Tax Law

Governments get their financial support by taxing the people or organizations, who either reside within the country or who are citizens. Tax law governs the method and the amount of taxation. In the United States (US), tax law originates with the United States Congress, specifically with the House of Representatives. However, most of the detailed tax rules are actually enacted by the Department of the Treasury, which is an agency of the United States government, and its subagency, the Internal Revenue Service (IRS). Regulations issued by the Department of the Treasury must conform both to the Tax Code, which is the law enacted by Congress and to any constitutional requirements; otherwise, the regulation may be voided by the courts.

Because the tax amount depends on the transactions, especially the receipt of income, tax authorities depend heavily on self-reporting by taxpayers. Since some people are dishonest, the IRS reviews many tax returns through audits.

Tax History

Before 1913, the US government's main source of income was from excise taxes. However, the government's revenue requirements could not easily be fulfilled by excise taxes, so in 1913, the 16th amendment to the U.S. Constitution was added, thus beginning the era of the federal income tax:

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration."

The federal government tried to enact an income tax several times before, but it was declared unconstitutional by the courts, which partly explains the wording of the 16thamendment.

Before 1939, the tax code consisted of individual revenue acts enacted by Congress. Then in 1939, Congress consolidated all the federal tax laws into what is known as the Internal Revenue Code (IRC) of 1939, publishing them in a logical sequence in a separate part of the Federal Register. Major revisions also occurred in 1954 and 1986. New amendments to the tax code are incorporated into the Internal Revenue Code of 1986.

Tax Law Sources

The Tax Code, found in Title 26 of the US Code and enacted by Congress, defines what income is, exemptions, what expenses can be deducted, filing requirements, and other necessary components of the tax system. After the Constitution, the Tax Code is considered the highest authority, which any regulations promulgated by agencies of the US government must conform to.

Tax treaties, which usually pertain to transactions where the tax laws of different countries may apply, also have the force of law. When provisions in the tax law conflict with the provisions in a tax treaty with another country, the most recently enacted provision takes precedence. However, the taxpayer is generally required to note where there is a conflict, if the taxpayer uses the treaty provision.

Generally, administrative tax laws are issued by either the U.S. Treasury Department or the IRS and published in the Federal Register. Regulations generally start as Proposed Regulations, which are published to allow comments by the public or by those who may be affected by the regulation. After the comment period, the Proposed Regulation becomes a Finalized Regulation, issued as a Treasury Decision, which has the force of law and can be cited as precedent. However, proposed regulations cannot be cited as precedent. Treasury Decisions report new Regulations, changes to existing Regulations, or how the Treasury Department interprets a specific court decision.

Temporary regulations are issued by the IRS to cover situations that require immediate resolution or interpretation, though some temporary regulations can last for many years.

Revenue procedures are official statements of a procedure that affects taxpayers under the code, statutes, treaties, and regulations and are published annually in the Internal Revenue Bulletin (IRB), by year and by the order in which the revenue procedure was enacted. Revenue Procedures cover the internal management practices and procedures of the IRS.

Revenue rulings, also published in the IRB, are issued by the IRS on how it would interpret the law to a specific set of facts. Although they provide interpretation of the tax law, they do not carry the authority of Regulations, since Regulations are approved by the Secretary of the Treasury, whereas revenue rulings are not. Although taxpayers do not necessarily have to follow revenue rulings, any deviation from the rulings must be noted on the tax return, which may cause the return to be examined. Rulings and procedures may be revoked or modified by later rulings or procedures, Regulations, court decisions, or legislation.

A private letter ruling is issued by the IRS to a specific taxpayer, where, for a fee, the IRS describes how it would treat a proposed transaction. The taxpayer can rely on that ruling, but no one else can. It applies only to the specific taxpayer and only if the proposed transaction accurately described the actual transaction. Letter rulings were once private, but are now published with private information redacted.

Determination letters are much like letter rulings, in that the taxpayer requests information from the IRS on how it would treat a given transaction. However, a determination letter usually rules on a transaction that has already occurred and is not published. Determination letters are usually issued by the Area Director of the IRS rather than the National Office of the IRS, which issues letter rulings.

General Counsel Memoranda (GCM), Technical Advice Memoranda (TAM) and Field Service Advice (FSA) are internal memoranda that are issued to offer guidance to IRS employees working in the field. Although they are published, they cannot be used as precedent, but they do provide guidance as to how the IRS will treat given situations.

Legislative Process

  • Federal tax legislation originates in the House of Representatives, specifically by the House Ways and Means Committee.
  • Proposals by the committee are then voted on by the entire House of Representatives.
    • The House of Representatives votes on the proposals of the House Ways and Means Committee without modifying those proposals.
  • Bills that are approved by the House are then sent to the Senate Finance Committee, who may modify the proposals before sending it to the floor for a debate or vote.
    • Senators have the power to amend proposals by the Senate Finance Committee by attaching riders, which is why changes are frequently made to proposals in the Senate.
If the Senate accepts the legislation unmodified: If the Senate modifies the legislation:
  • A Joint Conference Committee, consisting of members from the Senate Finance Committee and the House Ways and Means Committee, attempts to arrive at compromise legislation.
    • Committee Reports of these meetings usually explain the reasons for the proposals, so the reports are often used by the courts to divine the intent of Congress.
  • The compromise bill is then voted on by both the Senate and House of Representatives.
  • The approved bill is sent to the President of the United States, who can then either sign the legislation or veto it.
  • If the President signs the bill or if a veto is overridden by 2/3 votes of both Chambers of Congress, then the legislation becomes part of the Tax Code.
    • Historically, fewer than 10% of vetoed bills are overridden by Congress.

Tax Court System

While Congress enacts a law, the courts interpret it. A particular decision of the court is called a holding. Holdings of higher courts must be followed by the lower courts in the system, known as the doctrine of stare decisis.

As the highest court in the land, the US Supreme Court ultimately decides what the law actually means, especially as it applies to the case before it. A decision by the US Supreme Court is precedential throughout the United States.

Beneath the Supreme Court are 2 sets of court systems in which a tax decision can be appealed. The 1st system consists of the regional Courts of Appeal that cover 12 major regions of the United States. Rulings by these Courts of Appeal have precedence only for the region for which they serve. The lowest level of the system consists of the District Courts whose rulings address a specific case and are not precedential. However, only a US District Court allows a jury trial.

If the taxpayer is unsatisfied with a decision made by the IRS, then the taxpayer can take the case to a court of original jurisdiction, of which there are 4 to choose from: Federal District Court, US Court of Federal Claims, US Tax Court, Small Cases Division of the US Tax Court. However, decisions made by the Small Cases Division are not published nor can they be appealed, either by the taxpayer or by the IRS. Only cases that involve disputes of $50,000 or less may be taken up by the Small Cases Division.

The other major system is the US Tax Court. Because it is a specialized court, the rulings issued by the US Tax Court are precedential. Appeals from the US Tax Court are heard by the Court of Appeals. If the taxpayer appeals an IRS decision to the tax court, the tax does not have to be paid until the decision is rendered. However, the tax must be paid before an appeal is filed with the District Court or the Court of Federal Claims.

The losing party can appeal the decision of a court of original jurisdiction to the Circuit Court of Appeals, consisting of 11 geographic circuits, the District of Columbia, and the Federal Circuit. The taxpayer must select the Court Of Appeals that has jurisdiction based on where the taxpayer lives. However, decisions by the US Court of Federal Claims, which can handle any claim against the United States government, must be appealed to the US Court Of Appeals for the Federal Circuit.

If the taxpayer files for bankruptcy, then the automatic stay may prevent the IRS from pursuing any further action, if the disputed item occurred more than 3 years prior to the bankruptcy.

If the IRS loses in the court of original jurisdiction, then whether it will appeal or not will depend on several factors:

Even if the IRS loses, it may not necessarily agree with the court's decision, in which case, it will publish an Action on Decision, which is a document stating whether the IRS agrees, or acquiesces, to the court's holding or whether it disagrees, or non-acquiesces, to the holding. If the IRS issues a non-acquiesces policy, then it will not follow the court's decision in disposing of other cases with the same controlling facts. However, if the decision was made by a Court of Appeals, then the decision will be followed by the IRS for those taxpayers who live within the geographic area served by that court, but it will not follow the decision outside of that area.

If a party is affected by any adverse decision by an appellate court, then that party may petition the US Supreme Court for a review of the case. However, most often, the petition will be denied, since the Supreme Court rarely reviews tax cases. However, any decision rendered by the Supreme Court must be followed by the IRS and has precedential value in all US courts.

An illustration of the U.S. tax court system.