State Law: The Foundation for Federal Tax Law

Abstract

To determine if property exists for purposes of federal income tax law, a bifurcated analysis is needed because state law creates the legal rights and interest associated with property, but federal income tax law determines if the rights or interest are sufficient to create property for a specific tax purpose. Recent court cases and Internal Revenue Service rulings are examined to clarify: • What legal rights and interest are held by a taxpayer under state law, and • Whether those rights and interest are property for purposes of federal income tax law. Although state law provides the foundation for federal income tax law, B. Bittker has noted that its consideration “rarely rises to conscious level.” This article reviews the interrelationship of state and federal law in defining property rights and interest—and, in doing so, creates the conscious awareness needed for effective tax planning.