Post on 26-Dec-2015
Chapter 1Chapter 1
Federal Income Taxation -An Overview
Federal Income Taxation -An Overview
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Kevin MurphyKevin MurphyMark HigginsMark Higgins
Kevin MurphyKevin MurphyMark HigginsMark Higgins
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What is the Definition of a Tax?
What is the Definition of a Tax?
An enforced, involuntary contribution
Required and determined by law
Providing revenue for public and
governmental purposes
For which no specific benefits or
services are received
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Standards of a Good Tax System
Adam Smith’s Four Criteria
Standards of a Good Tax System
Adam Smith’s Four Criteria
Equality Tax should be based on the taxpayer’s
ability to pay
Horizontal Equity: Two similarly situated
taxpayers are taxed the same
Vertical Equity: Differently situated taxpayers
are taxed differently but fairly
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Standards of a Good Tax System
Adam Smith’s Four Criteria
Standards of a Good Tax System
Adam Smith’s Four Criteria
EqualityCertainty
When and how a tax is to be paid should be known to the taxpayer
The taxpayer should be able to determine the amount of the tax
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Filing RequirementsFiling Requirements
Return must be filed annually Calendar-year individuals file and pay
on or before the 15th day of AprilMay receive an extension of time to file but
not time to pay
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Standards of a Good Tax System
Adam Smith’s Four Criteria
Standards of a Good Tax System
Adam Smith’s Four Criteria
EqualityCertaintyConvenience
Tax should be levied when the taxpayer has funds available to pay
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Standards of a Good Tax System
Adam Smith’s Four Criteria
Standards of a Good Tax System
Adam Smith’s Four Criteria
EqualityCertaintyConvenienceEconomy
The costs of complying with the tax system should be minimal
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Tax ComputationTax Computation
Tax = Tax Base X Tax Rate
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Tax ComputationTax Computation
Tax = Tax Base X Tax Rate
the value subject to taxation
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Tax Rates for Income TaxTax Rates for Income Tax
• Marginal Tax Rate is the rate of tax on the next dollar of taxable income
• Average Tax Rate is the rate equal to the total tax divided by the tax base
• Effective Tax Rate is the rate equal to the total tax divided by economic income
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Tax StructuresTax Structures
Proportional
average tax rate remains the sameas tax base increases
average rate
tax base
tax
rate
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Tax StructuresTax Structures
Regressive
average tax rate decreases astax base increases
average rate
tax base
tax
rate
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Tax StructuresTax Structures
Progressive
average tax rate increases astax base increases average rate
tax base
tax
rate
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Major Types of U.S. TaxesMajor Types of U.S. Taxes
Individual Income
Sales
Total Taxes
Property
Employment
All Others
Corporate Income
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Types of U.S. TaxesTypes of U.S. Taxes
Income TaxTaxes are paid by individuals,
corporations, estates, and trustsTax base is total income less allowed
reductions
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Types of U.S. TaxesTypes of U.S. Taxes
Employment TaxTaxes are paid by employees, employers,
and self-employed taxpayerTax base is wages and salaries earnedTwo major types
Social Security Unemployment
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Types of U.S. TaxesTypes of U.S. Taxes
Sales TaxTaxes are paid by purchasers of goods
and servicesTax base is the selling price of a product or
a service
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Types of U.S. TaxesTypes of U.S. Taxes
Property TaxTaxes are paid by owners of propertyTax base is the assessed value of real or
personal property (ad valorem)
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Types of U.S. TaxesTypes of U.S. Taxes
Excise TaxTaxes are paid by purchasersTax base is the quantity purchased and not
the value of the purchase
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Types of U.S. TaxesTypes of U.S. Taxes
Wealth Transfer Tax Taxes are paid by entity transferring
propertyTax base is the value of the property
transferred Transfers to spouses and charities are
excluded Lifetime Unified Credit excludes up to $2M in
2007 Donors may exclude annual gifts of $12,000
per donee
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Tax FormulaTax Formula
Broadly defined income
Includes all forms ofincome(Chapter 3)
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Tax FormulaTax Formula
Broadly defined income
minus: Exclusions Income specificallyexcluded from income by legislative grace(Chapter 4)
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Tax FormulaTax Formula
Broadly defined incomeminus: Exclusions
Income to beReported
equals: Gross Income
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Tax FormulaTax Formula
Broadly defined incomeminus: Exclusionsequals: Gross Income
Amountsspecificallyallowed as subtractions (Chapters 5 - 7)
minus: Deductions
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Some Deduction ExamplesSome Deduction Examples
Expenses (Chapters 5 & 6) Current period expenditures incurred in order to earn income
Losses (Chapter 7) Transaction losses result when an asset is disposed of at a
price less than its tax cost Annual losses result when allowed deductions exceed
income
Exemptions (Chapter 8) A minimum amount of income needed for basic living Personal and dependency ($3,400 each)
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Deduction TypesDeduction Types
Gross Income
minus: For Deductions not restricted based on taxpayer’s income generally trade, business, rent or royalty expenses
minus: From Deductionsrestricted based on Adjusted Gross Incomegenerally personal expenses
–Itemized, or–standard amount (changes with filing status)
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Tax FormulaAdjusted Gross Income
Tax FormulaAdjusted Gross Income
Gross Income
minus: For Deductions
equals: Adjusted Gross Income [AGI]
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Tax FormulaTaxable Income
Tax FormulaTaxable Income
Gross Income
minus: For Deductions
equals: Adjusted Gross Income [AGI]
minus: From Deductions and Exemptions
Taxable Income
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Tax FormulaThe Tax
Tax FormulaThe Tax
Taxable Incometimes: Tax Rateequals: Income Tax Liabilityminus: Prepayments & Creditsequals: Tax or (Refund) due
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Audit and Appeals ProcessStatute of Limitations
Audit and Appeals ProcessStatute of Limitations
Three years from filing date Extends to six years if income is under-
reported by 25% of gross income No limitation for fraud or if no return is
filed
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Audit and Appeals ProcessSelection for Audit
Audit and Appeals ProcessSelection for Audit
Only about 2% of returns are audited
Procedures usedDiscriminant Function SystemTaxpayer Compliance Measurement
Program Document perfection & Information
matching
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Tax PlanningTax Planning
Goal is to maximize after-tax wealth
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Tax PlanningTiming
Tax PlanningTiming
Time Value of moneyDefer incomeAccelerate deductions
Marginal tax rateRecognize income in year of lower marginal rateRecognize deductions in year of higher marginal
rateShift income to taxpayer with lower marginal rate
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Tax PlanningTax Avoidance Vs. Tax
Evasion
Tax PlanningTax Avoidance Vs. Tax
Evasion Tax Avoidance - Taxpayers have no
obligation to pay more tax than the law requires
Tax Evasion - Taxpayers may not use fraudulent or deceptive behavior to hide tax liability
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Ethics Ethics
Preparers are subject to penalties for negligence and fraud
Ethical StandardsIRS Circular 230AICPA’s Code of Professional ConductAICPA’s Statements on Standards for Tax
Services