Taxation of Individuals & Business Entities Chapter 1

regressive tax rate structure

a tax rate structure that imposes a decreasing marginal tax rate as the tax base increases. As the tax base increases, the taxes paid increase, but the marginal tax rate decreases -in the united states, the social security tax and federal and state unemployment taxes deploy a regressive tax rate structure

progressive tax rate structure

a tax rate structure that imposes an increasing marginal tax rate as the base increases. As the tax base increases, both the marginal tax rate and the taxes paid increase -average tax rate in a progressive tax rate structure will always be less than or equal to the marginal tax rate

average tax rate

taxpayer's average level of taxation on each dollar of taxable income =(total tax/taxable income) -useful in budgeting tax expense

effective tax rate

taxpayer's average rate of taxation on each dollar of total income(taxable and nontaxable income) =(total tax/total income) -useful in comparing the relative tad burdens of taxpayers

what is the general purpose of a tax

to fund the operations of the government

substitution effect

one of the two basic responses that a taxpayer may have when taxes increase. The substitute effect predicts that, when taxpayers are taxed more, rather than work more, they will substitutes nontaxable activities (e.g., leisure pursuits) for taxable ones because of the marginal value of taxable activities has decreased

three basic tax rate structures

proportional, progressive, regressive

local taxes

taxes imposed by local governments (cities, counties, school districts, etc.)

graduated taxes

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 gradually lower) percentage rate

medicare tax

the Medical Health Insurance (MHI) tax. This tax helps pay medical costs for qualifying individuals. The Medicare tax rate for employees is 1.45% on salary or wages. An additional Medicare tax of .9 percent is assess on employees (not employers) on salary or wages in excess of $200,000 ($125,000 for married filing separate; $250,000 of combined salary or wages for married filing joint). Self-employed taxpayers pay both the employee and employer Medicare tax and additional Medicare tax.

self-employment taxes

social security and medicare taxes paid by the self-employed on a taxpayer's net earnings from self-employment. For self-employed taxpayers, the terms "self-employment tax" and "FICA tax" are synonomous

tax equals the tax base multiplied by the tax rate

tax = tax base * tax rate

Bill and Meredes file a joint tax return. They have $160,000 of taxable income this year (after all tax deductions). Assuming the following federal tax rate schedule applies, how much federal income tax will they owe this year?

tax bracket is $9,086 at 22% of taxable income in excess of $78,950 Bill and Mercedes will owe $26,917 computed as = $9,086 + 22% (160,000-78,950)

value added tax

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

estate tax

tax paid for an estate -death tax -based on fair market values of wealth transfers made upon death or by gift

gift tax

tax paid on a gift -based on fair market values of wealth transfers made upon death of by gift

explicit taxes

taxes directly imposed by a government -easily quantified

excise taxes

taxes levied on the retail sale of particular products. They differ from other taxes in that the tax base for an excise tax typically depends on the quantity purchased rather than a monetary amount. -transactions subject to state excise tax: alcohol, diesel fuel, gasoline, tobacco products, and television services

income tax

a tax in which the tax base is income. Income taxes are imposed by the federal government and by most states

transfer taxes

taxes on the transfer of wealth from one taxpayer to another. The estate and gift taxes are two examples of transfer taxes.

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.

flat tax

a single tax applied to an entire base

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

bracket

a subset (or portion) of the tax base subject to a specific tax rate. Brackets are common to graduated taxes

state tax

a tax imposed by one of the 50 U.S. states.

tax base

defines what is actually taxed and is usually expressed in monetary terms

tax rate

determines the level of taxes imposed on the tax base and is usually expressed as a percentage

proportional tax rate structure

also known as a flat tax, this tax rate structure imposes a constant tax rate throughout the tax base. As the tax base increases, the taxes paid increase proportionally.

tax-favored

an asset is said to be tax-favored when the income the asst produces is either excluded from the tax base or subject to a lower (preferential) tax rate, or if the asset generates some other tax benefit such as large tax deductions. -results in higher after-tax profits (or lower after-tax costs)

ad valorem tax

tax based on the value of property

key components of the definition of a tax are the payment is:

-required (it is not voluntary) -imposed by a government agency (federal, state, or local) -not tied directly to the benefit received by the taxpayer

not horizontally equitable

-same income will not pay the same federal income tax if one individual's income was earned as salary and the other individual income was tax-exempt municipal bond interest income, dividend income, or capital gains income -same dollar amount of purchases will not pay the same sales tax if one buys a higher portion of goods that are subject to a lower sales tax rate, such as groceries -real estate of the same value will not pay the same property tax if one individual owns farmland, which is subject to a lower property tax rate -estates of the same value will not pay the same estate tax if one individual bequeaths more of her property to charity or a spouse, because these transfers are not subject to estate tax

effective tax rate vs average tax rate

-the effective tax rate will always be equal to or less than the average tax rate -when a taxpayer has no nontaxable income the effective and average tax rates will be equal, but anytime a taxpayer has nontaxable income the effective tax rate will be less than the average tax rate

sales tax

a tax imposed on the retail price of goods (plus certain services). Retailers are responsible for collecting and remitting the tax; typically sales tax is collected at the point of sale -the tax base is the retail price of goods and some services

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 -the tax base is the retail price of goods owned, possessed, or consumed within a state that were not purchased within the state -used to discourage taxpayers from buying goods out of state, removes any competitive disadvantage a retailer may incur form operating in a state with high sales tax

personal property tax

a tax on the fair market value of all types of tangible property, except real property -both tangible and intangible -tangible personal property: automobiles, boats, private planes, business inventory, equipment and furniture -intangible personal property: stocks, bonds, and intellectual property

real property tax

a tax on the fair market value of land and structure permanently attached to land -land, structure, and improvements permanently attached to land

earmarked tax

a tax that is assessed for a specific purpose -the payment made by the taxpayer does not directly relate to the specific benefit received by the taxpayer

Which of the following common decisions would most likely NOT be influenced by the United States income tax laws?

choosing a vacation location

sin taxes

impose relatively high surcharges on alcohol and tobacco products

common state and local taxes

income taxes, sales and use taxes, excise taxes, property taxes

implicit taxes

indirect taxes that result from a tax advantage the government grants to certain transactions to satisfy social, economic, or other objectives. They are defined as the reduced before-tax return that a tax-favored asset produces because of its tax-advantage status

tax

is a payment required by a government that is unrelated to any specific benefit or service received from the government -fund operations of the government (raise revenue) -not intended to punish or prevent illegal behavior -encourages charitable contributions, retirement savings, and research and development

equity

one of the criteria used to evaluate a tax system. 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.

certainty

one of the criteria used to evaluate tax systems. Certainty means taxpayers should be able to determine when, where, and how much tax to pay

Conveneince

one of the criteria used to evaluate tax systems. Convenience means a tax system should be designed to facilitate the collection of tax revenues without undue hardship on the taxpayer or the government

economy

one of the criteria used to evaluate tax systems. Economy means a tax system should minimize its compliance and administration costs

horizontal equity

one of the dimensions of equity. Horizontal equity is achieved if taxpayers in similar situations pay the same tax

vertical equity

one of the dimensions of equity. 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

income effect

one of the two basic responses that a taxpayer may have when taxes increase. The income effect predicts that when taxpayers are taxed more (e.g., tax rate increases from 25 to 28 percent), they will work harder to generate the same after-tax dollars

social security tax

the Old Age, Survivors, and Disability Insurance (OASDI) tax. The tax is intended to provide basic pension coverage for the retired and disabled. Employees pay Social Security tax at a rate of 6.2% on the wage base (employers also pay 6.2%). Self-employed taxpayers are subject to a Social Security tax at a rate of 12.4% on their net earnings from self-employment. The base on which Social Security taxes are paid is limited to an annually determined amount of wages and/or net earnings from self-employment.

static forecasting

the process of forecasting tax revenues based on the existing state of transactions while ignoring how taxpayers may alter their activities in response to a tax law change

dynamic forecasting

the process of forecasting tax revenues that incorporates into the forecast how taxpayers may alter their activities in response to a tax law change

marginal tax rate

the tax rate that applies to the next additional increment of a taxpayers taxable income (or deductions). =(change in tax/change in taxable income) -useful in tax planning

unemployment tax

the tax that pays for temporary benefits for individuals terminated from their jobs without cause