Income Tax: Chapter 1 from Lecture

Separate Taxes Between:

Federal and State/Local

Federal Taxes Include:

Income taxes (individually and corporation), FICA taxes (social security and medicare), Excise taxes, Estate taxes.

State and Local Taxes Include:

Income taxes, Sales taxes, Excise taxes, Property taxes, Estate and/or inheritance taxes (pay on what you receive).

Pay Stub Taxes Include:

Federal Income tax, State Income tax, and FICA taxes.

Social Security Tax

Rate is 6.2% and you only pay up to $184,500 per year.

Medicare Tax

Rate is 1.45% and you pay for all wages.

FICA Tax

Rate is 7.65% and is the combination of Medicare and Social Security.

Employer Payroll Taxes Include:

1. Match FICA taxes; except the additional 0.9%.

2. Federal Unemployment Rate; rate is 0.6%

3. State Unemployment Rate; rate varies (most between 1% - 2.5%)

Numbers 2 and 3 are on wages up to $7,000. So any wages higher are not taxed.

The additional 0.9% on FICA taxes are paid by:

Single people whose income is greater than $200,000 and Married people whose income is greater than $250,000.

Sales Tax:

Occurs when you buy things like groceries, clothes, shoes, etc.

Excise tax:

Tax on purchasing specific items. (varies by each state) Most commonly include gasoline, alcohol, and cigarettes.

Local Government Excise Tax:

Includes hotels and rental cars.

Property Tax:

Includes business assets (all assets a business has) and personal assets ( property and wehicles).

Taxes at Death:

Someone will be named as the executor and the executor will be responsible for getting the affairs in order.

Executor Responsibilities:

1. File a tax return for year of death.

2. Settle the estate:

• Determine all assets.

• Use assets to pay off any liabilities.

• Remaining assets is the value of the estate. Estate tax is approximately 45%.

3. Unified transfer credit → can offset taxes owed on estate up to $15 million.

Gift Tax:

Paid by the person who gives the gift. Rate is 45%. (ex. someone is in poor health so they give large sums of money to family and friends).

Annual Gift Exclusion:

Every year you may exclude gifts up to $19,000 per person from the gift tax. So if Single you can give $19,000 per child, but if married you can give $38,000 per child.

Tax Holiday:

If the government tells a business if you open up a new plant in this specific city you will be excluded from some taxes for some period of time. (ex. BMW plant in Tuscaloosa)

The first year taxes were enacted and why:

In the year 1861 and it was to pay for the Civil War. In 1865 the war ended and so did the tax.

The second time taxes were enacted:

In 1894 and the tax payers sued and the court ruled it was unconstitutional.

The third time taxes were enacted:

In 1909 on corporations only. The tax payers sued again, but the supreme court ruled it was okay.

The fourth time taxes were enacted:

In 1913 the 16th amendment was passed in the U.S. constitution. This allows federal income tax on individuals.

What were the rates of the first income tax?

Rates were 2% - 6% and only paid by few people with the highest income.

When does the tax law change?

Every year.

Between 1913 and 1939 what happened?

Tax laws became very complex.

In 1939 what was created?

The Internal Revenue Code of 1939. This summarized the changes to the tax law.

When were the next 2 tax codes released?

In 1959 and 1986.

Between 1939 and 1945 what happened?

Federal Income Tax became a mass tax. This means it was paid by many people. 74% of people paid income taxes when WWII happened.

In 1943 congress passed:

Current Tax Payments Act.

Tax Structure:

Tax Base (amount to be taxed)

x Tax Rate

= Taxable Income

Tax Rates can be:

Proportional, Progressive, or Regressive.

Proportional Tax Rate:

The rate is constant regardless of the size of the tax base. Also known as 1 or flat rate.

Progressive Tax Rate:

The rate increases as the tax base increases. (ex. income tax)

Regressive Tax Rate:

The rate decreases as the tax base increases. (ex. social security)

Average Tax Rate:

Equal to a tax payer’s total tax liability divided by their total tax base; is sometimes used to compare tax burdens across different tax payers or a tax payers tax burden across time.

Marginal Tax Rate:

The tax rate applicable to the tax payer’s next dollar of the tax base.

Tax Administration (In the U.S.)

Tax laws enforced by the Internal Revenue Service (IRS). IRS is part of the treasury department in the U.S. IRS has the power to audit. 0.2% of tax payers get audited.

Increase the odds of being audited by the IRS:

1. Errors in tax return.

2. Large cash transactions.

3. Owning a business.

4. Higher income.

5. Claim deductions outside of the normal range of people at your income.

6. Informants (someone telling the IRS that you are committing tax fraud)

Three types of Audits:

Correspondent, Office, and Field.

Correspondent Audit:

Receive a letter from the IRS. You agree then pay and your done. Disagree explain why and hope they agree.

Office Audit:

You go to the IRS office.

Field Audit:

IRS comes too you. This usually means something big.

When the Audit is Complete:

You Issue Revenue Agents Report (RAR).

If you disagree with the IRS your options are to:

Appeal to the IRS or take IRS to court (its very costly).

How long does the IRS have to audit you?

As long as you file in time they have 3 years. Example: for tax year 2026 you file in April of 2027. IRS has till April of 2030.

IRS gets 6 years to audit if:

Income is under reported by more than 25%.

IRS gets no limit to audit if:

Tax return is considered fraudulent, like ridiculously wrong.

When the Audit is complete:

If you owe money you must pay:

• What you owe

• Interest

• Penalties

Potential Penalties:

1. Failure to file: 5% per month up to a maximum of 25%.

2. Failure to pay: (file return and don’t have money to pay or you owe money on an audit) 0.5% per month up to a maximum of 25%. Months are every 30 days (ex. 1 month = 1 to 30 days, 2 month = 31 to 60 days)

If you have both failure to file penalty and failure to pay penalty:

You can credit your failure to pay penalty from failure to file penalty.

Civil Fraud Penalty:

Up to 75%

Criminal Fraud Penalty:

Up to 75% and guilt time.

Negligence Penalty:

20%