1-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-2 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-3 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-4 History of Taxation  First Federal income tax in 1861  Repealed after Civil War  Reinstated in 1894  Supreme Court ruled unconstitutional in 1895  16 th Amendment on March 1, 1913  Revenue acts prior to codification in 1939 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-5 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-6 Revenue Sources ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-7 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-8 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-9 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-10 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-11 Structure of Corporate Tax Rates (2 of 2) First $50K15 % of Taxable Inc > $50K But Not > $75K$7, % of Taxable Inc > $75K But Not > $100K13, % of Taxable Inc > $75K > $100K But Not > $335K $22, % of Taxable Inc > $100K > $335K34% of Taxable Inc > $10M But Not > $15M3.4M + 35% of Taxable Inc > $10M > $15M But Not > $18,333,333$5.150M + 38% > $15M > $18,333,33335% of Taxable Inc ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-12 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-13 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-14 Other Types of Taxes  State and local income taxes  State and local franchise taxes  Wealth transfer taxes  Estate tax - Repealed in 2010; likely to be reinstated at 2009 rates  Gift tax  Other types of taxes  Prop., excise, sales, & employment taxes ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-15 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-16 Criteria for a Tax Structure (2 of 3)  Convenience  Easily assessed, collected, and administered  Simplicity  Should not be overly complex ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-17 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-18 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) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-19 Economic Objectives  Raise Revenues for Government Operations  Stimulate Private Investment  Reduce Unemployment  Mitigate Effects on Inflation ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-20 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-21 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) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-22 Tax Law Sources (1 of 2)  Legislative  Internal Revenue Code  Congressional Committee reports  Executive (administrative)  Income tax regulations  Revenue Rulings  Revenue Procedures  Letter Rulings ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-23 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-24 Enactment of a Tax Law (1 of 4) 1. House of Representatives responsible for initiating new tax legislation  President may make proposal to Congress with studies on needed tax reform prepared by Treasury 2. Referred to the House Ways and Means Committee (HW&MC) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-25 Enactment of a Tax Law (2 of 4) 3. Voted on by HW&MC  Forwarded to House of Representatives for a vote if approved by HW&MC 4. Voted on by House of Reps  If approved, sent to Senate Finance Committee (SFC) 5. Voted on by SFC  If approved, sent to Senate for a vote  Bill may be different than House version ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-26 Enactment of a Tax Law (3 of 4) 6. Senate considers bill and may add amendments 7. Voted on by Senate  If approved, sent to Joint Conference Committee (JCC) to reconcile bill 8. JCC produces final bill  Sent back to House and Senate to vote on final bill ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-27 Enactment of a Tax Law (4 of 4) 9. If JCC bill approved, sent to President for approval or veto 10. Presidential veto may be overturned by 2/3 vote in both House & Senate 11. Committee reports prepared by staff of HW&MC, SFC, and JCC ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-28 Administration of the Tax Law and Tax Practice Issues  Organization of the IRS  Enforcement procedures  Selection of returns for audit  Statute of limitations  Interest  Penalties  Administrative appeal procedures ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-29 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-30 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-31 Components of a Tax Practice  Tax compliance and procedure  Tax research  Tax planning and consulting  Financial planning ©2011 Pearson Education, Inc. Publishing as Prentice Hall

1-32 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 1-33 ©2011 Pearson Education, Inc. Publishing as Prentice Hall