Ch1. Tax Law Basics — Structure of Taxation and the Duty to Pay

What Is a Tax?

Tax: A compulsory financial charge imposed by a government authority on individuals and entities to fund public services, enforceable by law.

Four Core Characteristics of Taxes:

1. Compulsory: Imposed by law regardless of the taxpayer’s consent
2. Non-quid-pro-quo: No direct, specific benefit in return (unlike fees or fines)
3. Statutory: Must be authorized by legislation (no taxation without statutory basis)
4. Public purpose: Revenue used to fund public goods and services

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Classification of Taxes

Federal vs. State and Local Taxes

Level	Major Taxes	Administering Agency
Federal	Income tax, corporate tax, estate tax, gift tax, payroll tax, excise tax	IRS (Internal Revenue Service)
State	State income tax, sales tax, property tax, state estate/inheritance tax	State department of revenue / taxation
Local	Property tax, local income tax, transfer tax	County / municipal government

Direct vs. Indirect Taxes

Type	Definition	Examples
Direct tax	Taxpayer = burden-bearer (paid directly by the person bearing the economic cost)	Income tax, corporate tax, property tax, estate tax
Indirect tax	Taxpayer ≠ burden-bearer (business collects and remits, but consumer bears the cost)	Sales tax, excise tax, customs duties

Proportional vs. Progressive vs. Regressive

• Progressive (graduated): Higher rates apply at higher income levels — federal income tax (10%–37%), estate tax
• Proportional (flat): Single rate for all — corporate tax (21%), some state income taxes
• Regressive: Effective rate falls as income rises — sales tax, payroll tax (Social Security wage cap)

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Foundational Principles of US Tax Law

Constitutional Basis — No Taxation Without Legislative Authority

The 16th Amendment (1913) gives Congress the power to “lay and collect taxes on incomes.” The Anti-Deficiency Act principle and Article I, Section 8 underpin the requirement that all federal taxes flow from statutory law (the IRC).

Taxes cannot be imposed by executive order alone — Congress must authorize every tax.

Tax Equity

Horizontal equity: Taxpayers with the same economic capacity pay the same tax. Vertical equity: Taxpayers with greater ability to pay bear a greater tax burden — the rationale for progressive income tax rates.

Substance-Over-Form

The IRS taxes economic substance, not merely the legal form of a transaction. If a transaction is structured to avoid tax while having no business purpose, the IRS may recharacterize it (the economic substance doctrine, codified at IRC § 7701(o)).

Good Faith

Both taxpayers and the IRS are expected to act in good faith. Taxpayers have the right to rely on IRS published guidance (Revenue Rulings, Revenue Procedures, Private Letter Rulings), and the IRS may be estopped from inconsistent positions in certain circumstances.

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The Basic Structure of Tax Calculation

All US federal taxes follow this general computation:

Gross Income (all income from whatever source derived — IRC § 61)
  − Adjustments to Income (above-the-line deductions)
= Adjusted Gross Income (AGI)
  − Standard Deduction (or Itemized Deductions)
  − Qualified Business Income Deduction (§ 199A, if applicable)
= Taxable Income
  × Tax Rate
= Tentative Tax
  − Tax Credits
  − Prepayments (withholding, estimated payments)
= Tax Due (or Refund)

Gross Income: Broadly defined under IRC § 61 — wages, salaries, tips, business income, capital gains, interest, dividends, rents, royalties, and more.

Adjustments (above-the-line): Deductions taken before computing AGI — IRA contributions, student loan interest, HSA contributions, self-employment tax deduction.

Standard Deduction (2024): $14,600 (single),$29,200 (married filing jointly), $21,900 (head of household).

Tax Credits: Reduce the actual tax owed dollar-for-dollar — more valuable than deductions.

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The Tax Obligation: Arising, Becoming Fixed, and Terminating

Arising

A federal tax liability arises automatically when a taxable event occurs — earning income, selling an asset, receiving a gift, etc. No IRS notice is required for the liability to exist.

Becoming Fixed

Self-assessment (most federal taxes): The taxpayer calculates and reports their own tax liability on a return. This covers individual income tax, corporate tax, and estate/gift tax.

IRS assessment: If a return is not filed or is incorrect, the IRS can issue a notice of deficiency and assess additional tax.

Terminating

A tax liability is extinguished by:

• Payment: Full payment of the assessed amount
• Statute of Limitations on Assessment:
  • Standard: 3 years from the later of the return due date or filing date
  • Substantial understatement (>25% of gross income): 6 years
  • No return filed or fraudulent return: No limit (the IRS can assess indefinitely)

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Taxpayer Rights

The Taxpayer Bill of Rights (IRC § 7803(a)(3))

The IRS recognizes 10 fundamental taxpayer rights:

1. The right to be informed
2. The right to quality service
3. The right to pay no more than the correct amount of tax
4. The right to challenge the IRS’s position and be heard
5. The right to appeal an IRS decision in an independent forum
6. The right to finality
7. The right to privacy
8. The right to confidentiality
9. The right to retain representation
10. The right to a fair and just tax system

IRS Appeals

Taxpayers who disagree with an IRS determination may appeal to the IRS Office of Appeals (an independent function within the IRS) before going to court.

Pre-Assessment Review

Before the IRS formally assesses a deficiency, it sends a 30-day letter (or a 90-day statutory notice of deficiency), giving the taxpayer an opportunity to respond.

Judicial Forums for Tax Disputes

1. US Tax Court: Most common forum; taxpayer does not have to pay first
2. US District Court: Must pay first and sue for a refund
3. US Court of Federal Claims: Pay first, then claim refund
4. US Courts of Appeals: Review of Tax Court and District Court decisions
5. US Supreme Court: Final authority on federal tax law

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Key Filing Deadlines

Tax	Deadline
Individual income tax (Form 1040)	April 15 (6-month extension available)
Corporate income tax (Form 1120)	April 15 for calendar-year corps
Estate tax (Form 706)	9 months from date of death
Gift tax (Form 709)	April 15 of following year
Estimated taxes	April 15, June 15, Sep 15, Jan 15
FBAR (foreign bank accounts)	April 15 (auto-extension to Oct 15)

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Learning Checklist

• Explain the four core characteristics of a tax
• Distinguish federal taxes from state and local taxes with examples
• Explain the difference between direct and indirect taxes
• Walk through the basic tax computation (gross income → tax due)
• Describe the Taxpayer Bill of Rights and the three judicial forums for tax disputes