Tax exam 1

The first time taxes were implemented

1860s during the civil war, it was a temporary income tax.

Second time taxes were implemented

1890s, the supreme court decided it was unconstitutional because the constitution says ny direct tax has to be proportional based upon the census of each state, this lasted one year.

The third time taxes were implemented

1913, when the 16th amendment was passed, allowing congress to collect taxes not based on census, but based on income.

Top individual tax rate

37%

three ingredients of taxes

mandatory payment, government entity, you receive no direct benefits

tax equation

tax rate (percentage) x tax base

three rates of tax

average, effective, marginal

average tax rate equals

total tax / taxable income

effective tax rate equals

total tax / total income

marginal tax rate equals

rate that applies to the next dollar of income

three tax rate structures

proportional, progressive, regressive

proportional tax structure

as tax base goes up, rate stays the same (sales tax)

progressive tax structure

as tax base goes up, rate goes up (income tax)

regressive tax structure

as base goes up, rate goes down (FICA, regressive because there is a cap on the social security portion)

two parts to tax laws

social engineering, raising revenue

three types of taxes

federal, state, local

federal tax

individual income tax (50%), FICA (30%), corporate income tax (10%), excise tax (5-7%), estate gift tax (1%)

state tax

sales + use tax, individual/corporate tax, excise tax

local tax

property tax

5 parts to evaluating tax systems

sufficiency, equity, certainty, convenience, economy

sufficiency

assessing the size of the tax revenues that must be generated and making sure that the tax system has enough money to pay

equity

is the tax system fair?

horizontal equity

are two people who make around the same money paying around the same in taxes?

vertical equity

at higher levels of income, people should be paying higher levels of taxes

certainty

when, where, and how to file your taxes. Makes the system stronger, more people will pay.

Convenience

tax system should be designed to collect taxes without hardship on people

economy

the administrative cost to collect taxes should be low

three ways the government could increase tax revenue

increase tax rates, broaden tax base, create new taxes

static forecasting

not looking at human behavior, increasing tax rates without thinking.

income effect

usually lower class thinking, people will work more to pay their increased amount of taxes

substitute effect

upper class thinking, people will work less to stay in lower brackets to avoid paying higher taxes

dynamic forecasting

takes into account human behaviors

When do you need to file taxes?

if your gross income is greater than your standard deduction

4 types of filing statuses

single, married filed separately, married filed jointly (qualified widow / surviving spouse), head of household

when do you file taxes?

april 15th

rules regarding extensions

anyone can file for an extension, which gives you 6 months. Even though you file for an extension, you still have to pay the money on april 15th.

purpose of the statue of limitations

time limit for the IRS to assess additional taxes and amend your return

standard statue of limitations

3 years from the later of either when you filed or the original due date of your return

When the statute of limitations would be 6 years

if there is a substantial understatement of gross income by more than 25%

When the statute of limitations would be unlimited

if you commit fraud, or you fail to file a return

Three methods of IRS audit

DIF function, Information Matching System, Document Action Perfection Program

DIF Function

discriminate function (scoring system) where if your return looks different than others in your bracket your DIF score will be higher. With a high DIF score, you may be selected for an audit.

Information matching system

comparing tax return information with W2s, bank statements, etc.

Document action perfection program

looking for math errors

People most likely to be audited

high income, schedule C people (business owners), those that engage in foreign transactions

three types of audits

correspondence, office exam, field exam

correspondence audit

80% of audits, conducted through the mail, never have to speak to an agent, limited to one of two items on the return

office exam audit

you have to go to the IRS office and resolve the issues in person

field exam audit

least common, the IRS comes to you

Process to appealing a deficiency

1. pay the taxes or appeal to the IRS appeals division

2. Either pay then, or take it to court

Three trial level courts used for tax disputes

tax court, district court, us court of federal claims

tax court

national court, judges that are tax experts hear your case with no jury, you do not have to pay the taxes first

district court

local court, cause may be heard by a civil or criminal jury, you must pay the taxes first and then sue the IRS for a refund

us court of federal claims

national court, for anyone that has a claim against the United States, must pay the taxes first and then sure for a refund

If you lose the US court of federal claims, where can you then take your case?

US circuit court of appeals

If you lose the US circuit court of appeals, where can you then take your case?

US supreme court

Steps to creating tax law

1. Begins in the house ways + means committee

2. Sent to the house of representatives

3. moves to senate finance committee

4. moved to floor of senate

Problem! the house and senate have passed different versions of the same bill

5. moves to the joint committee

6. moves to the floor of the senate

7. goes back to the full house

8. back to full senate

9. passed to the president

Executive branch involvement in tax law

US treasury - issues treasury regulation for new tax laws that are passed, which explains the bill that congress passed

IRS - issues revenue rulings, letter rulings, and revenue procedures

Judicial branch involvement in tax law

Ultimate decider of the law, court decisions have an effect on the law (stare decisis)

individual income tax formula equals

Gross income - deductions for AGI = AGI - below the line deductions = Taxable income - tax credits - prepayments = refund/final tax liability

Gross income

excludes excluded income and deferred income

Deductions for AGI

business expenses, rental property, contributions to retirement, ½ self employment tax, alimony (divorced before 2019)

AGI

determines below the line deductions and credits

below the line deductions

take the greater of either your standard deduction or itemized deduction (also includes qualified business income)

taxable income

this is what you use to calculate your income tax liability

“other” taxes

alternative minimum tax, self employment tax, net investment income tax, additional medicare tax

total tax liability

what you are responsible for paying in taxes

tax credits

more valuable than deductions because every dollar saves you on every dollar of tax liability

prepayments

withholding tax on paychecks, overpaid last year and it rolls over, estimated tax payments

Ordinary income includes

salary, pension, interest, business, nonqualified dividends, short term capital gains (schedule c)

Preferential income includes

long term capital gains, qualified dividends (0-20%)

Types of recognized captial gains/losses

assets held for investment (land, stocks, bonds), and personal use assets (cars, houses, etc.)

Caveat regarding personal use assets

gains are included in gross income, losses are not deductible

Downside to being someones dependent

it lowers your standard deduction, your standard deduction will either be the greater of $1250 or your

earned income + $400.

General requirements for claiming a dependent

1. they must be a US citizen/ resident of US, canada, or mexico

2. cannot have filed a joint return with a spouse (unless they have no tax liability and they want to file to get a tax return for money thats been withheld)

3. must be a qualifying child/relative

qualifying child tests

1. relationship

2. age

3. residence

4. support

relationship test (child)

..

Age test

under 19, except under 24 if they are a full time student, no age if permanently disabled

residence test

must reside in your house for more than 6 months

Support test (child)

the dependent did not provide more than half of their support. Scholarships do not court as support is from your parents

Relationship test (relative)

broader, includes people like parents, grandparents, aunts, uncles, friend

support test (relative)

YOU must pay more than half of their support

Gross income test

dependents gross income must be less than 4700

single

not married on the last day of the year

married filed jointly

you are married by the last day of the year (unless your spouse dies), you are both responsible for the tax liability

married filed separately

each spouse reports their own income andsdeductions, if one spouse itemizes they must both itemize

head of household

not married as of the last day of the year, not a qualifying widow, you pay more than half the costs of maintaining a home, and you have a qualifying person living with you

Why are filing statuses important

dictate standard deductions, tax schedules, and phase outs

qualifying person

dependent child, dependent relative who is your mother or father, qualifying relative who is not your parents (must live with you more than half of the year), must be a qualifying dependent, most be related to you through familiar relationship

Abandoned spouse

married, do not file a joint return, paid more than half the cost of maintaining a home, lived apart from their spouse for the last 6 months of the year

three parts to recognizing gross income

1. economic benefit - must receive something of value

2. realization event - must engage in a transaction with a third party that changes your property rights

3. recognized - income you report on your tax return

realized income

economic income from transactions (usually the same as recognized except there excluded or deferred income)

Return of capital principle

proceeds of sale - tax basis = gross income from sale

assignment of income doctrine

you cannot assign income from one individual to another. whoever performs the services recognizes the income

10 types of income

1. recovery of amounts previously deducted

2. annuities

3. dispositions to property

4. income from flow through entities

5. alimony

6. prizes and rewards

7. gambling winnings

8. social security benefits

9. imputed income

10. discharge of indebtedness

recovery of amounts previously deducted

you must include in your income the amount of tax benefits you received from deductions

Annuities

annuity exclusion ratio = investment in the annuity / the expected return… once you recover your full investment amount of thr annuity, the rest is all excluded income

dispositions in property

when you sell something you must recognize a gain or a loss

income from flow through entities

partners taxed on partnership income

alimony

payment made under a written agreement, the money must not be designated to be something else (child support), the parties do not live together when the money is paid, payments end when a partie dies. if you were divorced before 2019, alimony is gross income.