rulings
* private letter rulings
* determination letters
* revenue procedures
the president’s branch
what is the law
Judicial Law
Case Law:
* Usually a cse or controversy between a taxpayer and the IRS resulting in case law expressed in the opinion of a court
Statutory
Internal Revenue Code & treaties
come back to this. 1:02 into class 1
Interpretors of the IRC & Treaties
Congressional Committee Reports: 1 of the big 3 interpretors of the IRC
2nd interpretor of IRC is regulations: administrative action
3rd are the court decisions: judicial decisions
what was initially created by the Revenue Act of 1913
tax authority
the entire federal tax law was codified and entitled the Internal Revenue Code (IRC) of 19_ _ in what year
in 1939
a new codification of the “Code” in terms of the Internal Revenue Code was issued in what year
in 1954
the present “Code” is the Internal Revenue Code of what year ( _ _ _ _ ), as amended
(1986)
internal code of 1986, as amended
how is the Internal Revenue Code organized
- Subtitles, then
- Chapters & Subchapters, then
- Parts & Subparts, then
- Sections & Subsections, then
- Paragraphs & Subparagraphs
what is the legal impact of the Internal Revenue Code (IRC)
- source of statutory law on taxation
- must be adhered to unless a provision is declared unconstitutional
- only Congress can amend or change the code
- ambiguous provisions of the code are interpreted by the courts
how does a bill become a tax law under the legislative process
Start in
* House Ways & Means Committee, then forwarded to
* House for consideration & is voted on then forwarded to the next subcommittee
* next subcommittee is the Senate Finance Committee, they review (can make changes) and vote on what was received, then send to the Senates
* Considerations made by the Senate. There may be 2 separate bills from the House & the Senate bc of possible changes each may have made. The bill(s) are then considered & reviewed in a Joint Conference Committee with the head of both the House & Senate (this is if the House & Senate differ on terms of the bill. They negotiate to come up with a bill that is agreed upon with both the House & Senate and forward the bill to the President
* President receives the bill and will either approve or veto the bill. if vetoed, the bill returns to Congress to see if there are enough votes to overcome the veto
* the final step: the bill is incorporated into the code (if approved by the president or if the Presidents veto is overridden)
anything involving tax is supposed to start where
under the constitution in the House Ways & Means Committee
House Ways & Means Committee
Subset of the entire house
what are the functions of the Treasury
- enact regulations
- issue revenue rulings and private rulings
- issue revenue procedures
- issue determinatin letters
- mangage conflict with taxpayers
what branch of government cannot change statutory law without congressional action
the administrative branch
what are 2 administrative agencies
IRS & Treasury Department
since 1913, the entire body of statutory law concerning income taxation has been codified 3 times….. in what three year?
1939, 1954 & 1986 (the current code)
shortly after the passage of the 16th amendment, Congress passed what Act in 1913?
the Revenue Act of 1913: the first version of the law that would become known as the Internal Revenue Code (IRC)
what is the Internal Revenue Code (IRC or Code)
the statutory source of law on taxation
who can amend (change/adjust) the Code
Only Congress can amend the Code, since is it the source of statutory law in the US
when tax legislation arrives at the oval office, the president has what three options
- sign the bill & enact it into law
- veto the legislation
- refuse to sign the bill
what happens if the President signs the bill
the new legislation is now part of the body of tax law & is incorporated into the Code
what happens if the President vetoes the bill
congress can override the President’s veto by passing the bill with a 2/3rds majority vote in both houses. if override is successful, the legislation becomes part of the Code
is overriding a Presidents veto a difficult task?
usually yes it is bc its hard to solicit enough support to achieve a 2/3rds majority vote in both houses of congress
what happens if the President fails to sign the bill within 10 days
the bill becomes a law without the presidents signature
If Congress is in adjournment & the president fails to sign the bill within the 10 days allowed by the Constitution, what happens?
the bill does NOT become a law
what is a pocket veto
the failure of the president to sign the bill and therefore the failure of the bill becoming a law
what is the only statutory source of federal tax law & the starting point for tax determination & research
Internal Revenue Code
who is the CEO of the US Government
the President of the US
what is one of the presidents primary duties
enforce the law
who is responsible for the collection of taxes in the manner set forth in the IRC
the president of the US, but the president has delegated this authority to the Treasury Department, which in turn created, and delgated tax collection authority to the Internal Revenue Service (IRS)
Treasury Department
remains involved in the interpretation & clarification of tax law from an administrative standpoint by adopting Treasury regulations
when are Treasury Regulations deemed by the courts to have the full force & effect of law
when provided that the treasury regulations are consistent with the literal provisions of the IRC & Congressional intent at the time the law was passed
there are several types of Treasury Regulations and they can be classified by what two categories
classified based upon the stage of adoption and the function of the regulation
what types of Treasury Regulation are classified based upon the stage of adoption
- proposed regulations
- temporary regulations
- final regulations
what types of Treasury Regulations are classified by the function of the regulation
- Procedural regulations
- interpretative regulations
- legislative regulations
Regulations: Stage of Adoption
Proposed Regulations
- do not have legal precedence
- preview of final regulations
- to adopt the regulation, Treasury must comply with provisions of the Administrative Procedures Act (APA)
thought of as a first draft of final regulations. they have no legal precedence and are not binding on taxpayers (until the regulations become final)
Regulations: Stage of Adoption
Temporary Regulations
typically issued when the regulations will impact a larger # of taxpayers and the IRS wishes to give taxpayers guidance on how a particualr provision of the tax code will be interpreted
- issued when guidance is needed quickly
- same authoritative value as final regulations and are binding on taxpayers once issued & pending the adoption of final regulations in accordacne with the Administrative Procedures Act (APA)
Regulations: Stage of Adoption
Final Regulations
let taxpayers know how thet Treasury & IRS will interpret & enforece the tax law
- have force & effect of law provided that they are consistent with the IRC provisionos they interpret
- once issued, they are binding on taxpayers & Treasury (unless Treasury takes action to amend the regulations)
- courts are NOT bound by final regulations
Regulations: Function of Regulation
Procedural Regulations
- Are housekeeping instructions indicating how the Treasury & IRS will conduct their affairs
- Useful to a taxpayer when the taxpayer would like to request a ruling from the IRS & needs to know how to do so
- procedural regulations do not deal with substantive issues of tax law, but instead deal with administration of the tax system
Regulations: Function of Regulation
Interpretative Regulations
- Provide an official interpretation of the IRC & taxpayers may rely on these regulations in tax planning
- implement intent of committee reports & code
- can be overturned by courts if the courts deem the regulations were inconsistent with intent of Congress
Regulations: Function of Regulation
Legislative Regulations
- allows treasury to determine the details of the law
- Have full force & effect of law as if Congress had passed them
- Congress must specifically delegate authority
- Can be overturned by courts if the courts deem the regulations were unconstitutional
- When the Treasury enacts legislative regulations, they are treated as if they were passed by Congress & signed by the President
Tax Reform Act of 1986
was roughly revenue neutral (was not intended to raise or lower overall tax revenue, but it shifted some of the tax burden from individ to businesses
