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Unit 01. Introduction to TaxationThe first chapter in PAK outlines the basic purposes andprinciples of taxation. This is an overview chapter. Read it with the goal of gaining a broad understanding of tax purposes and principles. Although the history is interesting, for
with the goal of gaining a broad understanding of tax purposes and principles. Although the history is interesting, for our purposes, the sections on tax structure, types of tax, taxadministration, and understating the tax law will be relativelymore important.For efficiency and space reasons textbook examples are notcopied to the slides. Instead, you are asked to study specificexamples in the textbook when you read through the slides atvarious points.
These example-study notes are highlighted in
RED
Outline
History of taxation in the United States Types of tax rate structures Other type of taxes Criteria for a tax structure Objectives of the federal income tax law Objectives of the federal income tax law Entities in the federal income tax system Tax law sources Enactment of tax law Administration of the tax law and tax practice issues Components of a tax practice
History of Taxation Revenue Acts from 1913 to the Present
Early tax rates were relatively low and highexemption levels effectively exempt most of the USpopulation from paying taxes.
In 1939, less than 6% of US population paid a federal income tax.
federal income tax.
Due to need for increased government revenue tofund World War II, tax base was broadened sothat by 1945, 75% of the US population paidfederal income tax.
“Pay as go” withholding was added in 1943.
History of Taxation Revenue Sources
- Figure 1.1. Breakdown of Federal Revenues:1960-
Two Basic Components of TaxStructures
Tax base:^
The amount to which tax rate is applied to determinethe tax due. Example: taxable income
Tax rate:^
The percentage rate applied to the tax base
Types of Tax Rate Structures Individual Income Tax Rates for 2009
For 2009 thefederal income taxrate begins at 10%to increase to 15%,25%, 28%, 33%,and 35%. Fordetails see the inside front cover of inside front cover of the PAK textbook, orvisit IRS website at http://www.irs.gov/ pub/irs- pdf/i1040tt.pdf The two tables onthe right show thetax rates for twofiling statuses asexamples.
Types of Tax Rate Structures Marginal, Average, and Effective Tax Rates
Marginal tax rate – most useful rate in tax planning^
Tax rate applied to incremental amount of taxable income that isadded to tax base.
Study Example 1-4 on Page 1-
Average tax rate^
Total tax liability divided by amount of taxable income
Study Example 1
5 on Page 1
Effective tax rate
Study Example 1
5 on Page 1
Effective tax rate^
Total tax liability divided by total economic income
Study Example 1-5 on Page 1-
The marginal, average, and effective tax rates mayvary significantly from the nominal schedule rates.^
For example, even though the nominal maximum individualrate is 35%, the marginal rate will be increased by anyphase-out of exemptions or itemized deductions.
Types of Tax Rate Structures Determination of Taxable Income and Tax Due
Taxable income for all typesof taxpayers is calculatedby subtracting allowableexclusions, deductions, andexemptions from total income. The tax or refund due is
Gross Income -
Deductions
for
AGI
= AGI - Deductions
from
AGI
Taxable Income
income. The tax or refund due is calculated by subtractingallowable credits and/orprepayments from the grosstax liability resulting fromapplying applicable taxrates times taxable income.
Taxable Income
x
Individual Tax Rate
Gross Tax Due
-^
Credits & Payments
Tax or Refund Due
Criteria for a Tax Structure How to judge whether a tax structure is “good”? Equity: How fair is the tax structure? Problem: Fairness is very subjective!^ Vertical equity: Taxpayers who are not situated similarly should be treateddifferently. Horizontal equity: Similarly situated taxpayers should be treated the same. Certainty^ Stable source of government revenues Amount of liability for taxpayers Amount of liability for taxpayers Convenience - Easily assessed, collected, and administered Economy^ Minimal compliance and administration costs Businesses spent $148B to comply with federal tax law and $80B to comply with state and local taxes Cost to individuals $111B Simplicity - Should not be overly complex
Objectives of Federal Income Tax Law Economic Objectives:^
Raise Revenues for Government Operations
Stimulate Private Investment
Reduce Unemployment
Mitigate Effects on Inflation
Social Objectives:
Social Objectives:^
Encouragement of certain activities and industries^
Encourage corporate research activities by tax write-offs Encourage charitable contributions (tax deductible) Study Example 1-11 on Page 1- Income tax reform proposals (Advisory Panel Report in2005)^
Simplified Income Tax Plan (SITP)
Growth and Investment Tax Plan (GITP)
Entities in Federal Income Tax System Flow-Through Entities
Flow-through entities: Do no directly pay income tax^
Sole proprietorship (Also known as a Schedule C business).^ Business income earned by the proprietor is reported on Schedule C ofhis/her individual income return. Partnerships^ Study Example1-17 and Example -18 on Page 1- S Corporations S Corporations^ Study Example 1-19 and Example 1-20 on Page 1- LLC (Limited Liability Company)^ Study Example 1-21 on Page 1- LLP (Limited Liability Partnership)^ Study Example 1-22 on Page 1- Trusts and estates to the extent the trust’s or estate’s income is distributed(Example I: 1-23)
Entities in Federal Income Tax System Flow-Through Entities
Flow-through entities: Do no directly pay income tax^
Sole proprietorship (Also known as a Schedule C business).^ Business income earned by the proprietor is reported on Schedule C ofhis/her individual income return. Partnerships^ Study Example1-17 and Example -18 on Page 1- S Corporations S Corporations^ Study Example 1-19 and Example 1-20 on Page 1- LLC (Limited Liability Company)^ Study Example 1-21 on Page 1- LLP (Limited Liability Partnership)^ Study Example 1-22 on Page 1- Trusts and estates to the extent the trust’s or estate’s income is distributed(Example I: 1-23)
