Federal Tax I Chapter 1
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What is the IRS Definition of Tax?
Payment to a government authority that is required by law.
Payment is required pursuant to a legislative power to tax.
Purpose of the payment is to provide revenue for public purposes.
No specific special benefits, services, or privileges are received from paying the tax.
Examples that are not taxes: licensing fees, tolls, fines, penalties, city charges for water/sewage/garbage, special property assessments
With taxes, what is Equality?
A tax should be based on a taxpayer's ability to pay the tax.
With taxes, what is Horizontal Equity?
Similarly situated taxpayers pay the same amount of tax.
With taxes, what is Vertical Equity?
Taxpayers of different means are treated differently, but fairly according to ability to pay.
With taxes, what is Certainty?
Knowledge of when and how to pay the tax as well as ability to determine the amount to be paid.
With taxes, what is Convenience?
A tax should be levied as close to the time the taxpayer receives the money to pay the tax as possible.
How does the US tax system make paying federal income tax convenient?
The income tax is bases on a pay-as-you-go system which requires employers to withhold estimates of tax owed to the government. Taxpayers not subject to withholding are required to make quarterly payments of estimated taxes.
With taxes, what is Economy?
Compliance and administrative costs should be as small as possible relative to the income generated.
What is the Tax Liability formula?
Tax base x Tax rate
What are some examples of tax base?
- Sales tax: selling price
- Property tax: assessed value of the property
- Income tax: taxable income
What is Marginal Tax Rate?
The tax rate paid on the next dollar to be taxed.
What is Average Tax Rate?
The total tax paid divided by the tax base.
What is Effective Tax Rate?
The total tax paid divided by the sum of the tax base plus items exempted from the tax base (economic income).
What is a Proportional Rate Structure?
One tax rate is applied to all base levels.
What is a Regressive Tax Rate Structure?
The tax rate decreases as the tax base increases.
What is a Progressive Tax Rate Structure?
The tax rate increases as the tax base increases.
What are the major taxes in the United States?
- A. Income Taxes
- 1. Federal
- 2. State
- 3. Local
- C. Property Tax
- 1. Real property
- 2. Personal property
D. Employment Tax
E. Excise Tax
F. Transfer Tax
How does Social Security Tax work?
The employee pays a tax o wages and salaries earned which is matched by the employer. One part of the tax (OASDI) is paid up to a pre-determined base amount. MHI paid on all wages.
How does Self-Employment Tax work?
Individuals who are not employees pay the equivalent of the employee and employer rate (ie. they pay twice the social security rate: 12.4% and 2.9%) on the same pre-determined base on self-employment earnings.
How does Gift Tax work?
A tax is paid by the donor on the value of gifts made.
a. $13,000 per person per year exlusion.
b. Lifetime Unified Estate and Gift Tax Credit - allows the exclusion of $5,000,000 of gifts and property subject to estate tax.
What is an Estate Tax?
A tax paid on the value of assets held at death.
- a. Unlimited marital exclusion
- b. Lifetime Unified and Gift Tax Credit
What is the source of tax law?
- 1. Statutory/Legislative
- a. Constitution - 16th Admendment
- b. Internal Revenue Code of 1986
- 2. Administrative
- a. Regulations
- b. Revenue Rulings
- c. Letter Rulings
- d. Various other official/unofficial informational publications
- 3. Judicial
- a. Trial Courts
- b. Appellate Courts
- c. Supreme Court
Why does the tax law change?
Economic, social, and political reasons
What is the Income Tax Formula?
- All income
- - Exclusions
- Gross Income
- - Deductions
- - Exemptions
- Taxable Income
- x Tax Rate Schedule
- Income Tax on Taxable Income
- -Tax Credits
- Income Tax Liability
- -Tax Prepayments (withholdings/estimated tax)
- Tax Due (Refund)
What is Income?
Any amounts received during the period.
- a. ordinary income
- b. capital gains
What are Exclusions?
Amounts of income received that are specifically excluded from taxation. Amounts excluded are never subject to tax.
What are Deferrals?
Amounts received in the current period are not taxed in the current period, but are to be taxed at some point in the future.
What are Deductions?
Amounts that the tax law specifically allows as a reduction in taxable income.
What are Exemptions?
A pre-determined amount which an income tax entity is always allowed to deduct. The most common exemption is for individual taxpayers and their dependents.
What are Tax Credits?
Direct reductions in the tax liability for entering into certain types of transactions.
What are the issues with Filing Returns?
All tax entities must file and annual return.
Due date is the 15th day of the 4th month, 15th day of 3rd month for corporations.
Can apply for automatic extension of 6 months. Estimate of tax due must be paid with extension.
What is the Statute of Limitations on Tax Returns?
Time period during which taxpayers and IRS can correct errors on returns. General limit is years. Period is for 6 years when omission of gross income is greater than 25% No statute of limitations for returns with criminal fraud.
What are the Main Considerations with Shifting Income and Deductions?
a. Marginal tax rates
b. Time value of money
What are the Rules of Thumb with Shifting Income?
- a. Defer recognition of income
- b. Accelerate recognition of deductions
- c. Put income into the year with the lowest MTR
- d. Put deductions into te year wit the highest MTF
What is Income Splitting?
Taking advantage of the progressive nature of the tax rate structure by allocating income into other tax entities to achieve lower overall marginal and effective tax rate on the same amount of income.
What is Tax Avoidance?
Using legal means to reduce your income tax.
What is Tax Evasion?
Using illegal means to reduce taxes.
1. Willfulness to enter into the evasion - the taxpayer knows that what they are doing is illegal.
2. resulting underpayment of tax.
3. An affirmative action to evade - Unintentional mistakes and math errors are not evasion
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