Basic Income Spring 2018 Assignment 1 Receipts

PART I THE GENERAL PRINCIPLES

Assignment 1: Receipts and Taxpayers
Study Section 61(a)

Note Section 74(a) and (b); section 102(a); Reg. 1.61-1(a), Reg. 1.61-14

Pulsifer v. Commissioner
64 T.C. 245 (1975)

Respondent determined a deficiency of $2,449.41 against each of the three petitioners for
1969. The sole issue for decision is whether petitioners, who were minors in 1969, must
include in gross income in 1969 their winnings from the 1969 Irish Hospital Sweepstakes
which were deposited with the Irish court.

The petitioners, Stephen W. Pulsifer, Susan M. Pulsifer and Thomas O. Pulsifer, are
brothers and sister. They filed their 1969 Federal income tax returns, using a cash receipts
and disbursements accounting method.

Mr. [Gordon] Pulsifer [the taxpayers' father] acquired an Irish Hospital Sweepstakes
ticket in his name and the names of his three minor children. On March 21, 1969 he and
petitioners received a telegram from the Hospital Trust advising them that their ticket
would be represented by Saratoga Skiddy, a horse which would run on their behalf in the
Lincolnshire Handicap. Saratoga Skiddy placed second, winning $48,000.

When he applied for the winnings, Mr. Pulsifer was advised that three-fourths of the
amount would not be released to him because the ticket stub reflected three minor co-
owners. He was further advised that, pursuant to Irish law, the withheld portion together
with interest earned to date would be deposited with the Bank of Ireland at interest to the
account of the Accountant of the Courts of Justice for the benefit of each of the
petitioners. The money would not be released until petitioners reached twenty-one or
until application on their behalf was made by an appropriate party to the Irish court for
release of the funds. Mr. Pulsifer was sent his share of the prize.

The amounts paid over and credited to each of the petitioners were principal of
$11,925.00 plus interest of $250.03, or $12,175.03. Mr. Pulsifer, as petitioners' next
friend and legal guardian, has since filed for release of those funds, and he has an

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absolute right to obtain them. [The court noted that the record did not disclose whether he
had already received the funds at the time of trial.]

Both parties agree the prize money is income to the petitioners. The only question is in
what year it must be included in income. Petitioners contend that they should not be
required to recognize the Irish Hospital Sweepstakes winnings held for them by the Irish
court in 1969. They reason that neither the constructive receipt nor the economic benefit
doctrines apply, and that all they had in 1969 was a nonassignable chose in action.
Respondent argues that the economic benefit doctrine applies, thereby dictating
recognition of the prize money in 1969. See Rev. Rul. 67-203, 1967-1 C.B. 105. We
agree with respondent.

Under the economic benefit theory, an individual on the cash receipts and disbursements
method of accounting is currently taxable on the economic and financial benefit derived
from the absolute right to income in the form of a fund which has been irrevocably set
aside for him in trust and is beyond the reach of the payer's debtors. E. T. Sproull, 16
T.C. 244 (1951), affirmed per curiam 194 F. 2d 541 (C.A. 6, 1952). Petitioners had an
absolute, nonforfeitable right to their winnings on deposit with the Irish court. The money
had been irrevocably set aside for their sole benefit. All that was needed to receive the
money was for their legal representative to apply for the funds, which he forthwith did.
See Orlando v. Earl of Fingall, Irish Reports 281 (1940). We agree with respondent that
this case falls within the legal analysis set out in E. T. Sproull, supra.

In the Sproull case the employer-corporation unilaterally and irrevocably transferred

$10,500 into a trust in 1945 for taxpayer's sole benefit in consideration for prior services.
In 1946 and 1947, pursuant to the trust document, the corpus was paid in its entirety to
taxpayer. In the event of his death the funds were to have been paid to his administrator,
executor or heirs. The Court held that the entire $10,500 was taxable in 1945 because
Sproull derived an economic benefit from it in 1945. The employer had made an
irrevocable transfer to the trust, relinquishing all control. Sproull was given an absolute
right to the funds which were to be applied for his sole benefit. The funds were beyond
the reach of the employer's creditors. Sproull's right to those funds was not contingent,
and the trust agreement did not contain any restrictions on his right to assign or otherwise
dispose of that interest.

The record does not show whether the right to the funds held by the Bank of Ireland was
assignable. Petitioner claims they were not, but cites no authority for his position.
However, the result is the same whether or not the right to the funds is assignable.

Note on Sources of Income Tax Law

The opinion in Pulsifer probably looks like most other cases you may have encountered
in law school. There are a few differences, however, of which you may want to take note.
First, as in virtually all modern substantive tax cases, the plaintiff or petitioner is a

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taxpayer, and the taxpayer is suing the government for a determination of his liability
under the income tax law (the defendant is the Commissioner, if the taxpayer has not yet
paid and the suit is brought in Tax Court, or the United States, if the taxpayer has paid
and is suing for a refund in the district court or court of federal claims). (In older cases,
suits challenging unpaid assessments against the Commissioner by name (e.g., Helvering,
Eisner.) and suits for refund could be brought against the collector (e.g., Tait).

What is the source of the law applied in income tax cases? Although the court in Pulsifer
never even cites it, the principal source is, of course, the Internal Revenue Code, codified
as Title 26 of the United States Code. If the opinion had cited any section in the IRC, the
chances are good that it would have cited section 61, the generic provision commanding
that "gross income" means "all income from whatever source derived" (not a particularly
useful provision) and section 74, indicating that all "amounts received as prizes and
awards" are to be included in income.

As the opinion indicates, the Pulsifers did not argue that the winnings should never be
included in income; the only question was when the sweepstakes winnings would be
included in income. There was no general Code section to which the court might have
referred for guidance on this question. Despite the thickness of the Code, and its
reputation for infinite detail, there are a lot of relatively significant questions that are not
addressed in statutory language. Instead, the law has been developed through the
interaction of statute, judicial decision and regulatory pronouncements such as the
revenue ruling cited in the opinion.

The income tax law ordinarily only addresses the income tax consequences of legal
relationships that are determined under other bodies of law. Hence, in order to determine
the nature of the children's rights to their proceeds, and the role of the father as their next
friend and legal guardian in obtaining the funds for them, the court referred to Irish law.

Note on the Normative Structure of the Income Tax Base

Henry Simons, an economist, is generally credited with having been the first student of
the income tax in the United States to stress the importance of including all accretions to
wealth in the income tax base, both to enhance the fairness of an income tax, and to
minimize its interference with economic activity. The first point is probably intuitive: it
does not seem fair not to tax those with windfall incomes like sweepstakes prizes at least
as much as those with the same income from wages. This is especially important if
progressivity is an important aspect of the income tax. Current debates about the income
tax include the question whether the same sense of fairness should prevail when deciding
how much to tax returns from investments compared to wages.

The second point may not be as intuitive, but is equally important: if income from some
sources is taxed more lightly than income from other sources, people are likely to try to

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receive more of the lightly taxed income, and less of the heavily taxed income. To the
extent that this is possible across the economy as a whole, there will be a tendency to
over-invest in the sources that produce the more lightly taxed income. The tax thus has a
potentially distortionary effect on the economy, and could lead to a misallocation of
resources compared to the allocation that would have been obtained in the absence of the
tax.

Congress often acts to take advantage of this effect, by lowering the income tax on
sources of income that wants to encourage, such as low-income housing domestic
manufacturing or lending to municipal governments. Such distortions are likely to be
present, however, even in situations in which the tax law seems only to be following legal
distinctions first made for very different reasons, such as the difference between interest
and dividends paid by corporations.

Simon's formula is the standard articulation of this goal of income definition:

income is the “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."

Henry C. Simons, PERSONAL INCOME TAXATION: THE DEFINITION OF INCOME AS A

PROBLEM OF FISCAL POLICY 61 (1938). Robert Haig had earlier defined income "as the
money value of the net accretion to one's economic power between two points in time."
Robert M. Haig, "The Concept of Income -- Economic and Legal Aspects," reprinted in
READINGS IN THE ECONOMICS OF TAXATION 54, 75 (R. Musgrave & C. Shoup, eds. 1959)
These two formulations, usually understood to be equivalent, are often referred to as the
"Haig-Simons" concept of income.

Congress has never endorsed this formula as the standard (indeed, you should soon be
able to make persuasive arguments that it is not the standard that current law actually
implements). Nor has the Supreme Court ever used the Haig-Simons concept in
articulating the bounds either of the income tax statute or of the power granted to
Congress by the sixteenth amendment to impose an income tax. Nevertheless, the Haig-
Simons concept is lurking behind many policy discussions of the income tax. Legislative
proposals are frequently analyzed in terms of the extent to which they bring the income
tax closer to, or farther from, conformity with the Haig-Simons norm.

If the income tax base could be designed according to a fully implemented Haig-Simons’
standard, it would be neutral among various ways of producing and acquiring
consumption values. Supporters of the income tax can observe that, by reference to
Simons’ standards, we can make predictions about the economic effect of errors in
defining the tax base (something that may be less possible for other tax bases), and can

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even use the income tax deliberately to depart from neutrality. The closer the income tax
is to being all-encompassing, the closer to being economically neutral among sources of
income it will be.

The income tax has another advantage over some other tax bases, notably the property
tax, in that for much of its scope, it can rely on existing commercial relationships in
defining its base and in its overall administration. The current tax system relies heavily
on the procedures for employer withholding and reporting that ensure that wage
compensation is not overlooked, and that taxes on such wages are actually collected.
Only relatively recently have efforts been made to extend withholding and payer
reporting. Such efforts do not always have the intended results, as the Lyskowski case
below indicates.

Note on Progressive Rates

Mr. Pulsifer added his children's names to his lottery ticket. Was this just an act of
parental altruism? No. The rest of the answer lies in the rate structure of the income tax.

The explicit rates. A progressive rate structure has always been a feature of the federal
income tax, although the degree of progressivity has varied. Under a progressive income
tax, each incremental addition to income is taxed at higher rates. Each "marginal rate,"
that is, the rate that applies to the next increment (or bracket) of income, is higher than
the rate that applied to previous increments.

In 1969, an individual who earned more than $200,000 was subject to a 77% tax rate on
any amounts above $200,000. Note that this does not mean that such a taxpayer would
pay $154,000 in taxes on income of $200,000. A taxpayer is ordinarily entitled to "use"
the lower brackets on income below the threshold at which the top rate begins. The
taxpayer’s total tax liability is the sum of the tax due (at increasing rates) on each
incremental bracket amount. Thus a taxpayer's average or effective rate on all of his
income is lower than his marginal rate at which taxed the next dollar would be taxed.
After the top bracket is reached, as income continues to increase, the difference between
the marginal rate and the average rate becomes smaller. (Historically there have been
exceptions to this general operation of rate brackets, but they have clearly been treated as
exceptions. See the discussion immediately below of the phase-out of the personal
exemption.)

In 1969, a taxpayer reporting $48,000 faced a top marginal rate of 63.5%. A single
taxpayer receiving $48,000 would have paid about $3000 on the first 12,000; $4,000 on
the next, almost $7,000 on the third and more than $7,000 on the last, for a total of about
$22,000. An individual who reported less than $12,000, however, had a top marginal rate
of only 24%. Four taxpayers each reporting $12,000 would therefore pay only about
$3,000 each for a total tax liability of about $12,000.

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The current rates are considerably less progressive than those faced by taxpayers at the
time of the Pulsifer case. The top rates are not as high, and the brackets used to assign
these rates are not nearly as broad, in the sense that the highest rates are imposed on
income levels that, adjusted for inflation, are far lower than in the past.

The brackets and rates for the current tax year are in your statutory supplement; they are
different from those contained in the language of section 1 as enacted because they reflect
the inflation adjustments required by section 1(f).

A true sense of the progressivity of the income tax cannot be seen only by looking at the
rates, since there are several sources of additional progressivity that are not reflected in
the rates themselves.

THE MATERIAL DISCUSSING THE PERSONAL EXEMPTION MAY BE OMITTED IN

2018.

The personal exemption. The 2017 tax reconciliation act eliminated the personal
exemption for the years 2018 through 2025. In the past it has effectively made the
brackets for lower incomes dependent upon the personal circumstances of the taxpayer.
First, each individual is allowed a personal exemption under section 151 for herself and for each of her dependents and a minimum
standard deduction under section 63. These two provisions create an additional tax bracket below the formal tax brackets outlined in
the statute. Political rhetoric sometimes suggests that these "hidden brackets" should represent a meaningful attempt to establish the
minimum cost of everyday living as the personal exemption, and the average amount of certain other costs as the standard deduction.
As a historical matter, however, they have rarely served this purpose.

For most of the last 20 years, the benefit of the personal exemption was phased out for individuals with incomes over an inflation
adjusted amount under section 151(d)(in 1990, the amount was $150,000 for joint filers). This phase out further enhanced the
progressivity of the current tax. This phase-out, popularly known as PEP, for Personal Exemption Phaseout, has been subject to
considerable Congressional tinkering. It was itself phased out in “the Bush tax cuts” in a way that resulted in the full availability of
the personal exemptions for all taxpayers beginning in 2010; it has been reinstated for 2013 and following years. ]

The itemized deductions (and limitations thereon). Second, many deductions allowed to
individuals for actual costs incurred for such things as medical treatment (generally called
personal deductions) are only allowed to the extent that they exceed a prescribed
percentage of the taxpayer's income computed without regard to the deduction. (This
reference amount is called adjusted gross income and is defined in section 62.) The more
income a taxpayer has, the higher the taxpayer’s expenses must be before any part
becomes deductible. Additional income from any source reduces the benefit from such
an otherwise allowed deduction, and, again, produces a top marginal rate on the
additional dollar received higher than the stated rates. The deductions for medical
expenses in section 213 and for casualty losses in section 165 are examples of deduction
subject to such limits.

NOTE FOR 2018: THE 2017 TAX RECONCILIATION ACT ELIMINATED THE
DEDUCTIONS THAT WERE PREVIOUSLY LIMITED BY SECTION 67 AND

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REMOVED THE LIMITATION IN SECTION 68 FOR THE YEARS 2018 THROUGH

2015. YOU NEED NOT MASTER THE OPERATIONS OF THESE PROVISIONS.
Some itemized deductions have from time to time been further limited in ways, including the limitations in sections 67
and 68, that further enhance progressivity. The function of adjusted gross income and the operation of sections 67 and
68 are considered later in the course.

The earned income credit. Third, the earned income credit in section 32 provides (in
2013) low-income taxpayers a credit between $487 and $6,044, phased out for taxpayers
making between $14,340(single with no dependents) and $ 51,567 (joint filers with three
or more children. (The credit varies depending upon the number of children, up to three,
per filing unit.) This provision not only provides a credit against the liability computed
under the rates set out above, but also, because it is "refundable" in effect produces a
"negative" tax liability. Because amounts above the phase out level are taxed at the
regular rate, and reduce the amount of credit available, the phase-out of the earned
income credit produces a relatively high marginal tax rate and a wrinkle of regressivity in
a feature that otherwise greatly enhances the progressivity of the income tax.

The child credit against tax liabilities provided in section 24 will further reduce the taxes
owed by those with children, although in a slightly more complicated way than a simple
additional lower bracket. It too is phased out in higher tax brackets. See the Note on the
Child Credit in the material on the taxable unit.

When first introduced, the earned income credit was largely justified as an offset to the
federal payroll taxes. Because they are imposed at a flat rate and their base is subject to a
cap, these payroll taxes would otherwise undo most of the overall progressivity of the
combined federal taxes.

Note on the Kiddie Tax

Mr. Pulsifer's strategy to split the winnings and enjoy the lowest rates four times
apparently worked under the tax law in 1969. (In the litigated case, he lost only on the
timing question.) However, the strategy would work under current law only if his
children were older than 18 if they are also financially independent, or older than 23 if
they are not), because of the effect of section 1(g), not so affectionately called the kiddie
tax. The computations required by that section are aimed at taxing a child's unearned (in
general, any income other than for services performed) income as if it had been received
by the parent.

THE 2017 TAX RECONCILIATION ACT SIMPLIFIED THE KIDDIE TAX FOR THE
YEARS 2018 THROUGH 2025 BY MAKING THE UNEARNED INCOME OF
CHILDREN SUBJECT TO THE SAME RATES AS IS APPLIED TO TRUSTS AND
ESTATES.

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There is an election under section 1(g)(7) that allows most parents to include the child's
investment income directly on their return, rather than reporting it on a separate return
and calculating a special rate derived from the parent’s rate. This reporting mechanism
suggests the purpose of the provision—to tax the income from the assets of the family
unit as if the family unit, rather than the individual or the married couple, were the
relevant economic actor, but without affecting the way the child’s income from her own
labor is taxed.

The government never challenged Mr. Pulsifer's claim that the ticket had in fact been
purchased in all four names. Not all taxpayers are lucky enough to have the Service
accept such a favorable interpretation of the facts, as the following private letter ruling
indicates.

Private Ruling 84-33-014

May 8, 1984

Dear [taxpayer]:

This is in response to a letter in which a ruling was requested on the tax consequences of
a prize won by Taxpayer.

You state that Taxpayer, a minor child, won a contest sponsored by Cereal Company.
The prize is a week-long training session at a soccer school for Taxpayer and up to 19 of
his friends. Cereal Company will provide the participants with the tuition, meals and
lodging for one week, and air transportation. Four adults, including Taxpayer's parents or
legal guardians, will receive a week-long vacation in a nearby city after chaperoning
Taxpayer and the other participants to the school.

The contest committee will issue one Form 1099 in the name of Taxpayer. You request a
ruling as to whether the Taxpayer must report the entire value of the prize in his gross
income even though only a small portion of the prize directly benefits him.

Section 74 of the Internal Revenue Code generally provides that gross income includes
amounts received as prizes or awards.

The basic rule in determining to whom an item of income is taxable is that income is
taxable to the one who earns it even though he assigns it to another. In enunciating this
rule, the Supreme Court of the United States stated in Helvering v. Horst, 311 U.S. 112

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(1940), 1940-2 C.B. 206, that "the power to dispose of income is equivalent of ownership
of it. The exercise of that power to procure the payment of income to another is the
enjoyment and hence the realization of the income by him who exercises it." See
Revenue Ruling 58-127, 1958-1 C.B. 42.

Acceptance of the prize by Taxpayer will give Taxpayer the right to control which of his
friends receive the beneficial enjoyment from the income. Thus, under the assignment of
income principles stated in Horst, Taxpayer will be in receipt of the full value of the prize
and he must include it in his gross income under section 74 of the Code. If he refuses the
prize, the value of the prize will not be includible in his gross income.

A copy of this ruling letter should be attached to the federal tax return of Taxpayer in the year in which the
prize is accepted. We have enclosed a copy for that purpose.

This ruling is directed to the taxpayer who requested it. Section 6110(j) of the Code provides that it may
not be used or cited as precedent.

This ruling applies only to the Plan and trust submitted and is directed only to the taxpayer who requested
it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent. Except as
specifically ruled on above, no opinion is expressed as to the federal tax consequences of the transaction
described above under any the provision of the Code. If the Plan or trust are substantially amended, this
ruling may not remain in effect. [Ed. Note: the boilerplate language such as this at the end of IRS private
letter rulings will be omitted from such items appearing later in the materials.]

Note on the Rule-making Functions of the Internal Revenue Service

The Internal Revenue Service interprets the Internal Revenue Code through several
distinct processes. Working with the Treasury Department, the IRS drafts regulations,
which are published in the Code of Federal Regulations. Regulations are intended to be
rules of general applicability. They are binding on both the IRS and the taxpayers.

It also issues rulings on a case by case basis. Some rulings are intended to advise the
general public, and are therefore referred to as "published." They are denominated by the
cite "Rev. Rul.", and are published weekly in the Internal Revenue Bulletin, which is
republished annually as the Cumulative Bulletin (C.B.). Published rulings purport to
address only limited factual circumstances, but may be used as authority by taxpayers and
by revenue agents.

Other rulings are issued only to provide advice with respect to a particular problem posed
with respect to a particular taxpayer. They are issued either as a result of a taxpayer's
request for advice (and frequently referred to as a "private letter ruling" or PLR), or as a
result of an auditing agent's request for advice.

The terms under which this guidance is made public is prescribed by section 6110. Under
this statute information relating to particular taxpayers must be deleted, and these less
formal rulings “may not be used or cited as precedent.” In the past this guidance was

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usually called either Technical Advice Memoranda (TAM) or Field Service Advice
(FSA). In ongoing attempts to avoid disclosure requirements, the IRS has in recent years
experimented with the procedures for generating several other types of documents similar
to TAMs and FSAs, and as a consequence there has an increase in the number of possible
labels for such internal IRS rulings. More recently, these documents may be referred to
as Chief Counsel Advice (CCA) or Generic Legal Advice Memoranda (GLAMs).

Unlike many other regulatory actions of agencies of the federal government, these
regulations and rulings of the Internal Revenue Service are not ordinarily subject to
judicial review when they are first promulgated. They can be challenged in court only by
a taxpayer who is adversely affected by them in a controversy over an actual liability.

In the administration of the tax law, the Service must reach many more members of the
public than those with access to the formal sources of law relied on by lawyers,
accountants and other tax professionals. To reach them, it issues many publications with
summaries of the most commonly encountered problems and produces often arcane
instructions to forms.

In recent years, IRS enforcement efforts have been augmented by increased withholding
and reporting requirements imposed on payers of income. The message communicated by
withholding and payer reporting is not always clear, as the next case indicates.

Lyszkowski v. Commissioner
T.C. Memo 1995-235

In 1989, petitioner received slot machine winnings in the amount of $1 million from a
casino in Atlantic City, New Jersey. The corporation representing the casino where
petitioner won that amount, the Boardwalk Regency Corporation, issued to petitioner a
Form W-2G, but did not withhold any taxes from the winnings.

Petitioners filed a joint federal income tax return for the taxable year 1989. On that
return, petitioners reported wage income in the amount of $19,120, taxable interest
income in the amount of $15,562, and taxable Social Security benefits in the amount of
$3,804. Petitioners did not report the $1 million slot machine winnings on their 1989 tax
return.

On October 16, 1991, respondent sent an Information Request to petitioners regarding the
$1 million unreported gambling winnings for the taxable year 1989. Petitioners did not
respond to this request or to other correspondence from respondent with respect to the
taxable year 1989. Respondent included the $1 million unreported slot machine winnings

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in petitioners' income and, on November 5, 1992, issued a statutory notice of deficiency

for the 1989 taxable year.

Petitioner says he is willing to pay those taxes rightfully owed, but will not "volunteer" to
pay taxes where Congress does not require it. He presents a clever, but misguided,
reading of the Internal Revenue Code to justify his failure to report, and pay income taxes
on, his slot machine winnings. ... Because of the warmth and fervor with which petitioner
has advanced his arguments, the Court will try to answer them fully. Regretfully, the
Court concludes that no analysis or exegesis of legal authorities will mollify petitioner,
who only wants to hear that, for whatever reason, his $1 million slot machine winnings
are tax free.

Petitioner assumes that, since the slot machine winnings are exempt from withholding of
tax at the source of the winnings under section 3402(q)(5) of subtitle C, he has no
obligation to report and pay taxes on the winnings as gross income under subtitle A. No
such inference is to be drawn.

Subtitle A imposes an income tax on individuals. Sec. 1. This tax is imposed on taxable
income, the calculation of which begins with gross income as defined by section 61.
Section 61(a) broadly defines gross income: "Except as otherwise provided in this
subtitle, gross income means all income from whatever source derived". The Supreme
Court has "given a liberal construction to this broad phraseology in recognition of the
intention of Congress to tax all gains except those specifically exempted." Commissioner
v. Glenshaw Glass Co., 348 U.S. 426 (1955). The Code, specifically subtitle A, contains
no exclusion of any gambling winnings, including slot machine winnings, from gross
income. The Supreme Court has interpreted gross income to encompass "accessions to
wealth, clearly realized, and over which the taxpayers have complete dominion."

Petitioner then tries to analogize these slot machine winnings to wages. He states that,
like wages, all taxes due on the winnings should have been withheld at the source. He
states that, if any tax is due, the casino should be forced to pay it for its gross negligence
in not informing petitioner of the instructions on the back of the recipient's copy of the
Form W-2G.

In this case, the payers were not obligated to withhold. Petitioner received all of his slot
machine winnings. The lack of withholding does not affect petitioner's obligation to
report the slot machine winnings as income under section 61. The only result is that
petitioner does not have a withholding credit to offset part or all of the tax liability.

Note on Reporting and Withholding Requirements

Most adults are aware of the fact that employers must file Form W-2s with the IRS and
provide each employee with a copy, indicating the amount of wages earned and the
amounts of income tax withheld. Most payers of interest and dividends also must provide

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their recipients with the appropriate 1099 form. Most businesses that pay more than $600
to a single payee must also provide their recipients with a Form 1099 (as was mentioned
in the soccer camp ruling). Most gambling operations must similarly file a W-2G with the
IRS and provide the recipient with a copy. (Only a smattering of the code sections
outlining these requirements, generally in sections above 6000, are in your statutory
supplement.) As the taxpayer in Lyszkowski discovered, the fact that a payment is
reported on a W-2G without withholding does not mean that all income tax obligations
related thereto have been met.

Sometimes these reporting requirements serve more than just the purposes of the income
tax. For instance, in order to make money laundering more difficult, those who receive
more than $10,000 in cash from a single customer are obligated to file a Form 8300
reporting such transactions.

In general, withholding of income taxes due must be taken by payers only when the
payment is wages, or certain larger gambling winnings. (In general, withholding must be
paid on winnings of $5,000 or more unless the taxpayers won at bingo, keno or on the
slots, as Lyszkowski did.) Withholding may also be required if the recipient has failed to
provide certain kinds of information needed for the reporting obligation.

A withholding obligation may also apply in other contexts, for instance, if the payee is a
foreign person.

Note on Payroll Taxes, Investment Income Taxes and Other Uses for the
Measurement of Income

This course will focus on the income tax, but mention must be made of the presence of
other income-related taxes.

Payroll Taxes. Once was a time when the relevant rates and thresholds were sufficiently
low that focusing only on income taxes and ignoring payroll taxes imposed under
sections 3101 and following was justified. That is becoming increasingly not the case, as
payroll taxes now ordinarily total more than 15% of wages up to $117,000. (12.4%
toward Social Security (OASI), 2.9% for Medicare with the nominal burden being split
between employer and employee. An additional Medicare Tax of .9% is due on wages
in excess of $200,000 per year, section 3101(b)(2). These taxes are imposed in a flat rate,
with no exempt amount. Equivalent taxes are collected from the self-employed, section
1401 and following. There are other smaller taxes on payroll, including unemployment
taxes, that are usually paid as state taxes but are part of a larger federal regulatory
structure.

Although the payroll tax base and the base from which withholding must be taken are
generally the same as the income tax base derived from labor there are many small

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deviations in the definition of these three tax bases, especially in the rules under which
fringe benefits may be included.

The structure of the payroll taxes greatly detracts from the overall progressivity of the
combined federal taxes on income. The regressivity of the payroll taxes provided a
substantial part of the basis for political support of the earned income tax credit; indeed,
the earned income credit has at times been calibrated deliberately to represent an
approximate offset to the payroll taxes paid by lower income households.

It is estimated that almost 75% of those individuals earning under $75,000 pay more in
payroll taxes than in income taxes. Indeed, although as much as half of the households
in the United States paid no income tax in recent years, this was in large part of the effect
of the earned income credit, which only counteracted a part of the payroll taxes for this
part of the population, and the special provisions regarding the taxation of the elderly.

Unearned Income Medicare Contribution. As part of the larger healthcare provisions

enacted in the Healthcare Reconciliation Act of 2010 and the Affordable Care Act,
Congress introduced in section 1411 an entirely new tax of 3.8% on the investment
income of higher income individuals. Unlike the existing payroll taxes, it is not set up as
a traditional “trust fund” tax the proceeds of which are to be credited to the social
security/medicare system; its only connection in the legislation passed to funding
medicare is its title.

There is much about the base of this tax that is outlined only in regulations. It is clearly
intended to include not just dividends, interest and other similar types of income
traditionally treated as “investment income,” but also certain other types of non-wage
income, including gains from trading in financial instruments and sales of businesses in
which the taxpayer does not actively participate. Like the payroll tax base, the items
included in the base for this tax are a subset of the items included in the regular income
tax base.

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