Federal Income Tax

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What is Income?

Annuities and Pension

  • To determine tax for annuities, calculate an exclusion ratio and then you are taxed on the ratio multiplied by the yearly payout. See rule 72.
  • For pensions, the employer contribution is taxable but the employee contribution is treated like the annuity (deferred taxation). Se rule 72.

Cases

Commissioner v. Duberstein

Burnet v. Sanford & Brooks Co.

Claim of Right

North American Oil Consolidated v. Burnet

United States v. Lewis

Transfer of property that is subject to Debt

Crane v. Commissioner

Statutes

  • 172: Net operating loss carryovers

Tax Arbitrage

  • Person A is taxed marginally at 40% and has $1M that he wants to invest entirely in bonds. Assume that the federal bond interest rate is 10% and the municipal bond interest rate is 8%. This means that the implicit tax rate on the municipal bond is 20%. If this person invests ALL of his money in bonds, he should invest in the tax free bonds so that he can get the 20% implicit tax rate on the interest earned from the investment.
  • Person B is taxed marginally at 10% and has $1M that he wants to invest entirely in bonds. Assume that the federal interst rate is 10% and the minicipal bond interest rate is 8%. This means that the implicit tax rate on the municipal bond is 20%. If this person invests ALL of his money in bonds, he should invest in the federal bonds, so he keeps his 10% tax rate in the interest earned from the investment.
  • Imagine person A does not have any liquid cash, but still has the marginal tax rate of 40%. Imagine he borrows $1M and has to pay $100k in interest every year and that he can deduct this interest from his other taxable income. If he can do this, he will use the $1M to purchase the tax free bonds. His interest from the bonds will be $80K, but he will save another $40K in tax every year in tax. He should keep lending and purchasing bonds, till the amount of his deductions will put him in a lower tax braket such that his margin tax rate is lower than the 20% implicit tax rate on the.

Timing of Income

Cases

Cottage Savings Association v. Commissioner