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AN INTRODUCTION TO TAXATION (1 of 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. AN INTRODUCTION TO TAXATION (2 of 2). Tax law sources

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AN INTRODUCTION TO TAXATION (1 of 2)

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  1. ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

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 History of Taxation • First Federal income tax in 1861 • Repealed after Civil War • Reinstated in 1894 • Supreme Court ruled unconstitutional in 1895 • 16th Amendment on March 1, 1913 • Revenue acts prior to codification in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

  5. Manner in Which Tax Law Is Changed or Modified • Federal income tax is changed on an incrementalbasis rather than a complete revision • The tax law has been referred to as a quiltwork of tax law ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  6. Revenue Sources ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  11. Structure of Corporate Tax Rates(2 of 2) ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  12. Marginal, Average, and Effective Tax Rates for Taxpayers • Marginaltax 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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

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

  17. Criteria for a Tax Structure(3 of 3) • Economy • Minimal compliance and administration costs • Businesses spent $148Bto comply with federal tax law and $80B to comply with state and local taxes • Cost to individuals $111B ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  19. Economic Objectives • Raise Revenues for Government Operations • Stimulate Private Investment • Reduce Unemployment • Mitigate Effects on Inflation ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  24. 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) ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  25. 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 ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  26. 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 ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  27. 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 ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  31. Components of a Tax Practice • Tax compliance and procedure • Tax research • Tax planning and consulting • Financial planning ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

  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 PearsonEducation, Inc. Publishing as Prentice Hall

  33. ©2011 PearsonEducation, Inc. Publishing as Prentice Hall

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