Federal Income Tax Spring 2016 Professor O Reilly

Transcription

1 Federal Income Tax Spring 2016 Professor O Reilly Initial Assignment for Tuesday, January 12th, please read Notes on the Federal Income Tax Course & complete Problem Set One.

2 Notes on the Federal Income Tax Course January 2016 This course differs in important ways from the classic first-year law school case method classes such as torts and contracts. There are probably more numbers involved, but there is also a difference in emphasis. The traditional first year law course is conducted using the case method. The focus of the case method is not to convey the main legal rules of a subject, but to develop analytical skills relevant to practicing law. The case method involves attempting to solve a problem in a law school class, a legal problem. The core premise of traditional graduate professional education in law and business is that developing the skills necessary to address a problem is an essential starting point in a professional career and almost the only thing that can be accomplished in a classroom setting in just two or three years. In legal education, the goal of the case method is prepare students to locate, understand and digest the legal materials (legal opinions, statutes and regulations) that might be relevant to a legal problem, and then to formulate the relevant legal principles that apply to the particular problem. In practice, the typical case-method class involves discussing one or more cases, and perhaps some other material, that have been assigned and read earlier. Typically, the final exam of a case-method course contains a few questions, each involving a narrative calling for a answer identifying potential legal issues arising out of the facts, plus evaluating the merits of possible legal positions taken by parties who have been mentioned in the narrative. None of the questions on such an exam may have a correct conclusion, and the most successful answers may be the ones that spot the most relevant legal issues, explain the relevant legal principles most cogently, and make the most effective arguments for and against possible outcomes to potential disputes that might arise out of the narrative. A case-method instructor may believe that a well crafted question does not have an obviously right answer there may be conflicts among the authorities and no settled precedents on point. A strong case for an unlikely conclusion might be considered a fine answer.

3 2 This is not a case method class: An important objective of the class is to learn black letter law: A substantial number of federal tax rules. Most questions on the exam will be designed to have right answers. Often the answers will be numbers. (A s tax liability for 2015 = $9400 or B can deduct $380.) Not many cases will be assigned. Many provisions of the Internal Revenue Code will be assigned, plus a number of related tax regulations. Although questions and discussion are encouraged, and valuable, the format of most classes will be a lecture describing the federal tax law that applies to various situations. Why? This is not a case method class even though some of the points in favor of the case method for teaching law may also apply to tax law It s not possible to cover most of the tax law rules that a tax lawyer should know in law school. Tax rules are always changing anyway. It s inadequate to just learn rules without learning how evaluate which rules are relevant to a situation. A client can hire an accountant to handle a situation that is clearly covered by black letter law. A tax lawyer has to know how to analyze situations that go beyond the black letter law. Federal tax law, however, does not lend itself to the case method: It is not a common law subject. Not only are the large majority of federal tax rules based on federal statutes, these rules did not develop out of, or modify, common law principles. While practicing tax lawyers must often deal with situations in which there is no rule directly on point, they must do so based on their background knowledge of many black letter rules. For the most part, solving realistic tax law problems requires knowledge of more tax rules and principles than can be covered in an introductory tax course. The basic tax course is designed to provide a general introduction to the topic for students who do not intend to practice tax law.

4 3 These students can benefit from an overview of tax law so that they can recognize potential tax issues and be able to consult knowledgeably with tax specialists when necessary. Following a case method format would limit the breadth of topics that could be surveyed in the only tax course that these students may take. Federal judges are not always enthusiastic about tax cases on their docket. So Judges may be less sensitive to distinctions between holdings and dicta in the tax case law, and less receptive to the sort of nuanced legal analysis that can be successful in common law or constitutional cases. There s often less return on investment to identifying the scope of a holding or distinguishing one tax case from another. For that reason, close reading of tax cases is not emphasized in this course. A further reason not to follow the case method in the introductory tax course: many clients wish to take a very conservative approach to potential tax issues. In other words, many clients do not want to take a significant risk that the government will reject the client s tax position. For example, suppose one business buys another business. In many cases, the owners of the business being sold may have to pay significant federal taxes on the proceeds of the sale. But in some circumstances, it may be possible to put off that tax bill for many years, even indefinitely. Let s say it s not clear whether it s legitimate for the seller to put off paying federal income tax on the sale. Maybe the seller has a good case, but not an airtight one. If the seller decides not to pay the tax, and the IRS thinks that it should have, things might get very unpleasant for the seller or at least the seller might be afraid that things would get unpleasant. It s not just the risk of a disagreeable conflict with the federal government and significant tax penalties. Because federal taxes can be very large, the whole business strategy involved in selling the business might fall apart if the tax bill is larger than expected. As a result, for many clients, the most important aspect of tax advice is knowing what the IRS s view of the tax law is, which is typically the worstcase scenario. As opposed to: what do you, as a lawyer, think is the best interpretation of the tax law. Even if you think that the IRS s view of the tax law

5 4 is likely to be rejected by the courts, your client may wish to avoid the risk of a protracted dispute with the IRS. Often, it s easier to determine what the IRS s view of the tax law is than to determine what the best interpretation of the legal authorities is. It s not always necessary to use the full force of the case method to determine the IRS position. The IRS may have clearly announced its position, or for other reasons it might be pretty clear what the IRS position would be. And for some clients, that s really all that they want to know. This is only true relatively speaking. Tax lawyers do confront situations in which it s necessary to ascertain the best answer in the same way that a lawyer would formulate an opinion in environmental law, constitutional law or labor law. But it s true enough to justify having a course in which there are (mostly) right answers, where right does not necessarily mean indisputably right, but rather right for clients that want to avoid the risk of disputes with the IRS. So this course will probably cover more ground than most first year courses, and there will be more right and wrong answers. (Plus more numbers.) That doesn t mean that there aren t gray areas in tax there are plenty just that tax requires more background to deal competently with the gray areas than is required for some other subjects. And many other courses provide opportunities to develop skills in close readings of cases and weighing conflicting and ambiguous authorities. In this course, it will be important to develop a strategy for mastering, organizing and retaining many complicated but definite rules.

6 Problem Set One Tax Rates & Tax Liability If you reside in the United States, chances are you will be obligaged to pay various taxes imposed by various levels of government. There are property taxes, gasoline taxes, sales taxes, payroll taxes and income taxes. The focus of this course is on just one type of tax the federal income tax. If you finance your lifestyle mostly through wages or salary, this is often your largest single tax liability. An Oregon resident earning $100,000 a year might owe about $20,000 in annual federal income tax, a little under $10,000 in Oregon income tax, and around $7000 in payroll taxes. The federal income tax is imposed on the taxpayer s taxable income, which is the person s gross income (roughly, total income) minus deductions. Tax liability is determined (under 1 of the Internal Revenue Code) by applying the applicable tax rate to the taxpayer s taxable income. For example, suppose Ms Greene is single and has 2015 taxable income of $60,000. Using the tax table for 2015, Greene s federal income tax liability is $10, Although for many taxpayers, tax liability can be determined by using a tax tables provided with the instructions for filing a tax return, we will use the tax rate tables provided by the IRS. (The tables are revised every year to adjust for inflation, so the tables provided in IRC 1 cannot be used.) A copy of the 2015 tables is provided in the front of the paperback text for the course, and appears at the end of this problem set. These tables are from Revenue Procedure , which the IRS released in November For a single taxpayer, the relevant rates appear in Table 3. The rates vary according to the taxable income of the taxpayer. For example, a 10% rate applies to a single taxpayer with a taxable income up to $9225; the federal income tax liability of a single taxpayer with taxable income = $5000 would be $500. The federal income tax liability of a single taxpayer with taxable income = $8200 would be $820. In the case of the single taxpayer with taxable income of $60,000, we use row 3 of table 3, which applies to single taxpayers with taxable income between $37,450 & $90,750. According to the table, the applicable tax liability is $ plus 25% of the amount over $37,450. Here, the amount over $37,450 equals $22,550: $60000 $37450 = $ Twenty five percent of $22,550 = $ Adding $ to $ $10, If a married couple filing a joint return has a combined taxable income of $60,000, table 1 applies. The applicable rate is given in row 2 of table 1, for taxable income above $18,450 up to $74,900. The tax = $ % of the amount over $18,450. $60000 $18450 = $41550, and 0.15 $41550 = $ ; $ $ = $ (Note that for the same taxable income, tax liability is generally less for married filing jointly than for single.) Question 1 Suppose Mr Black s 2015 taxable income = $100,000. If Black is single, what is Black s 2015 federal income tax liability? Question 2 Suppose Mr & Mrs White have $100, taxable income. If the Whites file a joint return, what is their 2015 federal income tax liability?

7 Rev Proc Internal Revenue Bulletin SECTION 1. PURPOSE This revenue procedure sets forth inflation-adjusted items for SECTION ADJUSTED ITEMS.01 Tax Rate Tables. For taxable years beginning in 2015, the tax rate tables under 1 are as follows: TABLE 1 Section 1(a) Married Individuals Filing Joint Returns and Surviving Spouses Not over $18,450 10% of the taxable income Over $18,450 but not over $74,900 $1,845 plus 15% of the excess over $18,450 Over $74,900 but not over $151,200 $10, plus 25% of the excess over $74,900 Over $151,200 but not over $230,450 $29, plus 28% of the excess over $151,200 Over $230,450 but not over $411,500 $51, plus 33% of the excess over $230,450 Over $411,500 but not over $464,850 $111,324 plus 35% of the excess over $411,500 Over $464,850 $129, plus 39.6% of the excess over $464,850 Bulletin No November 17,

8 Rev Proc Internal Revenue Bulletin TABLE 2 Section 1(b) Heads of Households Not over $13,150 10% of the taxable income Over $13,150 but not over $50,200 $1,315 plus 15% of the excess over $13,150 Over $50,200 but not over $129,600 $6, plus 25% of the excess over $50,200 Over $129,600 but not over $209,850 $26, plus 28% of the excess over $129,600 Over $209,850 but not over $411,500 $49, plus 33% of the excess over $209,850 Over $411,500 not over $439,000 $115,737 plus 35% of the excess over $411,500 Over $439,000 $125,362 plus 39.6% of the excess over $439,000 TABLE 3 Section 1(c) Unmarried Individuals (other than Surviving Spouses and Heads of Households) Not over $9,225 10% of the taxable income Over $9,225 but not over $37,450 $ plus 15% of the excess over $9,225 Over $37,450 but not over $90,750 $5, plus 25% of the excess over $37,450 Over $90,750 but not over $189,300 $18, plus 28% of the excess over $90,750 Over $189,300 but not over $411,500 $46, plus 33% of the excess over $189,300 Over $411,500 not over $413,200 $119, plus 35% of the excess over $411,500 Over $413,200 $119, plus 39.6% of the excess over $413,200 TABLE 4 Section 1(d) Married Individuals Filing Separate Returns Not over $9,225 10% of the taxable income Over $9,225 but not over $37,450 $ plus 15% of the excess over $9,225 Over $37,450 but not over $75,600 $5, plus 25% of the excess over $37,450 Over $75,600 but not over $115,225 $14, plus 28% of the excess over $75,600 Over $115,225 but not over $205,750 $25, plus 33% of the excess over $115,225 Over $205,750 not over $232,425 $55,662 plus 35% of the excess over $205,750 Over $232,425 $64, plus 39.6% of the excess over $232,425 TABLE 5 Section 1(e) Estates and Trusts Not over $2,500 15% of the taxable income Over $2,500 but not over $5,900 $375 plus 25% of the excess over $2,500 Over $5,900 but not over $9,050 $1,225 plus 28% of the excess over $5,900 Over $9,050 but not over $12,300 $2,107 plus 33% of the excess over $9,050 Over $12,300 $3, plus 39.6% of the excess over $12,300 November 17, 2014 Bulletin No