Baylor University | ACC 3304 | Betty Xing | Final Exam Chapter Notes

components of a tax payment

1. required by law

2. imposed by a government agency

3. not tied to a direct benefit received

primary purpose of taxes

to raise government revenue

secondary purpose of taxes

encourage socially beneficial behavior; discourage socially destructive behavior

types of federal taxes

- income

- employment and unemployment

- excise

- transfer

income tax

paid by individuals (F1040) and corporations (F1120)

employment and unemployment tax

- old age, survivors, and disability income (OASDI) aka Social Security @ 6.2%

- medical health insurance (MHI) aka Medicare @ 1.45% for employee and employer (2.9% together)

- additional Medicare @ 0.9% above $200,000 (only employee)

- unemployment tax @ 6% of first $7000 of wages (federal credit capped at 5.4%)

excise tax

- levied on particular products

- tax base is quantity

transfer tax

- estate tax: assessed based on FMV of wealth transferred at death

- gift tax: assessed based on the FMV of wealth transferred by gift

types of state and local taxes

- income

- sales

- use

- property

- excise

- unemployment

- transfer

sales tax

- flat, each state has it's own

- not imposed on everything, depends on state & local government

use tax

- same rate as sales tax

- based on retail price of goods owned, possessed or consumed within a state that were not purchased within the state

- not useful because hard to track

property tax

- Ad Valorem (according to value)

- real property: land & building

- personal property: all other property

general tax formula

tax base ($) * tax rate (%)

tax base

$ being taxed on (i.e. taxable income)

tax rate

- defined by law

- expressed as %

- relationship with base

different tax rate structures

1. proportional

2. progressive

3. regressive

proportional tax rate structure

tax rate is constant (i.e. sales tax)

progressive tax rate structure

tax rate increases with base (i.e. income tax)

regressive tax rate structure

tax rate decreases with base (i.e. social security)

three ways to measure tax rates

1. statutory marginal tax rate (SMTR)

2. average tax rate (ATR)

3. effective tax rate (ETR)

statutory marginal tax rate (SMTR)

rate on the next dollar of taxable income (change in tax / change in taxable income); most useful in tax planning

average tax rate (ATR)

average rate on each dollar of taxable income (total tax / total taxable income); most useful in budgeting

effective tax rate (ETR)

average rate on each dollar of total income (total tax / total income); most useful in investment planning

after-tax rate of return

- evaluate investments

- ATR = pre-tax rate of return (1 - tax rate))

- gives rise to implicit tax

implicit tax

pre-tax return of regular investment - pre-tax return of tax-advantaged instrument

five tax system criteria commonly used to evaluate a tax system

1. sufficiency

2. equity

3. certainty

4. convenience

5. economy

sufficiency

does the tax system raise enough tax revenues to cover government expenditures?

equity

are tax burdens distributed fairly across taxpayers? is the tax system based on a taxpayer's ability to pay?

- horizontal equity

- vertical equity

horizontal equity

similar situations = same tax; evaluate tax liability of taxpayers in the same economic situation

vertical equity

greater ability to pay = more tax (in $ or %); evaluate tax liability of taxpayers in different economic situations

certainty

are taxpayers able to determine: when to pay, where to pay, how to determine the amount of tax?

convenience

are taxes collected without undue hardship on the taxpayer or the government?

economy

are taxes collected at a low cost to the government? are taxes collected at a low cost to the taxpayer?

under what circumstances are individual taxpayers required to file a return?

if gross income >= specified threshold

what affects income thresholds

- filing status, age, GI

- inflation

- more scrutining

Whether a taxpayer is due a refund determines whether a taxpayer is required to file a tax return

False

1 multiple choice option

A taxpayer whose income falls below the income thresholds is not precluded from filing

True

1 multiple choice option

Individual tax return due date

April 15

due date for individual tax return extension period

6 months

if the taxpayer paid too much, he

receives a refund

if the taxpayer paid too little, he

has to make a payment

if the taxpayer fails to file a return

penalty of 5% of the tax due for each month (or partial month) that the return is late (maximum penalty = 25%)

what defines the period in which the taxpayer can amend the return or the IRS can assess a tax deficiency for a specific tax year?

statute of limiations

how long is the statue of limitations in general

3 years & later (actual filing date, original due date 4/15)

how long is the statute of limitations if the taxpayer omits items of gross income that exceed 25% of gross income reported on the tax return?

6 years & late (actual filing date, original due date 4/15)

how long is the statute of limitations if the taxpayer files a fraudulent return

indefinite

how long is the statute of limitations if the taxpayer fails to file a return

indefinite

for a taxpayer to claim a position on a return, the taxpayer should either have

1. substantial authority for the item or

2. a reasonable basis for the position and it is disclosed on the return

two categories of tax authority

- primary authorities

- secondary authorities

primary authorities

official sources of tax law generated by the legislative branch, judicial branch, and executive/administrative branch

secondary authorities

unofficial tax authorities that interpret and explain the primary authorities (i.e. textbook, RIA checkpoint interpretations)

legislative tax authority sources

1. the U.S. Constitution

2. internal revenue code (IRC)

3. tax treaties

judicial tax authority

courts interpret code and settle disputes between IRS and TPs when they interpret tax laws differently (represent highest tax-specific authority)

courts in judicial tax authority

- Supreme Court

- U.S. Circuit Courts of Appeal

- U.S. Tax Court

- U.S. Court of Federal Claims

- U.S. District Court

stare decisis

courts will rule consistently with (a) previous rulings and (b) rulings of higher courts with appellate jurisdiction

administrative tax authority

U.S. Treasury (IRS is a part of)

four sources of administrative tax authority

1. treasury regulations

2. revenue rulings

3. revenue procedures

4. letter rulings

treasury regulations

treasury department's official interpretation of the Code have highest authoritative weight of all Treasure issued documents

three basic purposes of regulations:

1. interpretive

2. procedural

3. legislative

letter ruling types

- private letter rulings

- determination letters

- technical advice memorandums

tax research steps

1. understand facts using all available information

2. identify tax issues in the facts

3. locate relevant authorities

4. analyze tax authorities

5. document and communicate results

tax professional responsibilities & penalties

- tax professionals subject to various statues, rules, and codes of conduct

- a taxpayer will not be subject to underpayment penalty if there is substantial authority

- IRC imposes a penalty on a tax practitioner for any position that is not supported by substantial authority

- failure to comply with statues can result in being admonished, suspended, or barred from practicing

- IRS can impose criminal and civil penalties on both taxpayers and tax professionals to encourage tax compliance

sin tax

tax that discourages bad behavior

earmarked tax

a tax for a specific purpose

how much of social security is taxed (regressive tax rate)

the first $118,500

itemized deductions

personal in nature but are allowed to subsidize desirable activities or provide for taxpayer whose ability to pay has been involuntarily reduced

common itemized deductions

- medical expenses

- taxes

- interest

medical expenses

- reimbursed by health insurance

- not paid through FSA (flexible savings account)

- need to be for TP, spouse, dependents

deductible medical expenses

- prescriptions, doctor/hospital bills

- medical aids

- health insurance premiums (including long-term care)

non-deductible medical expenses

- cosmetics surgery (with exceptions)

- OTC drugs

transportation for medical purposes _____ per mile

21 cents per mile

lodging while away from home overnight for medical reasons

limit $50 per night per person

lodging and meals at hospitals and long-term care facilities

- hospitals: deductible

- long-term care facilities: deductible if primary purpose of stay is medical

medical expense deduction limitation (floor)

7.5%

medical expense deduction

actual expense - (7.5% * AGI)

medical expenses are deductible when

paid to the taxing authority

medical deduction is based on the percentage of the

year the taxpayer owned the house

total medical deductions are limited to

$10,000 maximum deduction

home mortgage interest is deductible on

the first $750,000 of "acquisition indebtedness"

acquisition indebtedness

debt used for acquiring, constructing, or substantially improving the residence

home equity loan interest is deductible if

- the same use as "acquisition indebtedness"

- amount of borrowing shares limit with mortgage, $750,000

investment interest

- in