Chapter 1 Understanding and Working With the Federal Tax Law Corporations, Partnerships, Estates & Trusts Copyright ©2006 South-Western/Thomson Learning Competing Objectives Result in a Complex Law Structure • • • • • Revenue Needs Economic Considerations Social Considerations Equity (Fairness) Considerations Political Considerations Corporations, Partnerships, Estates & Trusts C1 - 2 Economic Considerations (slide 1 of 2) • Control the economy (e.g., favorable depreciation deductions for purchase of business property) • Encourage certain activities (e.g., research and development deductions and credits) Corporations, Partnerships, Estates & Trusts C1 - 3 Economic Considerations (slide 2 of 2) • Encourage certain industries (e.g., agriculture and natural resources incentives) • Encourage small business (e.g., ordinary loss deduction on stock in small business) Corporations, Partnerships, Estates & Trusts C1 - 4 Social Considerations (slide 1 of 2) • Tax-free medical coverage provided by employers to encourage health insurance • Deferred tax treatment of certain retirement funds to encourage saving for retirement Corporations, Partnerships, Estates & Trusts C1 - 5 Social Considerations (slide 2 of 2) • Deduction for charitable contributions to encourage funding of socially desirable programs by private individuals and companies • Disallowed deductions for expenditures against public policy (e.g., illegal bribes, kickbacks) Corporations, Partnerships, Estates & Trusts C1 - 6 Equity Considerations (slide 1 of 4) • Alleviate the effect of double taxation: – Deduction for state and local taxes – Credit or deduction for certain foreign taxes – Deduction for dividends received by corporations to prevent triple taxation Corporations, Partnerships, Estates & Trusts C1 - 7 Equity Considerations (slide 2 of 4) • Wherewithal to Pay concept – Defers taxation when a taxpayer’s economic position has not changed – e.g., Exchange of assets might result in gain but no cash, so some tax may be deferred Corporations, Partnerships, Estates & Trusts C1 - 8 Equity Considerations (slide 3 of 4) • Annual accounting periods – In some cases, e.g., start-up businesses, a revenue-generating cycle may be greater than the 12 month maximum tax reporting period. – To accommodate this, net operating loss rules allow losses from one year to be used in another year. This minimizes the adverse impact of arbitrary reporting periods. Corporations, Partnerships, Estates & Trusts C1 - 9 Equity Considerations (slide 4 of 4) • Inflation adjustments are included in tax rate schedules. If earnings increase solely by cost-of living amounts, taxes will not be imposed at higher rates on the increase. Corporations, Partnerships, Estates & Trusts C1 - 10 Political Considerations • Special interest legislation • Response to public opinion (political expediency) • State and local influences Corporations, Partnerships, Estates & Trusts C1 - 11 Agencies Influencing Tax Law (slide 1 of 4) • Internal Revenue Service (IRS) – Works to get Congress to “close loopholes” – Publishes “statutory regulations” authorized by Congress and given force of law – Publishes other regulations which outline the IRS’ position on certain issues Corporations, Partnerships, Estates & Trusts C1 - 12 Agencies Influencing Tax Law (slide 2 of 4) • Aids to IRS in collecting revenue: – – – – Tax Return Audits Information reporting (W-2s and 1099s) Withholding Interest and penalty assessments Corporations, Partnerships, Estates & Trusts C1 - 13 Agencies Influencing Tax Law (slide 3 of 4) • Courts – Judicial concepts • • • • Substance over form Arm’s length Continuity of interest Business purpose Corporations, Partnerships, Estates & Trusts C1 - 14 Agencies Influencing Tax Law (slide 4 of 4) • Courts – Judicial rulings • Some rulings highlight undesirable aspects of present law, which may lead Congress to adopt a change in law Corporations, Partnerships, Estates & Trusts C1 - 15 Statutory Sources of Tax Law • Internal Revenue Code – Codification of the Federal tax law provisions in a logical sequence – Have had three codes: • 1939, 1954, 1986 Corporations, Partnerships, Estates & Trusts C1 - 16 Legislative Process For Tax Bills Corporations, Partnerships, Estates & Trusts C1 - 17 Joint Conference Committee Process House Version Amortization of goodwill and other intangible assets over 14 years Senate Version Amortization of only 75% of goodwill and other intangible assets over 14 years Joint Conference Committee Result Straight-line amortization of goodwill and other intangible assets over 15 years Corporations, Partnerships, Estates & Trusts C1 - 18 Arrangement of the Code • Subtitle A—Income Taxes – Chapter 1. Normal Taxes and Surtaxes • Subchapter A. Determination of Tax Liability – Part I. Tax on Individuals Sections 1 to 5 (Various Titles) – Part II. Tax on Corporations Sections 11 to 12 (Various Titles) Corporations, Partnerships, Estates & Trusts C1 - 19 Example Code Citation • Section 2(a)(1)(A) – – – – 2 (a) (1) (A) - Section number Subsection Paragraph number Subparagraph designation Corporations, Partnerships, Estates & Trusts C1 - 20 Tax Treaties •The U.S. signs tax treaties with foreign countries to: •Render mutual assistance in tax enforcement •Avoid double taxation •Neither a tax law nor a tax treaty takes general precedence •When there is a direct conflict, the most recent item will take precedence •A taxpayer must disclose on the tax return any position where a treaty overrides a tax law Corporations, Partnerships, Estates & Trusts C1 - 21 Administrative Sources of Tax Law •Treasury Department Regulations •Revenue Rulings •Revenue Procedures, and •Various other administrative pronouncements Corporations, Partnerships, Estates & Trusts C1 - 22 Regulations (slide 1 of 4) – Issued by U.S. Treasury Department – Provide general interpretations and guidance in applying the Code Corporations, Partnerships, Estates & Trusts C1 - 23 Regulations (slide 2 of 4) • Issued as: – Proposed: preview of final regulations • Do not have force and effect of law – Temporary: issued when guidance needed quickly • Same authoritative value as final regulations – Final: • Force and effect of law Corporations, Partnerships, Estates & Trusts C1 - 24 Regulations (slide 3 of 4) • Example of Regulation citation: Reg. § 1.117-4(c)(1) 1 = income tax regulation 117 = code section to which regulation pertains -4 = fourth regulation on section 117 issued Corporations, Partnerships, Estates & Trusts C1 - 25 Regulations (slide 4 of 4) • Example of Proposed Regulation citation: Prop. Reg. § 1.2 • Example of Temporary Regulation citation: Temp. Reg. § 1.274–5T(k) Corporations, Partnerships, Estates & Trusts C1 - 26 Revenue Rulings (slide 1 of 2) • Officially issued by National Office of IRS – Provide specific interpretations and guidance in applying the Code – Less legal force than Regulations – Issued in IRB and accumulated in the Cumulative Bulletins Corporations, Partnerships, Estates & Trusts C1 - 27 Revenue Rulings (slide 2 of 2) • Example of Temporary Revenue Ruling citation – Rev. Rul. 2004–18, I.R.B. No. 8, 509 • Revenue Ruling Number 18, appearing on page 509 of the 8th weekly issue of the Internal Revenue Bulletin for 2004 • Example of Permanent Revenue Ruling citation – Rev. Rul. 2004–18, 2004–1 C.B. 509 • Revenue Ruling Number 18, appearing on page 509 of Volume 1 of the Cumulative Bulletin for 2004 Corporations, Partnerships, Estates & Trusts C1 - 28 Revenue Procedures (slide 1 of 2) • Concerned with the internal procedures of IRS – Issued similar to Revenue Rulings – Issued in IRB and accumulated in the Cumulative Bulletins Corporations, Partnerships, Estates & Trusts C1 - 29 Revenue Procedures (slide 2 of 2) • Example of Revenue Procedure citation – Rev. Proc. 92-29, 1992-1 CB 748 • 29th Rev. Procedure in 1992 found in volume 1 of Cumulative Bulletin on page 748 Corporations, Partnerships, Estates & Trusts C1 - 30 Letter Rulings (slide 1 of 2) • Provide guidance to taxpayer on how a transaction will be taxed before proceeding with it – Issued for a fee upon a taxpayer’s request – Describe how the IRS will treat a proposed transaction • Apply only to the taxpayer who asks for and obtains the ruling – Post-1984 letter rulings may be substantial authority for purposes of the accuracy-related penalty • Limited to restricted, preannounced areas of taxation Corporations, Partnerships, Estates & Trusts C1 - 31 Letter Rulings (slide 2 of 2) • Example of Letter Ruling citation – Ltr.Rul. 200414039 • 39th ruling issued in the 14th week of 2004 Corporations, Partnerships, Estates & Trusts C1 - 32 Other Administrative Pronouncements (slide 1 of 3) • Treasury Decisions-issued by Treasury Dept. to: – Promulgate new or amend existing Regulations – Announce position of the Government on selected court decisions – Published in the Internal Revenue Bulletin • Then transferred to the Cumulative Bulletin Corporations, Partnerships, Estates & Trusts C1 - 33 Other Administrative Pronouncements (slide 2 of 3) • Determination Letters – Issued by Area Director at taxpayer’s request – Usually involve completed transactions – Not published • Made known only to party making the request Corporations, Partnerships, Estates & Trusts C1 - 34 Other Administrative Pronouncements (slide 3 of 3) • General Counsel Memoranda • Technical Advice Memoranda • Field Service Advice Corporations, Partnerships, Estates & Trusts C1 - 35 Federal Judicial System FIGURE 1–1 Corporations, Partnerships, Estates & Trusts C1 - 36 Judicial Sources (slide 1 of 2) • There are four courts of original jurisdiction (trial courts) – – – – U.S. Tax Court: Regular U.S. Tax Court: Small Cases Division Federal District Court U.S. Court of Federal Claims Corporations, Partnerships, Estates & Trusts C1 - 37 Judicial Sources (slide 2 of 2) U.S. Court of Issue Number of judges per court U.S. Tax Court 19* U.S. District Court 1 Federal Claims 16 Payment of deficiency before trial No Yes Yes Jury trial No Yes No Types of disputes Tax cases only Most criminal and civil issues Claims against the United States Jurisdiction Nationwide Location of Taxpayer Nationwide IRS acquiescence policy Yes Yes Yes Appeal route Appeals U.S. Court of Appeals U.S. Court of for the Federal Court U.S. Court of Appeals *There are also 14 special trial judges and 9 senior judges. CONCEPT SUMMARY 1–1 Corporations, Partnerships, Estates & Trusts C1 - 38 Appeals Process • Appeals from District Court or Tax Court go to the U.S. Court of Appeals for circuit where taxpayer resides • Appeals from Court of Federal Claims is to Court of Appeals for the Federal Circuit • Appeal to the Supreme Court is by Writ of Certiorari – Only granted for those cases it desires to hear Corporations, Partnerships, Estates & Trusts C1 - 39 Courts’ Weights as Precedents • From high to low – Supreme Court – Circuit Court of Appeals – Tax Court (Regular), U.S. Court of Federal Claims, & U.S. District Courts • Decisions of Small Cases Division of Tax Court have no precedential value and cannot be appealed Corporations, Partnerships, Estates & Trusts C1 - 40 Tax Court (slide 1 of 2) • Issues two types of decisions: Regular and Memorandum – Regular decisions involve novel issues not previously resolved by the court • Regular decisions are published by U.S. government • Ismat M. Abeid, 122 T.C. 404 (2004) Corporations, Partnerships, Estates & Trusts C1 - 41 Tax Court (slide 2 of 2) • Tax Court Memorandum decisions – Memorandum decisions deal with situations necessitating only the application of already established principles of law • Memorandum decisions are officially published in mimeograph form only • Jack D. Carr, TC Memo 1985-19 • Jack D. Carr, 49 TCM 507 (CCH citation) • Jack D. Carr, RIA TC Mem. Dec. ¶85, 019 (RIA citation) Corporations, Partnerships, Estates & Trusts C1 - 42 Trial and Appellate Court Decisions • Examples of citations – Simmons-Eastern v. U.S., 73-1 USTC ¶9279 (D.Ct. Ga., 1972) (CCH citation) – Simmons-Eastern v. U.S., 31 AFTR2d 73-640 (D.Ct. Ga., 1972) (RIA citation) – Simmons-Eastern v. U.S., 354 F. Supp. 1003 (D.Ct. Ga., 1972) (West citation) Corporations, Partnerships, Estates & Trusts C1 - 43 Supreme Court Decisions • Examples of citations – U.S. v. The Donruss Co., (USSC, 1969) • • • • • 69-1 USTC ¶9167 (CCH citation) 23 AFTR2d 69-418 (RIA citation) 89 S. CT 501 (West citation) 393 U.S. 297 (U.S. Government citation) 21 L.Ed.2d 495 (Lawyer's Co-operative Publishing Co. citation) Corporations, Partnerships, Estates & Trusts C1 - 44 Tax Research Process FIGURE 1–3 Corporations, Partnerships, Estates & Trusts C1 - 45 Tax Research • Tax research is the method by which an interested party determines the best solution to a tax situation Corporations, Partnerships, Estates & Trusts C1 - 46 Tax Law Sources (slide 1 of 2) • Primary sources of tax law include: – – – – – – – The Constitution Legislative history materials Statutes Treaties Treasury Regulations IRS pronouncements, and Judicial decisions • In general, the IRS considers only primary sources to constitute substantial authority Corporations, Partnerships, Estates & Trusts C1 - 47 Tax Law Sources (slide 2 of 2) • Secondary Sources include: – – – – – Legal periodicals Treatises Legal opinions General Counsel Memoranda, and Written determinations • In general, secondary sources are not authority Corporations, Partnerships, Estates & Trusts C1 - 48 Assessing the Validity of Tax Law Sources (slide 1 of 4) • Regulations – IRS agents must give the Code and the Regulations equal weight when dealing with taxpayers and their representatives – Proposed Regulations are not binding on IRS or taxpayer – Burden of proof is on taxpayer to show Regulation incorrect Corporations, Partnerships, Estates & Trusts C1 - 49 Assessing the Validity of Tax Law Sources (slide 2 of 4) • Final Regulations tend to be of three types – Procedural: housekeeping-type instructions – Interpretive: rephrase what is in Committee Reports and the Code • Hard to get overturned – Legislative: allow the Treasury Department to determine the details of law • Congress has delegated its legislative powers and these cannot generally be overturned Corporations, Partnerships, Estates & Trusts C1 - 50 Assessing the Validity of Tax Law Sources (slide 3 of 4) • Revenue Rulings – Carry less weight than Regulations – Not substantial authority in court disputes Corporations, Partnerships, Estates & Trusts C1 - 51 Assessing the Validity of Tax Law Sources (slide 4 of 4) • Judicial sources – Consider the level of the court and the legal residence of the taxpayer – Determine whether the decision has been overturned on appeal Corporations, Partnerships, Estates & Trusts C1 - 52 Tax Planning • The primary purpose of effective tax planning is to reduce the taxpayer’s total tax bill – Must consider the legitimate business goals of taxpayer • A secondary objective of effective tax planning is to reduce, defer, or eliminate the tax • Tax avoidance vs. tax evasion – Tax avoidance is the legal minimization of tax liabilities and one goal of tax planning – Tax evasion is the illegal minimization of tax liabilities and can lead to fines and jail Corporations, Partnerships, Estates & Trusts C1 - 53 Electronic Tax Research (slide 1 of 3) • CD-ROM Services – CCH, RIA, and WESTLAW offer vast tax libraries – Provide search and browsing capabilities for various tax databases and links to tax documents Corporations, Partnerships, Estates & Trusts C1 - 54 Electronic Tax Research (slide 2 of 3) • On-Line Systems – Lexis/Nexis, CCH, RIA, and WESTLAW provide virtually instantaneous use of tax law sources – May be expensive but provides extremely current information Corporations, Partnerships, Estates & Trusts C1 - 55 Electronic Tax Research (slide 3 of 3) • The Internet provides a wealth of tax information – Information available on web pages of accounting and consulting firms, publishers, tax academics, libraries, and governmental bodies – Newsgroups and email capabilities provide opportunities to exchange tax information Corporations, Partnerships, Estates & Trusts C1 - 56 If you have any comments or suggestions concerning this PowerPoint Presentation for West Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA TRIPPEDR@oneonta.edu SUNY Oneonta Corporations, Partnerships, Estates & Trusts C1 - 57