In the past two weeks we covered The Ultimate US Tax Guide’s first three Key Tax Insights:
#1 – IRS correspondence does not necessarily equal error
#2 – Lack of IRS correspondence does not necessarily equal agreement
#3 – Your US tax residency status determines how you will be taxed
Before moving to Insight #4, though, I want to remind everyone of insight #1.
Why?
Because in the past four weeks since the 2019 tax filing deadline of July 15th, the IRS has been bombarding some of you with automated tax notices.
That didn’t take long!
If you receive, or have received, an IRS notice, please do the following:
Take a deep breath and recite this insight: “The fact that I have received a notice from the IRS doesn’t necessarily mean I did something wrong”, breathe deeply and repeat the insight. Then read the notice carefully: does what it says make sense to you (assuming you understand it)? Can you figure out what to do in response to the notice on your own? Can Google help you? Do you prefer to retain professional help?
Do not ignore IRS letters but do not fall into a panic either. It is quite possible that the letter was sent to you in error. It is also quite possible that the matter can be very easily resolved directly by you with. Or that the notice is just informative and requires no action from you.
The important thing is not to ignore it, and, if you don’t understand what the notice is about, that you seek guidance: online, by calling the IRS number on the notice, or by asking a professional for assistance.
In any case, don’t feel too special.
Based on discussions on several tax professional web boards I am on, other tax pros are also complaining about clients receiving a large number of notices. Your misery has plenty of company!
Now, let’s get straight into Tax Insight #4:
“By default, all income is gross income subject to income tax”
Powerful, right?
Which is why this insight is in the Top Five. Understanding this insight will help you avoid a lot of headaches and prevent you from making costly tax mistakes.
In my career as a tax professional, I regularly hear the same question from clients, again and again “Where does it say that this is taxable?”
They ask this question with a glint in their eyes, as if thinking, “OK, Ms. Tax Professional, prove it to me. Show me the law, the article, the whatever, that says that this specific thing is taxable. Oh, you can’t, can you? I knew it!! Can you say……. tax freeeeeee!!!!”
Not so fast. Unfortunately, that’s the wrong question to ask.
My answer to that question is always the same:
“First, you are asking the wrong question”, and
“Second, have you heard of Section 61?”, and
“Finally, actually, YOU are the one who NEEDS to PROVE that your specific item is NOT taxable”
Asking for confirmation that something is taxable starts from a fundamental erroneous assumption: That nothing is taxable until it’s proven taxable.
But, unfortunately, the reality is the opposite: everything is taxable until it’s proven not taxable.
The burden of proof is on the taxpayer, not on the government.
Clever, right?
This very simple trick by our legislators turns the tables on the taxpayer, and it makes it A LOT easier for the Treasury to assess income taxes.
How come?
The Internal Revenue Code (IRC), Title 26 of the US Code, Section 61, and Treasury Regulations Section 1.61-1 define what constitutes gross income for income tax purposes.
The IRC is THE tax law of the land. It is the highest legal tax authority in the United States. You may have heard of it r as the “Tax Code”. It is written by Congress and signed into law by the President.
Treasury Regulations are the highest administrative authority of the land, and they are issued by the Treasury Department. Income Tax Treasury Regulations are thus the second highest level of tax authority in the United States. You may have heard of them as “the Regs”.
The Tax Code and the Regs. are as authoritative as it gets in terms of US income taxes. And this is what they have to say about gross income subject to income tax:
Just kidding! But close.
Seriously, this is how the Internal Revenue Code defines gross income: “…..ALL income from whatever source derived….”
All income. All of it. From whatever, wherever and anywhere it comes from.
All income is gross income for income tax purposes.
Here is the Code Section itself:
That definition makes it pretty clear that all income is gross income. But, in case there was any doubt, the Treasury Regulations give the coup de grâce: “Gross income means ALL income from whatever source derived, unless EXCLUDED by law.”
Unless excluded by law.
There you have it.
In order for income to not be gross income, in order for income to not be subject to income tax, there needs to be an EXCLUSION. No exclusion? Tough luck.
What does this mean for us as taxpayers? That whenever we have any income, our departure point needs to be to assume that this income is gross income subject to tax. ALWAYS.
In order to exclude any income from taxation, we need to find a law that specifically excludes that type of income from being subject to income tax. We can’t start from the assumption that it is exempt until proven taxable, we need to start with the reverse assumption, and find the specific exclusion that helps us.
What are examples of specific exclusions?
The Foreign Earned Income Exclusion
The Foreign Housing Deduction
Employer-paid Health Insurance Premiums Exclusion
Municipal Bond Interest Exclusion
And many others.
There are a bunch of exclusions, luckily, and we are going to explore some of them as we discuss future tax insights. But barring exclusions:
Insight #4 “All income from anywhere is gross income subject to income tax”
And with that, I leave you to enjoy the rest of your week.
See you in seven days. Stay healthy!
Much love,
Marina