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The tax computation is really a simple word problem. It begins with gross income, which includes anything that could be considered income. Next, we exclude certain items. Planners then subtract deductions to arrive at taxable income. This is multiplied by a tax rate to arrive at taxes due, which can be reduced by credits against tax.
So where do planners learn about what items to deduct, exclude, and credit? That’s where the tax code comes in. I use an abridged version of the tax code edited by Danial Lathrope. The book includes the actual code (26 U.S.C.) and accompanying Treasury Regulations. The code provides general guidance. For example, section 162 states a taxpayer can deduct “all the ordinary and necessary expenses paid or incurred during the taxable year.” The accompanying treasury regulations add further detail and clarification. In the case of section 162, the regulations specifically explain a number of deductions.
This isn’t the end of source documents. Planners also use Private Letter Rulings, Revenue Rulings, and case law, which provide in-depth analysis and explanations of the above items. For example, section 163 allows taxpayers to deduct interest. But what is interest, really? That’s where case law comes is, as judges have written numerous decisions that contain all the elements that are necessary for a court to recognize an interest-bearing transaction.
So, when planners come up with a way to change a client’s tax position, what they’re really doing is taking a fact pattern, converting it to numbers, and aligning the data with various code provisions to manipulate the basic tax equation.
 26 U.S.C. §61
 26 U.S.C. Subchapter B, Part III is titled, “Items specifically excluded from gross income and includes such items as certain death benefits
 A “deduction” is subtracted from gross income (“all income from whatever source derived”) to arrive at “taxable income.”
 26 U.S.C. §63 (“taxable income” gross income minus the deductions allowed by this chapter.”)
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