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1-1©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-2
AN INTRODUCTION TO TAXATION (1 of 2)
History of taxationTypes of tax rate structuresOther types of taxesCriteria for a tax structureObjectives of Federal income
tax lawEntities in Federal income tax
system©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-3
AN INTRODUCTION TO TAXATION (2 of 2)
Tax law sourcesEnactment of a tax lawAdministration of the tax law
and tax practice issuesComponents of a tax practiceComputer applications in tax
practice©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-4
History of Taxation
First Federal income tax in 1861Repealed after Civil WarReinstated in 1894Supreme Court ruled
unconstitutional in 189516th Amendment on March 1,
1913Revenue acts prior to
codification in 1939©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-5
Manner in Which Tax Law Is Changed or Modified
Federal income tax is changed on an incremental basis rather than a complete revision
The tax law has been referred to as a quiltwork of tax law
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-6
Revenue Sources
1960 1975 1994 20090%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%IndividualFICACorporateOther
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-7
Types of Tax Rate Structures
Structure of individual income tax rates
Structure of corporate tax ratesMarginal, average, and effective
tax rates for taxpayersDetermination of taxable
income and tax due
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-8
Structure of Individual Income Tax Rates (1 of 2)
Tax BaseAmount to which tax rate is
applied to determine tax dueE.g., individual’s tax base for
Federal income is taxable income, Tax base for property tax generally
FMV of property subject to taxTax Rate
Percentage(s) applied to tax base©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-9
Structure of Individual Income Tax Rates (2 of 2)
ProgressiveRate increases as tax base increasesE.g., individual income tax
Proportional or flat taxE.g., sales tax
RegressiveRate decreases as tax base increasesE.g., FICA tax
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-10
Structure of Corporate Tax Rates(1 of 2)
Stair-step pattern of progressionTends to benefit small
corporationsBenefit of graduated tax rates
phased out between $100K and $335K, and $15M and $18.33M
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-11
Structure of Corporate Tax Rates(2 of 2)
First $50K 15 % of Taxable Inc
> $50K But Not > $75K $7,500 + 25% of Taxable Inc
> $75K But Not > $100K 13,750 + 34% of Taxable Inc > $75K
> $100K But Not > $335K $22,250 + 39% of Taxable Inc > $100K> $335K 34% of Taxable Inc
> $10M But Not > $15M 3.4M + 35% of Taxable Inc > $10M
> $15M But Not > $18,333,333 $5.150M + 38% > $15M
> $18,333,333 35% of Taxable Inc
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-12
Marginal, Average, and Effective Tax Rates for
Taxpayers
Marginal tax rateTax rate applied to incremental
amount of taxable inc that is added to tax base
Average tax rateTotal tax liability divided by amount
of taxable incomeEffective tax rate
Total tax liability divided by total economic income
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-13
Determination of Taxable Income and Tax Due
Gross Income- Deductions for AGI= AGI- Deductions from AGI= Taxable Incomex Individual Tax Rate= Gross Tax Due- Credits & Payments= Tax or Refund Due
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-14
Other Types of TaxesState and local income taxesState and local franchise taxesWealth transfer taxes
Estate tax - Repealed in 2010; likely to be reinstated at 2009 rates
Gift taxOther types of taxes
Prop., excise, sales, & employment taxes
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-15
Criteria for a Tax Structure
(1 of 3)
EquityVertical equityHorizontal equity
CertaintyStable source of gov’t revenuesAmount of liability for taxpayers
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-16
Criteria for a Tax Structure
(2 of 3)
ConvenienceEasily assessed, collected, and
administeredSimplicity
Should not be overly complex
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-17
Criteria for a Tax Structure
(3 of 3)
EconomyMinimal compliance and
administration costsBusinesses spent $148B to
comply with federal tax law and $80B to comply with state and local taxes
Cost to individuals $111B
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-18
Objectives of Federal Income Tax Law
Economic objectivesEncouragement of certain
activities and industriesSocial objectivesIncome tax reform proposals
Simplified Income Tax Plan (SITP)Growth and Investment Tax Plan
(GITP)©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-19
Economic Objectives
Raise Revenues for Government Operations
Stimulate Private InvestmentReduce UnemploymentMitigate Effects on Inflation
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-20
Entities in Federal Income Tax System (1 of 2)
Taxpaying entitiesIndividualsC corporations
Double taxation of C corp earnings
TrustsHybrid entity
May be taxpaying entity or flow-through
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-21
Entities in Federal Income Tax System (2 of 2)
Flow-through entitiesSole proprietorship
Also known as a Schedule C businessPartnershipsS CorporationsLLC (Limited Liability Company)LLP (Limited Liability Partnership)
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-22
Tax Law Sources(1 of 2)
LegislativeInternal Revenue CodeCongressional Committee reports
Executive (administrative)Income tax regulationsRevenue RulingsRevenue ProceduresLetter Rulings
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-23
Tax Law Sources(2 of 2)
JudicialCourt decisions
Trial courtsDistrict Court, Tax Court, U.S. Court of
Federal ClaimsAppeals courts
Circuit CourtsSupreme Court
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-24
Enactment of a Tax Law(1 of 4)
1. House of Representatives responsible for initiating new tax legislation
President may make proposal to Congress with studies on needed tax reform prepared by Treasury
2. Referred to the House Ways and Means Committee (HW&MC)
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-25
Enactment of a Tax Law(2 of 4)
3. Voted on by HW&MC Forwarded to House of
Representatives for a vote if approved by HW&MC
4. Voted on by House of Reps If approved, sent to Senate Finance
Committee (SFC)
5. Voted on by SFC If approved, sent to Senate for a vote Bill may be different than House
version©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-26
Enactment of a Tax Law(3 of 4)
6. Senate considers bill and may add amendments
7. Voted on by Senate If approved, sent to Joint Conference
Committee (JCC) to reconcile bill
8. JCC produces final bill Sent back to House and Senate to
vote on final bill
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-27
Enactment of a Tax Law(4 of 4)
9. If JCC bill approved, sent to President for approval or veto
10. Presidential veto may be overturned by 2/3 vote in both House & Senate
11. Committee reports prepared by staff of HW&MC, SFC, and JCC
©2011 Pearson Education, Inc. Publishing as Prentice Hall
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Administration of the Tax Law and Tax Practice
Issues
Organization of the IRSEnforcement proceduresSelection of returns for auditStatute of limitationsInterestPenaltiesAdministrative appeal
procedures©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-29
Selection of Returns for Audit
Self assessment & voluntary compliance
Discriminant Function System (DIF)DIF system generates “score” for
return based on return for add’l tax revenue
Returns manually screened by IRSDecide which returns to examine
furtherLess than 1% of all individual
returns are selected for examination each year
©2011 Pearson Education, Inc. Publishing as Prentice Hall
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Statute of Limitations
General rule 3 years from later of the date tax return was actually filed or due date
Six years if taxpayer omits items of gross income that in total exceed 25%
Indefinite if fraudulent return filed or no return filed
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-31
Components of a Tax Practice
Tax compliance and procedureTax researchTax planning and consultingFinancial planning
©2011 Pearson Education, Inc. Publishing as Prentice Hall
1-32
Computer Applications in Tax Practice
Tax return preparationTax planning applications
E.g., project depreciationTax research applications
RIA CheckpointCCH Tax Research NetworkIRS web site
©2011 Pearson Education, Inc. Publishing as Prentice Hall
Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark at University of Northern Colorado’s
Kenneth W. Monfort College of [email protected]
1-33©2011 Pearson Education, Inc. Publishing as Prentice Hall