C237 Taxation I

Internal Revenue Code of 1986

(main authority) - the codified tax laws of the United States. Although the Code is frequently revised, there have been only three different codes since the Code was created in 1939 (IRC of 1939, 1954, and 1986 -current tax code) THE CODE - a reference guide for all things TAX- changed every year, but created/overhauled only 3 times total.

Last real revamp of the tax code? **KNOW DATE FOR TEST**

- 1986 (tax version we currently use) - this is the current version on the code (modified yearly)

____________ represents 56.5% of all revenues collected in the US 47.3% on ______ 9.2% on ______

- income taxes - individuals - corporations

What are the types of Federal taxes?

- income taxes - employment (FICA) - excise taxes (gasoline, telephone) - transfer taxes

Tax professionals are subject to various statutes, rules, and codes of conduct. What are the main ones?

1. AICPA code of professional conduct 2. AICPA statements on standards for tax services 3. IRS's circular 230 4. State board of accountancy statutes

Medicare Tax

1.45% (each) +.9% for 200K + income (125K married filling separately, 250K filing jointly - pays for medical insurance for elderly or disabled

What are the Income Effect and Substitution Effects under the DYNAMIC form of revenue forecasting?

2 basic Tax payer responses to tax increase. Income effect: as tax rate goes up, people will work harder/ more to maintain same after-tax income Substitution effect: as tax rate goes up, people will substitute non-taxable activities because the marginal value of taxable ones has decreased

Revenue Rulings and Revenue Procedures

2nd in administrative authoritative weight after regulations for tax prep issues Revenue Rulings: (Binding until revoked or modified by IRS) address the specific application of the Code and regulations to a more detailed interpretation of specific factual situation/pattern. Revenue rulings have the same authoritative weight as revenue procedures. (prepaid interest deductions) Revenue Procedures: Issued by the national office of the IRS are much more detailed than regulations and explain in greater detail IRS practice and procedures in administering the tax law. Same authoritative weight as Revenue rulings. (ex. specific depreciation for depreciable assets) - published in the cumulative bulletin

IRS Letters

30-day - IRS letter after the audit that instructs the tax payer that he or she has 30 days to 1. request conference with an appeals officer (870 form signed when agreement reached) 2. Agree to the proposed adjustment 3. do Nothing 90-day - after 30-day letter, explains the tax payer has 90 days to 1. pay proposed deficiency 2. file a petition in the U.S. Tax Court to hear the case. (90-day letter aka statutory notice of deficiency)

Estate Tax

A "death tax" paid on total wealth (during person's life and death), collected after a person has died (for the estate) Rules 1. Property valued at its fair market value (FMV) on the date of death OR value 6 months after the date of death as long as the FMV has greatly diminished in that time. 2. Property transferred to spouses are exempt 3. Properties valued at less than 5,430,000 at the donors time of death are exempt.

Writ of Certiorari

A document filed (by losing party) to request the Supreme Court to hear a case.

Value-added tax (VAT)

A tax imposed on the producer of goods (and services) based on the value added to the goods (services) at each stage of production. Value-added taxes are common in Europe (type of sales tax)

Use Tax

A tax imposed on the retail price of goods owned, possessed, or consumed within a state that were not purchased within the state. (purchasing out of state, pay tax for own state - get a credit so not double taxed) enforced on car purchases at registration. Internet sales

Sales Taxes

A tax imposed on the retail price of tangible goods (plus certain services). Retailers are responsible for collecting and remitting the tax; typically sales tax is collected at the point of sale. *Sales tax not deductible on fed/income tax *Some states have no sales tax * Some food/ meds are exempt Cost of goods x tax base

What are the two types of tax services used in tax research and how are they arranged?

Annotated: a tax service (database) arranged by code section. Code, congressional committee reports, history, unofficial explanation, court cases, regulations and brief summaries (called annotations) of relevant authorities for each section RIA's Checkpoint and CCH's Tax Research Network Topical: Arrange by topics (ex. deductions for foreign adoptions) Easier to read than annotated

Flat tax vs Graduated tax

Flat tax (aka proportional tax) - A single tax rate applied through the tax base - Same rate for all taxpayers regardless of their income (sales tax) Graduated tax taxes in which the tax base is divided into a series of monetary amounts, or brackets, where each successive bracket is taxed at a different (gradually higher or lower) percentage rate. (e.g. income tax)

Tax Research

Is the process of applying tax law to a client's set of facts. Used to identify and analyze tax authorities to answer tax questions to find the best solution on a proposed or completed transaction 1. understand facts 2. identify issues (legal) 3. locate relevant authorities (code, court cases, letters, etc) 4. analyze tax authorities 5. document and communicate the results

acquiescence or nonacquiescence

Less common than above - issued sometimes when the IRS loses a case. acq: a written issuance IRS deciding to follow the court's adverse ruling in similar cases the future. Not that the IRS agrees but that they won't litigate this issue. nonacq: IRS decides to continue to litigate this issue for future cases and won't follow the ruling Nationwide. Action on decision: IRS pronouncement that explains the background reasoning behind an IRS acq/nonacq

Stare Decisis

Let the decision stand; decisions are based on precedents from decisions from previous cases or higher courts, unless decision is overturned

Tax Rate structures

Marginal average Average effective Types of taxes proportional, progressive, regressive

What is QBI - Qualified Business Income

Net business income from a qualified trade or business conducted in the United States. This is the tax base for the deductions for QBI Allows for up to 20% deduction of net business income for flow-through entities Deduction = Qualified business income x 20%

Three Legislative (highest authority) or statutory tax authorities

U.S. Constitution - Highest authority in the U.S. - little info on tax except 16th amendment Internal Revenue Code of 1986 Tax Treaties - agreements negotiated between countries that describe the tax treatment of entities subject to tax in both countries (U.S. Citizens earning investment income in Spain). The U.S. President has the authority to enter into a tax treaty with another country after receiving the Senate's advice.

Progressive tax rate

imposes an increasing marginal tax rate as the tax base increases eg. federal/state income taxes or gift tax - as income increases the rate also increases Average tax rate < or = to Marginal rate

Implicit vs Explicit Taxes

Implicit (often reduced)- indirect taxes that result from a tax advantage the government grants to certain transactions to satisfy social, economic or other objectives. defined as the reduced before-tax return that a tax-favored asset produces because of its tax advantage status. (income, employment/ unemployment taxes) -gov wants to give a break on something so they favor you doing one thing above something else. (things with a better return on investment) - eg. tax free municipal bonds. - deduct mortgage interest, but housing prices increase Explicit - taxes directly imposed by a government

Identify three types of entities that are subject to taxation in the US

Individuals C Corporations Flow-through entities (Sole Proprietorship, partnerships, S corps, LLC, LP, trusts, self-employed)

simple tax formula

Tax = Tax Base x Tax Rate Tax Base - the item that is being taxed (e.g., purchase price of a good, taxable income, fair market value for a property, etc.). Tax Rate - level of taxes imposed on the tax base and is usually expressed as a percentage

Static vs Dynamic

A type of Sufficiency measurement/ Forecasting Static Forecasting: revenues based on the existing state of transactions while ignoring how taxpayers may alter their activities in response to a tax law change. (could be large discrepancy if tax changes are made) Dynamic Forcasting: attempts to account for the revenues that incorporates into the forecast how taxpayers may alter their activities in response to a tax law change (based on assumptions and cannot guarantee accurate results) *do people change their habits when we raise taxes? Sometimes if incorrectly forecast and the sale of an item actually drops instead of increases then outcome would be opposite desired.

Self-employment Tax

All Social Security (12.4%) and Medicare (2.9%) taxes paid by the self-employed on a taxpayer's net earnings from self-employment. SS. Taxable income cap 118.5K Medicare increases to 3.8 for 200K + income

Proportional tax rate

Also known as a flat tax, imposes a constant tax rate throughout the tax base. Ex. property, franchise, sales, unified transfer tax system (estate), customs, excise

Letter Rulings

Below Revenue in authoritative weight, but more specific. Not used as precedent by taxpayers. Only hold weight for requesting parties Private Letter Rulings: IRS pronouncements in response to a taxpayers request for a ruling on specific issues for the taxpayer. (more common for large tax implications) only carries weight/authority for the requesting taxpayer, not any other taxpayers. (IRS has a list of refuse to rule) Determination Letters: rulings generally not controversial. Example request by an employer for the IRS to rule that the taxpayer's retirement plan is a "qualified plan" Technical advice memorandums: Generated for a completed transaction. Requested by an IRS agent by the national office usually during an audit. *guidance about the tax treatment being audited.

Real vs personal property taxes

Both collected annually based on the fair market value of... Real Property - f land and structures, and improvements permanently attached to land. Can't move. Personal Property - all types of tangible (cars, boats, private planes, business inventory, equipment, and furniture) and intangible (stocks, bonds, intellectual) property, except real property.

Adam Smith's 4 Cannons of Taxation

Criteria used to evaluate tax systems. 1. Equity 2. Certainty 3. Convenience 4. Economy & Simplicity

Computer programs used to audit tax returns

DIF (Discriminant Function) system - assigns a score to each tax return that represents the probability that the tax liability on the return has been underreported (a higher score = higher likelihood.) - looks at similar attributes from historical tax filings *Most important system document perfection program - all returns are checked for mathematical and tax calculation errors information matching program - compares info from other taxpayers (banks, employers, mutual funds, mortgages)

Statements on Standards for Tax Services (SSTS)

Ethical guidelines of the AICPA- Federal Tax Division for CPSs to promote high standards of tax practice 1. Tax Return Positions 2. Answer Questions on Returns 3. Certain procedural aspects of preparing Returns (rely on paperwork supplied) 4. Use of Estimates 5. Departure from previously concluded position if follows No.1 6. Advise promptly on errors found 7. For/ Content of Advice to Taxpayers

Courts that hear tax cases

For litigated cases tax payer must pay deficiency first and then request a refund, then sue and go to one of these courts. costly financially and emotionally so should be used as a last resort one of three trial-level courts. District Court: local court. It is the only court that allows a jury trial. There is at least one district court in each state. ( better for emotional pleas) Court of Federal Claims: It is a national court that only hears monetary claims against the federal government Circuit Court: (see below) U.S. Supreme Court: Highest court (precedence over all others) - Last chance for an appeal. Only hears a few tax cases a year. Only those of great significance so litigation ends at circuit court

Horizontal vs Vertical Equity

Horizontal equity is achieved if taxpayers in similar situations pay the same tax. (lots of exceptions - due to tax preferences salary vs tax-exempt investment, farmland vs buildings, more charity...) Vertical equity is achieved when taxpayers with "greater ability to pay" tax, pay more tax relative to taxpayers with a lesser ability to pay tax (wealthy). Some argue this should mean a higher tax rate while others argue for a flat tax.

Equity

How the tax burden should be distributed across tax payers. Is it fair to all? A tax system is considered fair or equitable if the tax is based on the taxpayer's ability to pay; taxpayers with a greater ability to pay tax, pay more tax.

U.S. Circuit Court of Appeals

If you don't like the result from other court rulings There are 13 U.S. Circuit Courts of Appeal; one for the Federal Circuit and 12 assigned to hear cases that originate from a specific circuit

What is the IRS Appeals and Litigation process?

Image IRS Exam

Two broad categories of tax authorities (sources)

Primary - Official sources of the tax law generated by legislative branch highest ruling authority (statutory authority issued by Congress - for research, planning, and compliance activities - Internal Revenue Code, Congressional Committee Reports Tax Treaty Regulations, Treasure Regulations) judicial branch (rulings by the Court decisions "law of the land" (courts listed above), executive/ administrative branch (*Treasury Regulations or IRS pronouncements - [1. Income Tax Regulations. 2. Revenue Rulings, 3. Revenue Procedures, 4. Letter Rulings] no authority since interpretive) Secondary - unofficial tax authorities that interpret and explain the primary authorities, - tax research services - tax articles - newsletters - textbooks. Secondary authorities may be very helpful in understanding a tax issue, but they hold little weight in a tax dispute.

Circular 230

Regulations governing the practice of attorneys, certified public accountants, enrolled agents, enrolled actuaries, and appraisers before the IRS. (who, what, how) lots of overlap with SSTS

Income Tax Formula

S-(S*t) or S(1-t) All sources of income - exclusions = gross income - deductions for AGI = AGI (Adjusted Gross Income) - deductions from AGI (exemptions & deductions) = taxable income x tax rate (from table) = gross tax - credits - prepayments = net tax payable or refund due

substantial authority

Standard to determine whether a tax practitioner may recommend and a taxpayer may take a tax return position with out being subject to IRS penalty and if it will hold up in an audit or litigation

State and Local Taxes

State = A tax imposed by one of the 50 U.S. states. Local = taxes imposed by local governments (cities, counties, school districts, etc.) State & Local Taxes - Sales/use - Property - Income - Excise (cigs/alcohol)

Employment Taxes.

Taxes consisting of the Old Age, Survivors, and Disability Insurance (OASDI) tax, commonly called the Social Security tax, and the Medical Health Insurance (MHI) tax known as the Medicare tax. 1. Social security/medicare Aka "FICA tax" or Federal Insurance Contribution Act 2. Federal and State unemployment Compensation Tax 2nd largest group of taxes imposed by US gov't.

Regulations

The treasury department's official interpretation of the IRC and are the highest authority issued by the IRS. 3 forms of Regulations Final -issued in final form, and until revoked represent the Treasury's interpretation of the code. Temporary - limited life (3 yrs for those issued after Nov 1988) Proposed - not in use, or carry weight. Issued to allow public to comment on them before becoming temporary or final.

For voiding Estate and Gift Taxes, what is the current amount they will exempt up to?

Up to $11.2M for 2018

U.S. Tax Court

a national court that only hears tax cases and where the judges are tax experts. The U.S. Tax Court is the only court that allows tax cases to be heard before the taxpayer pays the disputed liability and the only court with a small claims division (hearing claims involving disputed liabilities of $50,000 or less).

Tax. (CHAPTER 1)

a payment required by a government that is unrelated to any specific benefit or service received from the government 3 Criteria Payment must be *Required (not INVOLUNTARY) *Imposed by a government agency (federal, state, local) *Not tied directly to the benefit received by the taxpayer - Continuous debate whom to tax, what to tax, how much to tax

Citator

a research tool that allows one to check the status of several types of tax authorities. A citator can be used to review the history of the case to find out, for example, whether it was subsequently appealed and overturned, and to identify subsequent cases that cite the case. Citators can also be used to check the status of revenue rulings, revenue procedures, and other IRS pronouncements. Favorable rulings strengthen a case

Sufficiency**

a standard for evaluating a good tax system. Sufficiency is defined as assessing the aggregate size of the tax revenues that must be generated and ensuring that the tax system provides these revenues. Does tax bring in enough money for gov spending, defense, social services, etc A type of revenue forecasting *hard to estimate (forecast) with a rise/ change in gov spending.

income tax ***KNOW DATES FOR TEST***

a tax in which the tax base is income. income taxes are imposted by the federal government and by most states (most significant U.S. tax- 47.3% of all taxes collected in 2016) First income tax: 1861 to fund Civil War - expired in 1872 1892 - income tax resurrected - but ruled unconstitutional in Pollock v. Farmer's Loan & Trust Co in 1895 - because it must be uniform across all states Feb 1913 - 16th amendment - says, congress should have power to collect taxes on INCOME, without apportionment among the several states and without regard to any census or enumeration

Convenience

a tax system should be designed to facilitate the collection of tax revenues without undue hardship on the taxpayer or the government. =how easily assessed collected and administered (Estimated tax due April 15, June 15, Sept 15, and Jan 15)

Economy

a tax system should minimize its compliance and administration costs associated with the tax system. (How much does it cost how much does it cost to comply with the tax system Ex. The IRS collection costs amount to <0.5% of revenues Gov = good Individual = bad (record-keeping, accountant fees, attorney, tax system changes, etc) Simplicity - No undue complexity, easy to understand and comply (federal income tax does not meet this criteria)

Three types of IRS audits

correspondence examinations - (mail) most common type - request for more documentation, limited to 1-2 items, little guy office examinations (local IRS office) - more complex - small businesses, sole proprietorships, mid-high income (can bring tax adviser or attorney) field examinations - at taxpayer's place of business - mostly for business returns or complex individual returns - many items are examined can go on for months - years

Regressive tax rate

decreasing marginal tax rate as tax base increases. eg. Social Security tax (FICA) and federal and state unemployment taxes (sales tax is regressive in terms of effective rate. - the more you make, the less you pay in tax)

three basic purposes of Treasury regulations

interpretative - Treasury's interpretation of the Code and are issued under the treasury's general authority to interpret the Code. procedural -Treasury Department procedures as they relate to administering the Code. Example Statute of limitations for IRS assessment and collection legislative -(least common) issued when Congress specifically directs the Treasury Department to create regulations to address an issue in the are of law. In these instances, the Treasury is actually writing the law instead of interpreting the Code. Because legislative regulations actually represent tax law instead of an interpretation of interpretation so have more authoritative weight than the other regulations. Difficult to challenge these

Civil Penalties

monetary penalties imposed when tax practitioners or taxpayers violate tax statutes without reasonable cause—for example, as the result of negligence, intentional disregard of pertinent rules, willful disobedience, or outright fraud. Penalties No penalty if no tax is due Failure to File - 5% monthly up to 25% for late filing Failure to pay - .5% to 1% per month - taxes due, filed but not paid Inaccuracy - 20% on underpayment or understatement of items and income Fraud - 75%

Criminal Penalties

much less common than civil penalties Penalties are much higher and can include prison sentences, high fines (tax evasion, intent to defraud the government)

Question of fact vs. question of law

of fact: hinges upon the facts and circumstances of the taxpayer's transactions (business expense - ordinary, necessary, reasonable) of law: hinges upon the interpretation of the law, such as interpreting a particular phrase in a code section

Administrative Sources

regulations, revenue rulings, revenue procedures, letter rulings

Average Tax Rate (ATR)

represents a taxpayer's average level of taxation on each dollar of taxable income (used to determine what percent of taxable income earned is paid in tax) ATR = Total tax/ Taxable income

Gift Taxes

tax paid on a gift (charged immediately) levied on the giver/donor for transfer of property beyond an initial $14,000 (2013-2015) per givee/donee Rules 1. Charitable donations are exempt 2. Transfers between married partners are not subject to this tax 3. Calculated including previous year's taxable gifts (cumulative tax) 4. Donees are contingently liable if the donor does not pay

Earmarked tax

tax that is assessed for a specific purpose (e.g. education)

Ad Valorem Taxes

taxes based on the fair value of property

Sin Tax

taxes imposed on the purchase of goods -e.g., alcohol, tobacco products - that are considered socially less desirable.

Excise Taxes

taxes levied on the retail sale of particular products. They differ from other taxes in that that tax base for an excise tax typically depends on the quantity purchased rather than a monetary amount. *producer pays this tax not customers though it does increase prices on these items E.G. alcohol, diesel fuel, gasoline, tobacco, telephone usage, air transportation, tanning beds.

(Wealth) Transfer Taxes

taxes on the transfer of wealth from one taxpayer to another. The estate & gift taxes are two examples of transfer taxes, computed based on the fair market value of the transferred property.

Certainty

taxpayers should be able to determine when to pay , where to pay , and how much tax to pay Provides taxpayers with some degree of certainty concerning their annual tax liability amount (though income taxes are criticized as being too complex)

Social Security Tax

the Old Age, Survivors, and Disability Insurance (OASDI) Pays the monthly retirement, survivor and disability benefits for qualifying individuals 6.2% x2 = 12.4 (employer/employee) limited amount of wages annually - 128,400 wage cap

Statute of limitations

the period in which the taxpayer can file an amended tax return or the IRS can assess a tax deficiency for a specific tax year. For both amended tax returns filed by a taxpayer and proposed tax assessments by the IRS, the statute of limitations generally ends three years from the later of (1) the date the tax return was actually filed or (2) the tax return's original due date. (After this date, no changes can be made) for fraudulent return or no return - then no Statute of Limitations -used so things don't go on forever -mistakes - incorrect amts reported in favor of either the taxpayer or gov't - extension if taxpayer omits items of gross income exceeding 25%

Golsen Rule

the rule that states that the U.S. Tax Court will abide by the circuit court's rulings that has appellate jurisdiction for a case.

Marginal Tax Rate (MTR)

the tax rate that applies to the next additional increment of a taxpayer's taxable income (or deductions). (FORMULA Pictured) "Old" = current tax "New" = revised tax after incorporating additional income (or deductions) used for income tax it's a graduated tax rate

unemployment Taxes

the tax that pays for temporary unemployment benefits for individuals terminated from their jobs without cause. current rate is 6% though sometimes a gov credit reduces by 6-5.4 = .6%

Effective Tax Rate (ETR)

the taxpayer's average rate of taxation on each dollar of total income (both taxable and non-taxable) *Measures tax payer's ability to pay taxes - higher nondeductible = or less than the ATR ETR = Total tax/ total economic income