Business Income Tax - Chapter 2 & 3

Tax policy

A government’s attitude, objectives, and actions with respect to its tax system.

sufficiency

The first standard for a good tax. A tax should generate enough revenue to pay for the public goods and services provided by the government levying the tax.

static forecast

A projection of revenue gain or loss resulting from a tax rate change that assumes that the change will have no effect on the tax base.

dynamic forecast

A projection of revenue gain or loss resulting from a tax rate change that assumes that the change will affect the tax base.

income effect

A behavioral response to an income tax rate increase. Taxpayers engage in more income-producing activities to maintain their level of disposable income.

substitution effect

A behavioral response to an income tax rate increase. Taxpayers engage in fewer income-producing activities and more non–income-producing activities.

supply-side economic theory

A decrease in the highest income tax rates should stimulate economic growth and ultimately result in an increase in government revenues.

convenience

The second standard for a good tax. A tax should be convenient for the government to administer and for people to pay.

efficiency

The third standard for a good tax. Classical economic theory holds that an efficient tax is neutral and has no effect on economic behavior. In contrast, Keynesian theory holds that an efficient tax is a fiscal policy tool by which the government can affect economic behavior.

negative externalities

An undesirable by-product of the free enterprise system

tax preferences

In the general context, provisions included in the federal tax law as incentives to encourage certain behaviors or as subsidies for certain activities; in AMT context, specific items added to regular taxable income in the computation of AMTI.

Tax Expenditures Budget

Part of the federal budget that quantifies the annual revenue loss attributable to each major tax preference.

ability to pay

Economic resources under a person’s control from which he or she can pay tax

horizontal equity

One aspect of the fourth standard of a good tax: A tax is fair if persons with the same ability to pay (as measured by the tax base) owe the same tax.

vertical equity

One aspect of the fourth standard of a good tax: A tax is fair if persons with a greater ability to pay (as measured by the tax base) owe more tax than persons with a lesser ability to pay.

regressive rate structure

A graduated rate structure with rates that decrease as the base increases.

declining marginal utility of income

The theory that the financial importance associated with each dollar of income diminishes as the total income increases.

progressive rate structure

A graduated rate structure with rates that increase as the base increases.

average rate

The tax rate determined by dividing the total tax liability by the total tax base

net cash flow

The difference between cash received and cash disbursed.

time value of money

A dollar available today is worth more than a dollar available tomorrow because the current dollar can be invested to start earning interest immediately.

discount rate

The rate of interest used to calculate the present value of future cash flows

net present value (NPV)

The sum of the present values of all cash inflows and outflows relating to a transaction.

annuity

A cash flow consisting of a constant dollar amount for a specific number of time periods.

tax cost

An increase in tax liability for any period resulting from a transaction.

tax savings

A decrease in tax liability for any period resulting from a transaction.

deduction

An offset or subtraction in the calculation of taxable income.

private letter ruling (PLR)

The IRS’s written response to a taxpayer’s inquiry as to how the tax law applies to a proposed transaction.

market

A forum for commercial interaction between two or more parties for the purpose of exchanging goods or services.

private market

A market in which the parties deal directly with each other and can customize the terms of their agreement to meet their respective objectives.

arm’s-length transection

A transaction occurring between unrelated parties who are dealing in their own self-interest.

public market

A market in which the parties deal indirectly through an intermediary such as a broker or a financial institution.

related party transaction

A transaction between parties who share a common economic interest or objective and who may not be dealing at arm’s length.