CH 1: Understanding Federal Tax Law

What are the things that influence tax law? (7)

Revenue Needs
Economic Considerations
Social Considerations
Equity Considerations
Political Considerations
Influence of the Internal Revenue Service
Influence of the Courts

A description that characterizes tax legislation when it neither increases nor decreases the total revenue collected by the taxing jurisdiction. Thus, any tax revenue losses are offset by tax revenue gains.

revenue neutrality

What are the three economic considerations?

control of the economy
encouragement of certain activities
encouragement of certain industries
encouragement of small businesses

Congress also uses incentives like immediate expensing (§ 179) and bonus depreciation to stimulate the economy when needed.

control of the economy

The tax law provides incentives to encourage saving by giving private retirement plans preferential treatment. Contributions to certain Individual Retirement Accounts (IRAs), Keogh (H.R. 10 plans), and § 401(k) plans are deductible, and income from these contributions accumulates on a tax-free basis. It also encourages R&D activities

encouragement of certain activities

The tax law favors the development of natural resources (like oil and gas and mineral deposits) by permitting the use of percentage depletion and a write-off (rather than a capitalization) of certain exploration costs. Recent legislation provides incentives for clean and renewable energy sources (in addition to traditional sources). The railroad and banking industries also receive special tax treatment.

encouragement of certain industries

a shareholder in a small business corporation can take an ordinary deduction (rather than a capital loss) for a loss recognized on a stock investment. Another provision permits the shareholders of a small business corporation to make a special election that allows the profits (or losses) of the corporation to flow through to its shareholders (avoiding the corporate income tax)

encouragement of small businesses

what are the social considerations of tax law?

Health & accident benefits: Nontaxable medical benefits
Group life insurance: Nontaxable family protection
Charitable contributions: Encourages private charity
Education & adoption: Encourages education and adoption
Public policy expenses: Fines and bribes nondeductible

This concept recognizes the inequity of taxing a transaction when the taxpayer lacks the means with which to pay the tax. Under it, there is a correlation between the imposition of the tax and the ability to pay the tax. It is particularly suited to situations in which the taxpayer’s economic position has not changed significantly as a result of the transaction.

wherewithal to pay

A procedure whereby adjustments are made by the IRS to key tax components (e.g., standard deduction, tax brackets) to reflect inflation. The adjustments usually are made annually and are based on the change in the consumer price index.

indexation

A standard used when one must ascertain the true reality of what has occurred. Suppose, for example, a father sells stock to his daughter for $1,000. If the stock is really worth $50,000 at the time of the transfer, the substance of the transaction is probably a gift to her of $49,000.

substance over form

The standard under which unrelated parties would determine an exchange price for a transaction. Suppose, for example, Cardinal Corporation sells property to its sole shareholder for $10,000. In testing whether the $10,000 is an “arm’s length” price, one would ascertain the price that would have been negotiated between the corporation and an unrelated party in a bargained exchange.

arm’s length

In a tax-favored reorganization, a shareholder or corporation that has substantially the same investment after an exchange as before should not be taxed on the transaction. Specifically, the target shareholders must acquire an equity interest in the acquiring corporation equal in value to at least 40 percent of all the outstanding stock of the target entity.

continuity of interest

A justifiable business reason for carrying out a transaction. Mere tax avoidance is not an acceptable business purpose. The presence of a business purpose is crucial in the area of corporate reorganizations and certain liquidations

business purpose

A provision that limits the recognition of income from the recovery of an expense or a loss properly deducted in a prior tax year to the amount of the deduction that generated a tax saving.

tax benefit rule

A Regulation issued by the Treasury Department in temporary form. When speed is critical, the Treasury Department issues Temporary Regulations that take effect immediately. These Regulations have the same authoritative value as Final Regulations and may be cited as precedent for three years. Temporary Regulations are also issued as proposed Regulations.

Temporary Regulations

The U.S. Treasury Department Regulations (abbreviated Reg.) represent the position of the IRS as to how the Internal Revenue Code is to be interpreted. Their purpose is to provide taxpayers and IRS personnel with rules of general and specific application to the various provisions of the tax law. Regulations are published in the Federal Register and in all tax services.

Final Regulations

is issued by the National Office of the IRS to express an official interpretation of the tax law as applied to specific transactions. It is more limited in application than a Regulation. A Revenue Ruling is published in an Internal Revenue Bulletin (I.R.B.).

Revenue Rulings

A matter of procedural importance to both taxpayers and the IRS concerning the administration of the tax laws is issued as a Revenue Procedure (abbreviated Rev.Proc.). A Revenue Procedure is published in an Internal Revenue Bulletin (I.R.B.).

Revenue Procedures

A Notice is issued by the National Office of the IRS as official guidance when such information is needed before the time it takes to issue a Final Regulation. Such guidance is typically transitional until final guidance is issued. A Notice is published in an Internal Revenue Bulletin (I.R.B.).

Notices

The written response of the IRS to a taxpayer’s request for interpretation of the revenue laws with respect to a proposed transaction (e.g., concerning the tax-free status of a reorganization). Not to be relied on as precedent by other than the party who requested the ruling.

Letter rulings

TAMs are issued by the IRS in response to questions raised by IRS field personnel during audits. They deal with completed rather than proposed transactions and are often requested for questions related to exempt organizations and employee plans

Technical Advice Memoranda (TAMs)

Upon the request of a taxpayer, the IRS will comment on the tax status of a completed transaction. Determination letters frequently are used to determine whether a retirement or profit sharing plan qualifies under the Code and to determine the tax-exempt status of certain nonprofit organizations.

determination letters