Introduction. Terminology, Timing and Rates

• Pages: 1-9
• Author: Marvin A. Chirelstein,Lawrence Zelenak

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Introduction

TERMINOLOGY, TIMING AND RATES

(a) Tax Terminology

A brief presentation of income tax terminology may be useful by

way of introduction:

The computation of an individual’s tax liability begins with a

determination of gross income. This term is defined in Code § 61 as

encompassing “all income from whatever source derived ” except as

otherwise provided by the statute. For most individual taxpayers

gross income is made up of wages and salaries, dividen ds, interest

and rents, and gains from the sale of investments such as securities

and real estate. The definition of gross income is broad enough,

however, to include receipts from other, less familiar sources as well.

The statutory exceptions to the reach of § 61, w hich are fairly

numerous, are u sually ref erred to as exclusions from gro ss income

(sometimes the term exemption is used). A well-known example is

interest on state and municipal bonds, which is specifically excluded

from gro ss income by Code § 103(a). Excluded items simply d o not

enter into the computation of tax. Thus, an individ ual with $50,000

of salary plus $5,000 of interest on bonds issued by the State of Ne w

York has a gross income of only $50,000. Quite obviously, the effect

of the exclusion is to tax the excluded item at a rate of zero. The

benefit to an individual taxpayer depends on her own applicable tax

bracket, which in turn depends on how much income she receives

from taxable sources. If the taxpayer just mentioned would otherwise

be taxed at a rate of (say) 32% on the last $5,000 of non-excludable

income, the dollar value of the e xclusion from her standpoint is 3 2%

of $5,000, or $1, 600. If h er bracket rate were only 10%, the dollar

value of the exclusion would be only $500.

Having determined her gross income under § 61, the taxpayer

next subtracts all the outlays and expenditures that are a llowed by

the Code as deductions. Deductible items include the taxpayer’s

business expenses—w ages paid to employees, depreciation on

business equipment, fees paid to investment advisers, etc. —which

represent the cost of earni ng the gross income determine d above. In

addition, while personal living expenses (food, apartment rent) are

generally disallowed, the Code does permit certain items —for

example, charitable contributions—to be deducted, even though

plainly in the category of pe rsonal rather than business expense. As

a matter of tax arithmetic the dollar value of a deduction from gross