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1-1©2014 Pearson Education, Inc.
An Introduction
to TaxationChapter 1
AN INTRODUCTION TO TAXATION (1 of 2)
History of taxation in the U.S.Types of tax rate structuresOther types of taxesCriteria for a tax structureEntities in federal income tax
systemTax law sources
©2014 Pearson Education, Inc. 1-2
AN INTRODUCTION TO TAXATION (2 of 2)
Enactment of a tax lawAdministration of the tax law
and tax practice issuesComponents of a tax practiceComputer applications in tax
practice©2014 Pearson Education, Inc. 1-3
History of TaxationEarly PeriodsFirst federal income tax in 1861Repealed after Civil WarReinstated in 1894Supreme Court ruled
unconstitutional in 189516th Amendment on March 1,
1913©2014 Pearson Education, Inc. 1-4
History of TaxationRevenue ActsRev. acts prior to codification in
1939How tax law is changed or
modifiedFederal 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
©2014 Pearson Education, Inc. 1-5
History of TaxationRevenue Sources
1960 1975 1994 20120%5%10%15%20%25%30%35%40%45%50%
IndividualFICACorporateOther
©2014 Pearson Education, Inc. 1-6
Types of Tax Rate StructuresStructure of individual
income tax ratesStructure of corporate tax
ratesMarginal, average, and
effective tax rates for taxpayers
Determination of taxable income and tax due
©2014 Pearson Education, Inc. 1-7
[Tax base] x [Tax rate] = Tax dueTax Base
E.g., individual’s tax base for federal income is taxable income,
Tax base for property tax generally FMV of property subject to tax
Tax RatePercentage(s) applied to tax base
Structure of Individual Income Tax Rates (1 of 2)
©2014 Pearson Education, Inc. 1-8
ProgressiveRate increases as tax base increases
E.g., individual income taxProportional or flat tax
E.g., sales taxRegressive
Rate decreases as tax base increasesE.g., FICA tax
Structure of Individual Income Tax Rates (2 of 2)
©2014 Pearson Education, Inc. 1-9
Structure of CorporateIncome 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©2014 Pearson Education, Inc. 1-10
Structure of CorporateIncome Tax Rates (2 of 2)
1-11©2014 Pearson Education, Inc.
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
Marginal, Avg., & Effective Tax Rates for TaxpayersMarginal tax rate
Tax rate applied to incremental amount of taxable inc that is added to tax base
Average tax rate[Total tax liab.] / [Taxable income]
Effective tax rate[Total tax liab.] / [Total economic
inc.] ©2014 Pearson Education, Inc. 1-12
Determination of Taxable Income and Tax DueGross Income
- Deductions for AGI AGI
- Deductions from AGI Taxable Income
x Individual Tax Rate Gross Tax Due
- Credits & Payments Tax or Refund Due
©2014 Pearson Education, Inc. 1-13
Other Types of TaxesState and local taxesState and local franchise taxesWealth transfer taxes
Gift tax – levied on donorEstate tax – levied on decedent’s
estateUnified credit applies to gift & estate
taxOther types of taxes
Prop., excise, sales, & employment taxes
©2014 Pearson Education, Inc. 1-14
Criteria for a Tax Structure (1 of 4)
EquityVertical equityHorizontal equity
CertaintyStable source of government
revenuesAmount of liability for
taxpayers©2014 Pearson Education, Inc. 1-15
ConvenienceEasily assessed, collected, and
administeredSimplicity
Should not be overly complex
©2014 Pearson Education, Inc. 1-16
Criteria for a Tax Structure (2 of 4)
Criteria for a Tax Structure (3 of 4)
EconomyMinimal compliance and
administration costsBusinesses spent (in 2005)
$148B to comply with federal tax law and $80B to comply with state and local taxes
Cost to individuals $111B©2014 Pearson Education, Inc. 1-17
Criteria for a Tax Structure (4 of 4)
Objectives of federal inc. tax lawEconomic objectivesEncouragement of certain
activities and industriesSocial objectivesIncome tax reform proposals
Simplified Income Tax Plan (SITP)Growth and Investment Tax Plan
(GITP) ©2014 Pearson Education, Inc. 1-18
Economic ObjectivesRaise Revenues for Government
OperationsStimulate Private InvestmentReduce UnemploymentMitigate Effects on Inflation
©2014 Pearson Education, Inc. 1-19
Entities in Federal Income Tax System (1 of 2)
Taxpaying entitiesIndividualsC corporations
Double taxation of C corp earningsTrusts
Hybrid entityMay be taxpaying entity or flow-
through©2014 Pearson Education, Inc. 1-20
Entities in Federal Income Tax System (2 of 2)
Flow-through entitiesSole proprietorship
Also known as a Schedule C business
PartnershipsS CorporationsLLC (Limited Liability
Company)LLP (Limited Liability
Partnership)©2014 Pearson Education, Inc. 1-21
Tax Law Sources(1 of 2)
LegislativeInternal Revenue CodeCongressional Committee
reportsExecutive (administrative)
Income tax regulationsRevenue RulingsRevenue ProceduresLetter Rulings©2014 Pearson Education, Inc. 1-22
Tax Law Sources(2 of 2)
JudicialCourt decisions
Trial courtsDistrict Court, Tax Court, U.S. Court
of Federal ClaimsAppeals courts
Circuit CourtsSupreme Court
©2014 Pearson Education, Inc. 1-23
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)©2014 Pearson Education, Inc. 1-24
Enactment of a Tax Law (2 of 4)
3. Voted on by HW&MCForwarded to House of Representatives
for a vote if approved by HW&MC4. Voted on by House of Reps
If approved, sent to Senate Finance Committee (SFC)
5. Voted on by SFCIf approved, sent to Senate for a voteBill may be different than House
version ©2014 Pearson Education, Inc. 1-25
Enactment of a Tax Law (3 of 4)
6. Senate considers bill and may add amendments
7. Voted on by SenateIf approved, sent to Joint
Conference Committee (JCC) to reconcile bill
8. JCC produces final billSent back to House and Senate to
vote on final bill©2014 Pearson Education, Inc. 1-26
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
©2014 Pearson Education, Inc. 1-27
Administration of the Tax Law and Tax Practice IssuesOrganization of the IRSEnforcement proceduresSelection of returns for auditStatute of limitationsInterestPenaltiesAdministrative appeal
procedures©2014 Pearson Education, Inc. 1-28
Selection of Returns for Audit (1 of 2)
Tax system based on self assessment & voluntary complianceEnforcement necessary to
maintain integrity of tax system
©2014 Pearson Education, Inc. 1-29
Selection of Returns for Audit (2 of 2)
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
©2014 Pearson Education, Inc. 1-30
Statute of LimitationsGeneral 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©2014 Pearson Education, Inc. 1-31
Components of a Tax PracticeTax compliance and
procedureTax researchTax planning and consultingFinancial planning
©2014 Pearson Education, Inc. 1-32
Computer Applications in Tax PracticeTax return preparationTax planning applications
E.g., project depreciationTax research applications
RIA CheckpointCCH Tax Research NetworkIRS web site
©2014 Pearson Education, Inc. 1-33
ENDChapter 1
©2014 Pearson Education, Inc. 1-34
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