#12331 - Introduction - Taxation

Introduction

1. What is Income?

1. Haig-Simons Definition. Personal income is “the algebraic sum of (1) the market 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.”

2. Section 61. Gross income is “all income from whatever source derived.” §61 provides a non-exclusive list of items included within gross income, including compensation for services, business income, income from dealings in property, interest, rents, royalties, dividends, pensions, annuities, and income from the discharge of indebtedness. In general, gross income includes not only cash receipts, but receipts in the form of services, property, or payments to third parties on the taxpayer’s behalf. However, Congress has excluded from income certain receipts (e.g., certain fringe benefits provided by an employer to employees) that would otherwise be included.

3. Glenshaw Glass. Glenshaw Glass held that §61 reaches all “undeniable accessions to wealth, clearly realized, and over which the taxpayer has complete dominion.”

4. Gotcher. Gotcher (5th Cir.1968) held that, although §61 should be broadly interpreted, “exclusions from gross income are not limited to the enumerated exclusions.” But see Cesarini (6th Cir.1970), suggesting that, under the Code, “income from all sources is taxed unless the taxpayer can point to an express exemption.”

The Gotcher Court concluded that a taxpayer had no taxable income from an expenditure by his employer that benefitted him unless (1) there was an economic benefit to the recipient (2) that primarily benefited the taxpayer personally.

2. Income Tax Terminology and Concepts

5. Basis and Adjusted Basis. Basis is the portion of the sale proceeds from a piece of property that the taxpayer may recover without incurring tax liability. Adjusted basis in a purchased asset is typically the purchase price adjusted upward or downward to reflect subsequent expenditures or tax benefits attributable to the asset.

6. Adjusted Gross Income. AGI is gross income minus deductions for business expenses and various other listed expenses (§62). AGI is then reduced by personal exemptions and either the standard deduction or the sum of all itemized deductions. Taxpayers generally prefer deductions from gross income to itemized deductions, because itemized deductions (1) cannot be used in conjunction with the standard deduction and (2) are sometimes available only if they exceed 2% of AGI. By taking a deduction from gross income, a taxpayer can reduce AGI, thereby increasing the amount of her itemized deductions relative to the 2% floor.

7. Inflation. At present, the standard deduction, the personal exemption, and the rate tables are all adjusted for inflation.

8. Credits versus Deductions. A credit represents a direct reduction in tax in the amount of the allowable credit, while a deduction represents a reduction in taxable income that, in turn, reduces tax liability by the amount of the allowable deduction multiplied by the taxpayer’s marginal rate. Thus, a deduction is of greater dollar value to taxpayers with greater taxable income, while a credit provides similar reductions in tax to all taxpayers.

9. Double Taxation of Dividends. Corporations are not allowed to deduct income distributed as dividends to shareholders. Hence, these distributions are said to incur “double taxation,” since they are taxed at the corporate level and at the shareholder level (to the extent that both parties are subject to tax).

3. Tax Expenditures

10. Tax Expenditures. Tax expenditures are “revenue losses attributable to provisions of the Federal tax laws which allow a special...