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AN INTRODUCTION TO TAXATION (1 of 2) History of taxation Types of tax rate structures Other types of taxes Criteria for a tax structure Objectives of Federal income tax law Entities in Federal income tax system ©2009 Pearson Education, Inc. Publishing as Prentice Hall

AN INTRODUCTION TO TAXATION (2 of 2) Tax law sources Enactment of a tax law Administration of the tax law and tax practice issues Components of a tax practice Computer applications in tax practice ©2009 Pearson Education, Inc. Publishing as Prentice Hall

©2009 Pearson Education, Inc. Publishing as Prentice Hall History of Taxation First Federal income tax in 1861 Repealed after Civil War Reinstated in 1894 Supreme Court ruled unconstitutional in 1895 16th Amendment on March 1, 1913 Revenue acts prior to codification in 1939 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Manner in Which Tax Law is Changed Or Modified Federal income tax is changed on an incremental basis rather than a complete revision The tax law has been referred to as a quiltwork of tax law ©2009 Pearson Education, Inc. Publishing as Prentice Hall

©2009 Pearson Education, Inc. Publishing as Prentice Hall Revenue Sources ©2009 Pearson Education, Inc. Publishing as Prentice Hall 6

Types of Tax Rate Structures Structure of individual income tax rates Structure of corporate tax rates Marginal, average, and effective tax rates for taxpayers Determination of taxable income and tax due ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Structure of Individual Income Tax Rates (1 of 2) Tax Base Amount to which tax rate is applied to determine tax due E.g., individual’s tax base for Federal income is taxable income Tax base for property tax generally FMV of property subject to tax Tax Rate Percentage(s) applied to tax base ©2009 Pearson Education, Inc. Publishing as Prentice Hall 7

Structure of Individual Income Tax Rates (2 of 2) Progressive Rate increases as tax base increases E.g., individual income tax Proportional or flat tax E.g., sales tax Regressive Rate decreases as tax base increases E.g., FICA tax ©2009 Pearson Education, Inc. Publishing as Prentice Hall 7

Structure of Corporate Tax Rates (1 of 2) Stair-step pattern of progression Tends to benefit small corporations Benefit of graduated tax rates phased out between $100K and $335K, and $15M and $18.33M ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Structure of Corporate Tax Rates (2 of 2) First $50K 15% of Taxable Inc > $50K But Not > $75K $7,500 + 25% of Taxable Inc > $75K But Not > $100K 13,750 + 34% of Taxable Inc > $75K > $100K But Not > $335K $22,250 + 39% of Taxable Inc > $100K > $335K 34% of Taxable Inc > $10M But Not > $15M 3.4M + 35% of Taxable Inc > $10M > $15M But Not > $18,333,333 $5.150M + 38% > $15M > $18,333,333 35% of Taxable Inc ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Marginal, Average, and Effective Tax Rates for Taxpayers Marginal tax rate Tax rate applied to incremental amount of taxable inc that is added to tax base Average tax rate Total tax liability divided by amount of taxable income Effective tax rate Total tax liability divided by total economic income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Determination of Taxable Income and Tax Due Gross Income - Deductions for AGI = AGI - Deductions from AGI = Taxable Income x Individual Tax Rate = Gross Tax Due - Credits & Payments = Tax or Refund Due ©2009 Pearson Education, Inc. Publishing as Prentice Hall

©2009 Pearson Education, Inc. Publishing as Prentice Hall Other Types of Taxes State and local income taxes State and local franchise taxes Wealth transfer taxes Estate tax Gift tax Other types of taxes Property, excise, sales, & employment taxes ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Criteria for a Tax Structure (1 of 3) Equity Vertical equity Horizontal equity Certainty Stable source of gov’t revenues Amount of liability for taxpayers ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Criteria for a Tax Structure (2 of 3) Convenience Easily assessed, collected, and administered Simplicity Should not be overly complex ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Criteria for a Tax Structure (3 of 3) Economy Minimal compliance and administration costs Businesses spent $148B to comply with federal tax law and $80B to comply with state and local taxes Cost to individuals $111B ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Objectives of Federal Income Tax Law Economic objectives Encouragement of certain activities and industries Social objectives Income tax reform proposals Simplified Income Tax Plan (SITP) Growth and Investment Tax Plan (GITP) ©2009 Pearson Education, Inc. Publishing as Prentice Hall

©2009 Pearson Education, Inc. Publishing as Prentice Hall Economic Objectives Raise Revenues for Government Operations Stimulate Private Investment Reduce Unemployment Mitigate Effects on Inflation ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Entities in Federal Income Tax System (1 of 2) Taxpaying entities Individuals C corporations Double taxation of C corp earnings Trusts Hybrid entity May be taxpaying entity or flow-through ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Entities in Federal Income Tax System (2 of 2) Flow-through entities Sole proprietorship Also known as a Schedule C business Partnerships S Corporations LLC (Limited Liability Company) LLP (Limited Liability Partnership) ©2009 Pearson Education, Inc. Publishing as Prentice Hall

©2009 Pearson Education, Inc. Publishing as Prentice Hall Tax Law Sources (1 of 2) Legislative Internal Revenue Code Congressional Committee reports Executive (administrative) Income tax regulations Revenue Rulings Revenue Procedures Letter Rulings ©2009 Pearson Education, Inc. Publishing as Prentice Hall

©2009 Pearson Education, Inc. Publishing as Prentice Hall Tax Law Sources (2 of 2) Judicial Court decisions Trial courts District Court, Tax Court, U.S. Court of Federal Claims Appeals courts Circuit Courts Supreme Court ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Enactment of a Tax Law (1 of 4) House of Representatives responsible for initiating new tax legislation President may make proposal to Congress with studies on needed tax reform prepared by Treasury Referred to the House Ways and Means Committee (HW&MC) ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Enactment of a Tax Law (2 of 4) Voted on by HW&MC Forwarded to House of Representatives for a vote if approved by HW&MC Voted on by House of Reps If approved, sent to Senate Finance Committee (SFC) Voted on by SFC If approved, sent to Senate for a vote Bill may be different than House version ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Enactment of a Tax Law (3 of 4) Senate considers bill and may add amendments Voted on by Senate If approved, sent to Joint Conference Committee (JCC) to reconcile bill JCC produces final bill Sent back to House and Senate to vote on final bill ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Enactment of a Tax Law (4 of 4) If JCC bill approved, sent to President for approval or veto Presidential veto may be overturned by 2/3 vote in both House & Senate Committee reports prepared by staff of HW&MC, SFC, and JCC ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Administration of the Tax Law and Tax Practice Issues Organization of the Internal Revenue Service Enforcement procedures Selection of returns for audit Statute of limitations Interest Penalties Administrative appeal procedures ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Selection of Returns for Audit Self assessment & voluntary compliance Discriminant Function System (DIF) DIF system generates “score” for return based on return for add’l tax revenue Returns manually screened by IRS Decide which returns to examine further Less than 1% of all individual returns are selected for examination each year ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Statute of Limitations General rule 3 years from later of the date tax return was actually filed or due date Six years if taxpayer omits items of gross income that in total exceed 25% Indefinite if fraudulent return filed or no return filed ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Components of a Tax Practice Tax compliance and procedure Tax research Tax planning and consulting Financial planning ©2009 Pearson Education, Inc. Publishing as Prentice Hall

Computer Applications in Tax Practice Tax return preparation Tax planning applications E.g., project depreciation Tax research applications RIA Checkpoint CCH Tax Research Network IRS web site ©2009 Pearson Education, Inc. Publishing as Prentice Hall

©2009 Pearson Education, Inc. Publishing as Prentice Hall