Tax Exam 1

Tax

a payment required by a government that is unrelated to any specific benefit or service that is received from the government

Purpose of Taxes

to fund the operations of the government

Sin Taxes

taxes imposed on the purchase of goods that are considered socially less desirable

Earmarked Tax

a tax assessed for a specific purpose (ex education)

Tax =

Tax base x tax rate

Tax base

item being taxed and usually expressed in monetary terms

Tax rate

level of taxes imposed on tax base

US Income Tax Type

Graduated progressive tax system

Flat Tax

a tax in which a single tax rate is applied throughout the tax base

Graduated taxes

tax base is divided into a series of monetary amounts where each successive bracket is taxed at a different percentage rate (higher or lower)

Brackets

a subset of the tax base subject to a specific tax rate

Marginal Tax Rate

tax rate that applies to the next additional increment of a taxpayer's taxable income

Marginal Tax Rate =

(new total tax - old total tax)/(new taxable income - old taxable income)

Average tax rate

taxpayer's average level of taxation on each dollar of taxable income

Average tax rate =

total tax/taxable income

Effective tax rate

taxpayer's average rate of taxation on each dollar of total income

Effective tax rate =

total tax/total income

Proportional tax rate structure

constant tax rate throughout the tax base (flat tax)

Progressive Tax Rate Structure

imposes an increasing marginal tax rate as the tax base increases

Regressive Tax Rate Structure

imposes a decreasing marginal tax rate as the tax base increases

Federal Taxes

income tax, employment tax, excise tax, transfer tax

Income Tax

tax in which tax base is income (imposed by federal government and most states)

Employment Tax (Payroll Taxes)

FICA Tax (Medicare and Social Security), Self Employment taxes, FUTA/SUTA

Social Security tax

intended to provide basic pension coverage for the reties and disabled

Medicare Tax

helps pay medical costs for qualifying individuals

Self-employment taxes

social security and medicare taxes paid by self-employed on a taxpayer's net earnings from self-employment

Unemployment Taxes

FUTA/SUTA - pays for temporary unemployment benefits for individuals terminated from their jobs without cause

Excise Tax

taxes on the retail sale of particular products, typically depends on quantity purchased (producer usually pays and tax is built into cost of the good)

Transfer Taxes

taxes on transfer of wealth from one taxpayer to another

Estate and gift taxes

tax paid on estates and gifts based on fmv (taxes donors)

State and Local Taxes (SALT)

income tax, sales and use tax, property tax, excise tax

Sales Tax

tax imposed on retail price of goods

Use Tax

tax imposed on retail price of goods owned, possessed, or consumed within a state that were not purchased within the home state

Real Property Taxes

tax on fmv of land and structures permanently attached to land

Personal Property Taxes

tax on fmv of all types of tangible and intangible property (except real property)

Ad Valorem Taxes

tax base is property's fair market value

Explicit Taxes

taxes directly imposed by a government

Implicit Taxes

results from a tax advantage the government grants to certain transactions to satisfy social, economic, or other objectives

Types of taxpayers

individual, business, and not for profit

Analyzing a tax

taxing authority + taxpayer type + type of tax

After Tax Rate of Return (ATROR) =

BTROR x (1- tax rate)

Evaluating Tax Systems

sufficiency, equity, certainty, convenience, and economy

Sufficiency

a tax system must evaluate the ends it hopes to accomplish and estimate the expenses and forecast the revenues necessary to support such expenses

Static Forecasting

forecasting tax revenues based on the existing state of transactions while ignoring how taxpayers may alter their activities in response to a tax law change

Dynamic Forecasting

forecasting tax revenues that incorporates into the forecast how taxpayers may alter their activities in response to a tax law change

Income effect

when taxed more, taxpayers work harder to achieve same after-tax dollars

Substitution effect

when taxed more, tax payers will substitute nontaxable/leisure activities for taxable ones because the marginal value of taxable activities has decreased

Equity

tax system considered equitable if the tax is based on the taxpayer's ability to pay

Horizontal Equity

taxpayers in similar situations (same income) should pay the same amount of tax (not always true because of tax preferences)

Vertical Equity

taxpayers with greater ability to pay taxes should pay more

Certainty

taxpayers should be able to determine when, where, and how much tax to pay

Convenience

tax system should be designed to fairly collect taxes without imposing undue hardship

Economy

tax system should minimize compliance/administrative costs of code enforcement

Social Security Number

issued by social security administration to US citizens, residents, and non residents authorized to work in the US

Individual taxpayer identification number (ITIN)

issued by IRS for individuals who need a taxpayer ID number but are not eligible for an SSN

Employer Identification Number (EIN)

issued to businesses not only for filing taxes but also other business functions

Preparer Tax Identification Number (PTIN)

required by tax preparers who are paid to prepare or assist with federal tax returns

Centralized Authorization File Number (CAF)

issued to tax professionals who represent taxpayers before the IRS, especially in audits, appeals, or other IRS matters

Who must file

corporations, estates and trusts, and individuals

When should corporations file?

must file tax return regardless of income

When should estates and trusts file?

must file if gross income exceeds $600

When should individuals file?

generally not required if the standard deduction exceeds gross income and/or net self-employment income does not exceed threshold amount

S Corporation Filing and Extension Dates

Form 1120S, filing due date 3/15, extension due date 9/15

Partnership Filing and Extension Dates

Form 1065, filing due date 3/15, extension due date 9/15

Estate or Trust Filing and Extension Dates

Form 1041, filing due date 4/15, extension due date 9/30

Individual Filing and Extension Dates

Form 1040, filing due date 4/15, extension due date 10/15

Individual (Donor) Filing and Extension Dates

Form 709, filing due date 4/15, extension due date 10/15

C Corporation Filing and Extension Dates

Form 1120, filing due date 4/15, extension due date 10/15

NFP filing and Extension Dates

Form 990, filing due date 5/15, extension due date 11/15

Estate Filing and Extension Dates

Form 706, filing due date 9 months after death, extension due date 15 months after death

File Electronically

return considered filed when IRS accepts the return

File by mail

return considered filed on postmark date and must be properly addressed and have sufficient postage

Substantiation requirement

after filing taxpayers should keep records for at least 3 years

Utilization Ratio

Billable hours/total hours

IRS

government agency within the US treasury department that administers and enforces tax laws

Statute of Limitations

period in which a tax payer can file an amended tax return or the IRS can assess a tax deficiency for a specific tax year

SOL ends

3 years from later of: date tax return was filed or tax return's original due date

Exceptions to SOL

• extends to 6 years if taxpayer omits items of gross income > 25% of gross income reported on the return

• extends forever if taxpayer committed fraud or failed to file

Tax notice

informs the taxpayer about an issue, update, or action related to their tax account

Discriminant Function (DIF) System

uses historial IRS adjustment data to assign a score to a return for review (higher score = more likely of being selected for audit)

Document Perfection Program

tax returns checked for mathematical and tax calculation errors

Information Matching Program

matches taxpayer reported amounts to underlying tax documents sent separately to the IRS from the issuer

Correspondence audit

conducted through mail and limited in scope

Office Examinations

conducted at local IRS office and broader in scope/more complex

Field examinations

conducted at taxpayer's place of business or where books/records are kept (broadest in scope and most complex)

After the audit steps

1. IRS provides proposed adjustments

2. If dispute, taxpayer receives 30-day letter

3. If not settled, taxpayer receives 90-day letter

4a. TP pays disputed tax liability and then can filed/sue IRS in US District Court or US Court of Federal Claims for a refund

4b. TP does not pay tax liability and then can file in US Tax Court

US District Court

judges are generalists, if lose appeal to US Circuit Court of Appeals, if lose again appeal to US Supreme Court

US Court of Federal Claims

judges are generalists, if lose appeal to US Federal Circuit Court of Appeals, if lose again appeal to US Supreme Court

US Tax Court

hears only tax cases, judges are experts in tax, if lose appeal to US circuit court of appeals, if lose again appeal to US Supreme Court

30 day letter

letter from IRS that gives the taxpayer 30 days to pay the proposed assessment or request an appeals conference

90 day letter

letter from IRS that gives taxpayer 90 days to pay the tax or petition the US Tax Court to hear the case

Primary Authorities

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

Secondary Authorities

unofficial sources of law that interpret or explain primary authority (hold significantly less weight in a legal dispute)

Legislative Sources

the U.S. Constitution, the Internal Revenue Code, and tax treaties

Legislative Process for Tax Laws

1. HOR ways and means committee drafts tax bill then HOR votes (if passed, V1 of bill becomes an act)

2. Senate finance committee reviews and modifies act then senate votes (if passed, V2 becomes an act)

3. Both versions of act sent to Joint conference committee who resolves differences and sends back to HOR and Senate (if passed in each chamber, sent to president)

4. President can sign into law or vetoes the law

Judicial Sources

courts who interpret and apply the law

Types of federal courts

1. trial courts (district courts, tax court, court of federal claims)

2. US Circuit Courts

3. US Supreme court

Court Precedent

Supreme Court > Circuit Courts > Trial Courts

Golson rule

US tax court will follow the rulings of the circuit court that has appellate jurisdiction for the case

Administrative Sources

comes from US Treasury (regulations, revenue rulings, and revenue procedures)