Chapter 1

National sales tax:

differs from a VAT in that it would be collected on the final sale of goods and services. Consequently, it is collected from the consumer, not from businesses that add value to the product

Realty

generally includes real estate and any capital improvements that are classified as fixtures. Property owned by the Federal government is exempt from tax Some states provide for lower valuations on property dedicated to agricultural use or other special uses Some states partially exempt the homestead, or personal residence, portion of property from taxation. Lower taxes may apply to a residence owned by a taxpayer aged 65 or older. When non-income-producing property (e.g., a personal residence) is converted to income-producing property (e.g., a rental house), typically the appraised value increases. Some jurisdictions extend immunity from tax for a specified period of time (a tax holiday) to new or relocated businesses

Most states allow their residents some form of tax credit for

income taxes paid to other states.

Use tax

is an ad valorem tax, usually at the same rate as the sales tax, on the use, consumption, or storage of tangible property purchased outside the state but used in the state.

Gift taxes

is an excise tax levied on the right to transfer property. In this case, however, the tax is imposed on transfers made during the owner's life and not at death. $14,000 per annual exclusion

Value added taxes

is one of two proposals that would replace the Federal income tax. Under the VAT, a business would pay the tax (approximately 17 percent) on all of the materials and services required to manufacture its product.

Tax Avoidance is

legal form of reducing one's taxes

Ad Valorem

A tax imposed on the value of property. The most familiar ad valorem tax is that imposed by states, counties, and cities on real estate. Ad valorem taxes can, however, be imposed upon personal property

Regressive

social security tax. Not common. Opposite of progressive

Excise tax

A tax on the manufacture, sale, or use of goods or on the carrying on of an occupation or activity. Also, a tax on the transfer of property. Thus, the Federal estate and gift taxes are, theoretically, excise taxes.

The study of taxation is important because

taxes permeate our society

Other Taxes

Federal customs duties Franchise taxes: levied on the right to do business in the state. Occupational fees: A tax imposed on various trades or businesses.

A special agent joins the audit team when

taxpayer fraud is suspected.

An RAR (or Revenue Agent's Report) that results in a "no change" means

that the audit resulted in no additional taxes being due.

The effect of the Sixteenth Amendment to the U.S. Constitution was to validate

the Federal income tax imposed on individuals.

The taxpayer can litigate the case in

the Tax Court, a Federal District Court, or the Court of Federal Claims.

Tax Evasion is

the illegal avoidance form of taxes

A tax is proportional if

the rate of tax remains constant for any given income level. Such as federal excise tax of cigarettes

For state income tax purposes, "piggyback" means

applying a rate to the Federal income tax liability.

A diminishing number of states allow

deduction for Federal income taxes paid.

Personalty

defined as all assets that are not realty. Examples include a residence (realty that is personal use), an office building (realty that is business use), surgical instruments (personalty that is business use), and regular wearing apparel (personalty that is personal use)

Self employee have to pay

ER part and EE part

Statute of Limitation: Claims for refund

3 years from date filed or 2 years from date tax paid

Statute of Limitation: Tax deficiencies

3 years from the later of tax due date or date to file. >25% omission of income 6 years Indefinite if fraudulent or no return

Under the general rule, the IRS may assess an additional tax liability against a taxpayer within

3 years of the filing of the income tax return. If the return is filed early, the three-year period begins to run from the due date of the return (usually April 15 for a calendar-year individual taxpayer). If the taxpayer files the return late (i.e., beyond the due date), the three-year period begins to run on the date filed.

Don't forget the interest and penalties (no interest is allowed if the overpayment is refunded to the taxpayer within

45 days of the date the return is filed

Economy

A good tax system involves only nominal collection costs by the government and minimal compliance costs on the part of the taxpayer.

Certainty

A tax structure is good if the taxpayer can readily predict when, where, and how a tax will be levied. probably generates the greatest controversy.

Sales tax

A transaction tax imposed upon the sale of goods

Convenience

Administrative simplicity has long been valued in formulating tax policy. exists due to a heavy reliance on pay-as-you-go procedures.

A "no change" RAR results

An RAR (or Revenue Agent's report) that results in a "no change" means that the audit resulted in no additional taxes being due.

Tax Rates

What we are given Tax rates are applied to the tax base to determine a taxpayer's liability. The tax rates may be proportional or progressive.

Marvin is the executor and sole heir of his aunt's estate. The estate includes her furnished home, which Marvin is considering converting to rental property to generate additional cash flow.

Any rent Marvin receives from the property is taxed as income. Besides the real estate taxes, personal property taxes could be imposed on the furnishings. Marvin can expect an increase in the ad valorem property taxes levied by the local taxing authorities due to the commercial use of the property.

DIF

Discriminant Index Formulas: It is the DIF score given to a particular return that may lead to its selection for audit

Equality

Each taxpayer enjoys fair or equitable treatment by paying taxes in proportion to his or her income level. Ability to pay a tax is one of the measures of how equitably a tax is distributed among taxpayers. is present as long as one accepts ability to pay as an ingredient of this component.

A tax credit is allowed for amounts spent to furnish care for minor children while the parent works

Economic/Social considerations

Deductions for interest on home mortgage and property taxes on a personal residence:

Economic/Social considerations

Employment Taxes

Employment taxes are those taxes that an employer must pay on account of its employees. Also known as FICA Under 18 exempt: only children under 18 employed in the family's/parent's unincorporated business are exempted from FICA tax. Additional 0.9% > $200,000 Net investment income Tax 3.8% Currently, the FICA tax has two components: Social Security tax (old age, survivors, and disability insurance) and Medicare tax (hospital insurance).

The income-splitting benefits of filing a joint return

Equity and Political considerations

Net operating losses of a current year can be carried back to profitable years:

Equity considerations

Which governmental body administers the tax?

FICA is administered by the Federal government. FUTA, however, is handled by both the Federal and state governments

Upon whom is the tax imposed?

FICA is imposed on both the employer and employee, while FUTA is imposed only on the employer.

Employment Taxes (Unemployment)

FUTA (to provide funds the states can use to administer unemployment benefits) - 5.4% SUTA - may vary

Federal Excise Tax

Federal excise taxes had declined in relative importance until recently. Federal excise taxes on items such as tobacco products, fuel and gasoline sales, and air travel have increased. Some Federal excise taxes try to influence social behavior.

Failure to file (5%)

For failure to file a tax return by the due date (including extension), a penalty of 5 percent per month up to a maximum of 25 percent is imposed on the amount of tax shown as due on the return

1913 - 16th amendment

Government could impose taxes on people. The law allowed various deductions and personal exemptions of $3,000 for a single individual and $4,000 for married taxpayers.

Inheritance

If it taxes the right to receive property from a decedent, it is termed an inheritance tax. Unified transfer credit

Transfer at death. Estate:

If the tax is imposed on the right to pass property at death, it is classified as an estate tax.

Flat tax:

In its pure form, it would replace the graduated income tax rates with a single rate

Field Audit

Least common audit. Will come to the business. Will look at anything. Take long as it take. An audit by the IRS conducted on the business premises of the taxpayer or in the office of the tax practitioner representing the taxpayer.

How are returns selected for Audit?

Mathematical formulas Statistical sampling

Correspondence audit

Most common audit. Resolved by mail. Covers minor issues

What happens after audit

Negotiate through Appeals division The taxpayer can litigate the case in the Tax Court, a Federal District Court, or the Court of Federal Claims. The taxpayer may appeal to the Appeals Division of the IRS The taxpayer may attempt to negotiate a settlement with a higher level of the IRS

Which taxes are reduced based on a merit rating system?

Only FUTA

The exclusion from Federal tax of certain interest income from state and local bonds

Political considerations

The audit is resolved by mail.

Referred to as a correspondence audit, this type of audit covers a minor issue

Office Audit

Second most common. Bring in information to IRS for them to look at. May be more broad. An audit by the IRS of a taxpayer's return that is conducted in the agent's office Restricted in Scope

AICPA also states system should be:

Simple Neutral Clear and understandable Structured to minimize noncompliance Predictable amount and timing

Gambling losses in excess of gambling gains

Social considerations

Litigate

Tax court -> tax experts U.S District Court -> generalists. Possible jury trial U.S Federal claims -> national generalists All the court follows supreme court's rule

AICPA Ethical guidelines

The American Institute of CPAs has issued numerous pronouncements, called the "Statements on Standards for Tax Services," dealing with CPAs engaged in tax practice. Do not take questionable positions on a client's tax return in the hope that the return will not be selected for audit by the IRS. A practitioner can use a client's estimates if they are reasonable under the circumstances Every effort should be made to answer questions appearing on tax returns Upon learning of an error on a past tax return, advise the client to correct it. Do not, however, inform the IRS of the error.

Internal Revenue Service

The responsibility for administering the Federal tax laws rests with the Treasury Department. The IRS is part of the Department of the Treasury and is responsible for enforcing the tax laws. The Commissioner of Internal Revenue is appointed by the President and is responsible for establishing policy and supervising the activities of the IRS.

The income tax return for 2015 was filed on June 25, 2016.

The statute of limitations will begin to run on June 25, 2016.

The income tax return for 2015 was never filed because the taxpayer thought no additional tax was due.

The statute of limitations will not begin to run.

The income tax return for 2015 was prepared on April 4, 2016, but was never filed. Through some misunderstanding between the preparer and the taxpayer, each expected the other to file the return.

The statute of limitations will not begin to run.

How does the pay-as-you-go procedure apply to wage earners?

The tax law requires employers to withhold a specified dollar amount from wages paid to the employee to cover income taxes.

How does the pay-as-you-go procedure apply to persons who have income from sources other than wages?

The tax law requires the taxpayer to make quarterly payments to the IRS for estimated taxes.

The income tax return for 2015 was filed on February 19, 2016

The three-year statute of limitations will begin to run on April 15, 2016.

FICA v.s. FUTA

The two major employment taxes are FICA (Federal Insurance Contributions Act-commonly referred to as the Social Security tax) and FUTA (Federal Unemployment Tax Act). Both taxes can be justified by social and public welfare considerations. FICA is imposed on both the employer and employee, while FUTA is imposed only on the employer. FICA is administered by the Federal government. FUTA, however, is handled by both the Federal and state governments. Only FUTA are reduced based on a merit rating system.

One of the tax advantages of hiring family members to work in your business is that FICA taxes are avoided.

This statement is false because only children under 18 employed in the family's/parent's unincorporated business are exempted from FICA tax.

What is the purpose of the unified transfer tax credit?

To eliminate the tax on modest gifts and estates.

The audit is conducted at the office of the IRS.

Unlike a field audit, which involves an examination of numerous items reported on the return, an office audit is restricted in scope.

In addition to ethical constraints, a tax return preparer may be subject to certain statutorily sanctioned penalties, including the following:

Various penalties involving procedural matters. Penalty for understatement of a tax liability based on a position that lacks any realistic possibility of being sustained. Penalty for any willful attempt to understate taxes Penalty for failure to exercise due diligence in determining eligibility for, or the amount of, an earned income tax credit.

A taxpayer who sells property on an installment basis can recognize gain on the sale over the period the payments are received

Wherewithal to pay concept

Prepaid income is taxed to the recipient in the year received and not in the year earned

Wherewithal to pay concept

Does the use of the credit for a gift affect the amount of credit available for the estate tax?

Yes

Is the same amount available for both the Federal gift tax and the estate tax?

Yes

A tax is progressive if

a higher rate of tax applies as the tax base increases.

The Morgan family lives in Massachusetts. They moor their sailboat in Rhode Island. The Morgan's are trying to avoid

ad valorem tax on personalty

Severance tax

are transaction taxes that are based on the notion that the state has an interest in its natural resources (e.g., oil, gas, iron ore, or coal). Therefore, a tax is imposed when the natural resources are extracted.

Property tax (Ad Valorem)

based on value, property taxes are a tax on wealth, or capital land, house, vehicles, boat, RV

Tax became a thing because

of civil war. An income tax was first enacted in 1634 by the English colonists in the Massachusetts Bay Colony, but the Federal government did not adopt this form of taxation until 1861. In fact, both the Federal Union and the Confederate States of America used the income tax to raise funds to finance the Civil War.

By "decoupling," a state decides not to allow a

particular Federal provision (e.g., exclusion, deduction, credit) for state income tax purposes.

Failure to pay (0.5 %)

penalty for failure to pay the tax due as shown on the return is imposed in the amount of .5 percent per month up to a maximum of 25 percent

The Federal income tax, Federal gift and estate taxes, and most state income tax rate structures are

progressive

Tax Base

what tax calculated on: A tax base is the amount to which the tax rate is applied. tax base is taxable income. taxable income is gross income reduced by certain deductions.

Transaction

which characteristically are imposed at the manufacturer's, wholesaler's, or retailer's level, cover a wide range of transfers