The principle of progressive taxation is that tax rates applicable to increments of taxable income increase. Currently there are seven marginal brackets – eight if we count income that is below the threshold of taxable income. 1 If a taxpayer can spread his/her income among other taxpayers, more of taxpayer’s income will be subject to lower marginal rates of tax.
The Tax Formula
(gross income)
MINUS deductions named in § 62
EQUALS (adjusted gross income (AGI))
MINUS (standard deduction or itemized deductions)
MINUS (personal exemptions)
EQUALS (taxable income)
➔Compute income tax liability from tables in § 1 (indexed for inflation)
MINUS (credits against tax)
The following table represents the computation of the income tax burden of a person whose taxable income is $210,000. Imaginary marginal tax brackets are as noted. The total tax burden of this taxpayer is $50,000.
|
Income range |
Marginal Tax Rate |
Tax |
|---|---|---|
|
$0 to $10,000 |
0% |
$0 |
|
$10,000 to $60,000 |
10% |
$5000 |
|
$60,000 to $110,000 |
20% |
$10,000 |
|
$110,000 to $160,000 |
30% |
$15,000 |
|
$160,000 to $210,000 |
40% |
$20,000 |
|
Total |
$50,000 |
Our taxpayer might try to reduce his/her tax burden by “assigning” some of his/her taxable income to persons s/he controls – perhaps two children. Our taxpayer might decide that s/he and each of the two children should receive $70,000 of the original $210,000 total. The new tax computation table would be the following:
|
Income range |
Marginal Tax Rate |
Tax |
|---|---|---|
|
$0 to $10,000 |
0% |
$0 |
|
$10,000 to $60,000 |
10% |
$5000 |
|
$60,000 to $110,000 |
20% |
$2000 2 |
|
Total |
$7000 x 3 = $21,000 |
The total tax burden of three different persons, each with taxable income of $70,000, would be less than half the tax burden of one person with taxable income of $210,000. This characteristic of progressive tax rates has led taxpayers to create many schemes to “split income” so that more of it would be subject to lower rates of income tax.
The courts have created the “assignment of income” 3 doctrine to prevent abusive income splitting. In addition, Congress has created some statutory rules that limit assignments of income. We begin with the leading case.
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