Basic Income Tax, Second Edition © William P. Kratzke This work is licensed under a Creative Commons-ShareAlike 4.0 International License Original source: The Center for Computer-Assisted Legal Instruction (CALI) http://www.cali.org/books/basic-income-tax-second-edition Contents Basic Income Tax, Second Edition ................................................................................1 About the Author .....................................................................................................................1 Notices .......................................................................................................................................1 About CALI eLangdell Press.....................................................................................................2 Preface ......................................................................................................................................3 Chapter 1 The Government Raises Money: Introduction to Some Basic Concepts of Taxes and Taxing Income .........................................................................................4 1.1 Introduction to Some Basic Concepts..............................................................................4 The Ramsey Principle ......................................................................................................6 1.2 Taxing Income.....................................................................................................................8 Multiple-Choice ................................................................................................................9 1.3 Some Definitions ..............................................................................................................12 The Tax Formula ............................................................................................................12 Progressive Rates and Income Redistribution ...........................................................14 The Upside Down Nature of Deductions and Exclusions .........................................14 The Right Side Up Nature of Tax Credits ....................................................................16 Three Levels of Tax Law ................................................................................................17 1.4 Not All Income Is Taxed Alike..........................................................................................18 1.5 Layout of the Code ...........................................................................................................18 1.6 Illustration of the Tax Formula .......................................................................................19 1.7 Sources of Tax Law and the Role of Courts...................................................................22 Enforcement of the Tax Laws and Court Review .......................................................22 1.8 Some Income Tax Policy and Some Income Tax Principles ........................................24 1.9 What Is Income?................................................................................................................25 Consumption plus or minus increments to savings ..................................................25 1.9.1 Taxing Income Is Taxing Consumption Plus Increments to the Power to Consume..........................................................................................................................27 Three Principles to Guide Us Through Every Question of Income Tax ...........27 The Unit of Measurement of Income, Consump-tion, and Savings – USD .....27 1.9.2 Income, Consumption, and Value .......................................................................28 Taxing Only the Creation of Value? .....................................................................28 Tax Expenditures ...................................................................................................29 The Essence of Basis .............................................................................................30 Losses and Basis ....................................................................................................31 1.9.3 Basis – Or Keeping Score with the Government................................................31 Investment, Basis, Depreciation, and Adjustments to Basis ............................32 1.9.4 SHS Accounting for Spending Savings and Borrowing Money ........................33 The Relationship Between Basis and Deductions from Taxable Income .......33 1.9.5 Borrowing Money..................................................................................................33 Building a Stronger Economy ...............................................................................34 1.10 Wrap-up Questions for Chapter 1 ...............................................................................34 Chapter 2 What Is Gross Income: Section 61 and the Sixteenth Amendment ......35 The Tax Formula ....................................................................................................................35 2.1 The Constitutional and Statutory Definitions of “Gross Income” ...............................36 Capital and Surplus .......................................................................................................46 Substance and Form .....................................................................................................47 The Corporation as Separate Entity ............................................................................47 Determining gain or loss on disposition of property ................................................53 Exclusions from Gross Income .....................................................................................61 Basis, Restoration of Capital, and MONEY ..................................................................61 2.2 The Constitutional and Statutory Definitions of “Gross Income:” Accessions to Wealth .....................................................................................................................................63 2.2.1 Some Recurring Themes ......................................................................................63 A Little Algebra .......................................................................................................65 Taxability of a Price Reduction .............................................................................71 Other statutory items of gross income ...............................................................75 2.2.2 Section 61(a)(3): Gains Derived from Dealings in Property..............................75 Fluctuations in Value .............................................................................................76 Lump sum payments .............................................................................................78 2.2.3 Barter ......................................................................................................................78 Giving property as payment .................................................................................83 2.2.4 Improvements to Leaseholds and the Time Value of Money ..........................84 The cost of deriving income and depreciation ...................................................86 2.2.5 Imputed Income ....................................................................................................93 2.3 The Constitutional and Statutory Definitions of “Gross Income:” Realization ..........96 Consistency between tax and financial accounting ................................................ 106 2.4 The Constitutional and Statutory Definitions of “Gross Income:” Dominion and Control .................................................................................................................................. 106 Claim of Right doctrine ............................................................................................... 106 Security and damage deposits .................................................................................. 110 2.5 Wrap-up Questions for Chapter 2 .............................................................................. 111 Chapter 3 Exclusions from Gross Income ................................................................112 The Tax Formula ................................................................................................................. 112 3.1 The Society and Government that We Want ............................................................. 113 3.1.1 Gifts and Inheritances, § 102, and Related Basis Rules, §§ 1014, 1015 ....... 113 Mixing taxes to increase basis .......................................................................... 124 3.1.2 Exclusion of Gain from Sale of Principal Residence: § 121............................ 131 3.1.3 Interest on State and Local Bonds: § 103........................................................ 131 3.1.4 Scholarships: § 117............................................................................................. 133 3.1.5 Rental Value of Parsonages: § 107 ................................................................... 133 3.2 Social Benefits................................................................................................................ 134 A bit about insurance ................................................................................................. 134 3.2.1 Life Insurance Death Benefits: § 101 ..............................................................