chapter 01 introduction to taxation, the income tax formula, and form 1040ez “taxes, after all,...

Chapter 01 Chapter 01

Introduction to Taxation, the Income

Tax Formula, and Form 1040EZ

“Taxes, after all, are dues that we pay for the privileges of membership in an organized

society.” -- Franklin D. Roosevelt

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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IntroductionIntroduction

• An income tax was first enacted in 1861 and repealed after the Civil War ended

• An income tax law was passed in 1894 and was rejected by the Supreme Court in 1895.

• Sixteenth Amendment to the Constitution was passed in 1913– This is the basis of modern income tax law

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IntroductionIntroduction

• About 142.5 million individual income tax returns are filed annually– Almost 67% are filed electronically

• Individual income tax collections were about $1 trillion in 2008.

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LO #1 Progressive, proportional, and regressive tax structures


• Taxes are levied by multiplying a tax rate (the rate of tax) by a tax base (the amount taxed).– May be multiple rates on multiple bases

(see Table 1-2 for married taxpayers)

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• Progressive tax structure: – The tax rate increases as the tax base

increases.– Example is the U.S. income tax system

• Proportional tax structure: – The tax rate remains the same regardless

of the tax base.– Example is state or local sales taxes

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• Regressive tax structure: – The tax rate decreases as the tax base

increases.– Example is social security tax system

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LO # 2 Marginal and Average Tax Rates

LO # 2 Marginal and Average Tax Rates

• Average tax rate is the total tax paid on a certain amount of taxable incomeTotal tax / taxable income = average tax rate

• Marginal tax rates are the rate of tax that will be paid on the next dollar of income.– Determined with reference to tax rate

schedule– For example, a married couple will pay a

marginal rate of 15% on their $35,000th dollar of income.

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LO # 2 The Income Tax FormulaLO # 2 The Income Tax Formula

Income − Permitted Deductions from Income -------------------------------- = Taxable Income × Appropriate Tax Rates--------------------------------= Tax Liability− Tax Payments and Tax Credits---------------------------------= Tax Refund or Tax Due with Return

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LO #3 Components of Form 1040EZLO #3 Components of Form 1040EZ

• Taxpayers annually file a tax return using – Form 1040– Form 1040A– Form 1040EZ

• All follow the basic income tax formula

• Form 1040EZ is the simplest form

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• To use a 1040EZ taxpayer must meet all:– Single or married filing jointly – Under age 65 and not blind– No dependents– Taxable income < $100,000– Income only from wages, unemployment

compensation or interest ≤ $1,500– Claim no credits except EIC

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• Wages include salaries, tips, commissions, bonuses, severance pay, sick pay, meals and lodging, fringe benefits, etc.– Employees receive a Form W-2 indicating

total wage income in box 1

• Interest income is taxable unless specifically exempt – Interest income reported on Form 1099-INT

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• Unemployment compensation is taxable– Reported on Form 1099-G

• Permitted deductions are shown on line 5– $9,500 for single, $19,000 for married

• Total income minus permitted deductions equal Taxable Income (line 6)

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LO #4 Calculation of TaxLO #4 Calculation of Tax

• For taxable income up to $100,000, use tax tables (printed in Appendix D)

• Tax rate schedules used for higher income (printed on inside front cover)

• Tax tables calculate tax at the midpoint of the range on the table

• Tax rate schedules calculate tax precisely

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LO #3 Tax PaymentsLO #3 Tax Payments

• Tax liability is generally paid throughout the year through withholding tax payments deducted from wages– Also reported on W-2

• Low income taxpayers may be eligible for the Earned Income Credit– Discussed in chapter 9 with other credits

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LO #3 Tax PaymentsLO #3 Tax Payments

• A tax return is also used to “settle up” with the IRS at the end of the year.

• When filing a tax return, taxpayers will either – Owe the IRS (tax liability > payments)– Receive a refund (tax liability < payments)

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LO #5 Tax AuthorityLO #5 Tax Authority

• Tax authority is the body of law, regulation, and precedent that guide taxpayers, the IRS, and the courts in the proper application of tax law.

• Three types of primary tax authority:– Statutory sources– Administrative sources– Judicial sources

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• Statutory sources of tax authority– 16th amendment to the U.S. Constitution– Internal Revenue Code (IRC)

• Passed by Congress and signed into law by the president

– Committee reports from tax law process

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• Administrative sources of tax authority, in order of strength– Treasury Regulations (IRS Regulations)– Revenue Rulings– Revenue Procedures– Private Letter Rulings– IRS Notices

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• Judicial sources of tax authority– Courts resolve disputes between taxpayers

and the IRS.– Initial court of jurisdiction is either the

• Tax Court• U.S. District Court• U.S. Court of Federal Claims

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• Tax Court and District Court rulings can be appealed to the U.S. Court of Appeals and then to the Supreme Court

• U.S. Court of Federal Claims rulings can be appealed to the U.S. Court of Appeals – Federal Claims and then to the Supreme Court.

chapter 01 introduction to taxation, the income tax formula, and form 1040ez “taxes, after all,...

Documents

rate of tax

income tax formula income

tax credits

tax liability tax payments

tax refund

tax rate decreases

tax rate schedule

individual income tax