Acctg 811 Week 2

Tax Authority

Reasons to research tax authority

Compliance

US system is one of "self-assessment" thru "returns", backed up by:

  • withholding at the source
  • information reporting for many payments
  • examination to verify taxpayer claims

Transaction has happened, q. is how the facts fit the preexisting categories created by tax rules. Eg:

Focus is on reporting transactions on the forms that make up the returns

Planning

Advising on how tax rules affect the economics of transactions and the structure of transactions

Focus is on finding the relevant rules, determining what they mean and how they apply, and carrying out transactions accordingly

Policy

Public sector side of planning: What should the rules be. How to decrease the burden of taxes as "necessary evils".

Focus is on the economic incentives created by tax rules, and the psychology of taxpayers and tax collectors.

Sources of Tax Authority

See Chapter 2 Publisher's Powerpoints

The Internal Revenue Code

Vastly grown since origin in 1913, w/ annual changes at the margins

Basic unit: Sections, grouped into subparts, parts, subchapters, chapters (details below)

IRS Regulations & Statements of Position

Court Decisions

Tax is statute based, so court decisions less important here than in other areas of law

But role of courts means that the tax agency (IRS) is not the final authority as to what the rules mean. "Due process of law" means that taxpayers and the tax agency can both rely on stated rules, as interpreted by courts, until and unless Congress changes the law. The tax authorities cannot arbitrarily change the rules simply because they think the tax too low, or the result too favorable to the taxpayer.

The Categories of Tax Thinking

How the Internal Revenue Code is structured. Note that concepts that don't belong to established categories or that cut across categories -- such as "ownership", "related parties", "phase-outs", and use of losses to offset income -- tend to be badly organized and hard to find. Online Checkpoint

Determining Liability: Subchapter A

Secs. 1 - 59 w/ gaps. Rate Schedules for individuals (Secs. 1-5) and corps. Tax Credits of various types (for tax already paid, or as behavior inventives/tax engineering. Alternate Minimum Tax.

Determining Income: Subchapter B

Secs. 61-68 Definitions: Gross Income, Adjusted Gross Y, Taxable Y, etc. Note effect of this procedure on form design, esp. for individuals.

Secs. 71-90: Specific Inclusions.

Secs. 101 - 140: Specific Exclusions. (141-150 Exclusion of interest received on centain state/local government debt)

Secs. 151-153: Personal Exemptions (ie family allowances)

Secs. 161 - 198: Deductions for individuals and corporations

Secs. 211 -223: Deductions for individuals. 241-250 Deductions for corporations

Secs. 261 - 280H: Nondeductible items.

Other Significant Code Categories

  • Corporations and Shareholders: Subchapter C Secs. 301-385
  • Deferred Compensation Secs. 401-424
  • Timing: Periods and Methods Secs. 441 - 483.
  • Exempt Organizations Secs. 501 - 530
  • Partnerships Secs. 701-777
  • Sources Inside/Outside the US Secs. 861-999
  • Dispositions of Property Secs. 1001 - 1111
  • Capital Assets Secs. 1201 - 1298
  • S-Corporations and Shareholders: Subchapter S - Secs. 1361-1379

Also, other taxes (eg. Estate Tax Secs. 2001 ff), Procedure (Secs. 6001 ff) and Definitions (Secs. 7701 ff)

Most important code sections

Who and How Much? 1 and 11 - rate schedules. 401 and 501 - exempt orgs. 301 and 701 - shareholders and partners. 1(h) and 1221 - capital gains.

What? 61, 62, 63 - definitions (from income to taxable income)

162, 212, 262 - deduct costs of doing business and costs of some nonbusiness income but not personal living costs

1001 - property and basis. 165 - losses

When? 451, 461 (accounting methods) 168 - depreciation

Where? 861 Determination of sources

How the Categories shape the Structure of Returns

Form 1040

Tax Questions and Tax Authority

(Source of Q1 and Q2: newsgroup misc.taxes.moderated Sept. '02)

Question 1:

"I purchased my first home 1 year ago, and would like to sell. Is it correct to think that the only way to avoid capital gains tax (in this case) is to purchase a home of equal or greater value?"

Question involves Code Sec. 121 (effective 1997). If gain is excluded, then it's not reported on any form at all. What does the Code say? What does it mean?

If this is after the fact compliance, how do we know what the facts are? How do we handle ambiguity in the application of the rules to the facts? What if the client doesn't like the answer? (See Code Sec. 6694).

Question 2:

"Roth IRA contributions phase out at $95K-$105K, right? Is that based on gross or net income? Say my gross income is $120K and I have $30K in tax-deductable business expenses. Can I put $3K in my Roth?"

Consider looking at tax code, at return forms, and at IRS publications.

Question involves Code Secs. 408A (also 219 and 62 by cross reference.) This is an example of a "phase-out" rule. The definition of "adjusted gross income" is key to the answer.

Question 3:

Variant of Q1 (not from newsgroup)

"I want to sell an asset at a large profit. A close relative has a large capital loss they cannot use. Can we avoid capital gains tax if I give the asset to my relative, and my then relative sells it and gives the proceeds back to me."

Apart from any gift tax issues, there's no barrier in statute. But something "feels" wrong, and there's case law to consider. Kleuner v. CIR (1998)

The Limits to Reliance on Tax Authority

Court-Created Anti-Abuse Principles that may defeat an excessively favorable result.

  • Anti-Assignment of Income
  • Business Purpose
  • Step Transaction
  • Substance over Form

The Story of Mrs. Gregory

notes and format (c) 2001-02 Robert H. Daniels