Federal Taxation: Ch. 1
Arno and Bridgette are married and have combined W-2 income of $68,292. They received a refund of $197 when they filed their taxes. How much income tax did their employers withhold during the year? a. $6,406. b. $6,209. c. $6,012. d. The answer cannot be determined with the information provided.
Answer: a Feedback: Subtract $20,700 permitted deduction from W-2 income to get taxable income which is used for the tax tables. After determining total tax liability of $6,209, add $197 to get withholding.
Wanda and Austin are under the age of 65 and they file their tax return as married filing jointly. They had qualifying health coverage for three months during 2016. They were not eligible for an exemption. Their household income was $80,860. What is the amount of shared responsibility payment they must report on their 2016 income tax return? a. $1,128.00 b. $1,390.00 c. $1,504.00 d. $2,021.50
Answer: a Feedback: The ANNUAL payment is the greater of • [$80,860 - $20,700] X .025 = $1,504 • $695 X 2 = $1,390 Since Wanda and Austin had coverage for 3 months, they only owe the shared responsibility payment for 9 months. Thus, the $1,504 annual amount is multiplied by 9/12 to arrive at the correct answer of $1,128.
Who must obtain a preparer tax identification number?
Any paid preparer must obtain a preparer tax identification number. A paid preparer is someone who, for compensation, prepares all or substantially all of a tax return or tax form submitted to the IRS or a claim for refund.
What is meant by compensation for services? Give some examples.
Compensation for services is the broad category used by the IRS to encompass all forms of economic benefit a taxpayer may receive as a result of an employee/employer arrangement. Examples are: wages, salaries, tips, sick pay, bonuses, fringe benefits, commissions, etc.
Explain how to calculate the shared responsibility payment under the Affordable Care Act.
If a taxpayer does not have qualifying health care coverage and does not qualify for an exemption, the taxpayer must make a shared responsibility payment. The payment is calculated as the greater of the following: • 2.5% of household income that is greater than the tax return filing threshold or • $695 per adult and $347.50 per child with a family maximum of $2,085.
(Introduction) For tax year 2014, what proportion of individual income tax returns was filed on a Form 1040EZ, Form 1040A and Form 1040? What proportion was electronically filed?
In 2014, 15.6% of individual income tax returns were filed using a Form 1040EZ, 27.5% using a Form 1040A, and 56.9% using a Form 1040. Electronically-filed tax returns were 86.8% of total returns.
What six criteria must a taxpayer meet in order to file Form 1040EZ?
In order to use a 1040EZ, a taxpayer must meet the following criteria: • file the return as either single or married filing jointly, • be under age 65 and not blind, • have no dependents, • have total taxable income under $100,000, • have income only from wages, salary, tips, unemployment compensation, or taxable interest income of $1,500 or less, and • claim no tax credits except for the Earned Income Credit.
What is the definition of interest?
Interest is compensation for the "use of money" with respect to a bona fide debt or obligation imposed by law (e.g., judgments, loans, installment sales).
What federal tax forms do taxpayers normally receive to inform them of the amount of wages and interest they earned during the year?
Normally, wages are reported to taxpayers on a W-2 form and interest is reported on a Form 1099-INT.
What is the amount of the permitted deduction for single and married taxpayers who use Form 1040EZ?
On Form 1040EZ, taxpayers can take a permitted deduction on line 5 of $10,350 if the taxpayer's filing status is single or $20,700 if their filing status is married.
IRS rules for paid tax preparers apply to what types of tax professionals?
Paid tax preparer rules under Circular 230 apply to CPAs, attorneys, enrolled agents, registered tax preparers or any other person who, for compensation, prepares a tax return, provides tax advice or practices before the IRS
Name the three types of tax rate structures and give an example of each.
Progressive - U.S. federal income tax Proportional - "flat-tax" usually levied on property or sales at the state or local level Regressive - Social security tax
Explain what is meant by Public Law 100-14.
Public Law 100-14 is the 14th bill of the 100th Congress that was signed into law. All legislation passed by Congress and signed into law follows this numbering system - whether it is a tax bill or otherwise.
What are the three types of tax authority? Who issues each type?
Statutory Authority - issued by Congress Administrative Authority - issued by the IRS Judicial Authority - issued by the various courts in the U.S. judicial system
Discuss the concept of "tax authority." How does tax authority help taxpayers and tax preparers report tax items properly?
Tax authority represents the body of law, regulations, judicial decisions, and other items that provide taxpayers and tax professionals with guidance to correctly report taxable income.
Can a taxpayer rely on a Temporary Regulation as authority on how to treat a certain tax item? If so, how long is a Temporary Regulation valid?
Taxpayers can rely on temporary regulations. A temporary regulation has the same tax authority as a general or final regulation. It is effective as soon as it is issued and expires three years from the date of issuance.
Where are Revenue Rulings and Revenue Procedures found? When might a Revenue Ruling be useful to a taxpayer? When might a Revenue Procedure be useful to a taxpayer?
The IRS publishes all Revenue Rulings and Procedures in a series called the Cumulative Bulletin. Rulings and Procedures can also be located on the Web at www.irs.gov and other locations. Revenue Rulings are most useful to a taxpayer in determining the proper tax position to use regarding a given fact scenario. Revenue Procedures are used more often to provide resources such as tables, rates, guidelines, and safeguards (e.g., tax depreciation tables).
Differentiate between a General Regulation and a Legislative Regulation. Which one is the stronger tax authority?
The IRS writes general regulations to interpret the IRC under the general authority given to the IRS by Congress. A legislative regulation is a regulation written by the IRS under a direct mandate by Congress. In other words, Congress tells (or gives power to) the IRS to write the actual law through a legislative regulation. Legislative regulations have the full effect of law and are the strongest administrative authority.
What is the legislative process concerning tax laws? Where does tax legislation often begin?
The legislative process is shown in Table 1-4. Tax legislation usually begins in the Ways and Means Committee of the House of Representatives.
What are the advantages of petitioning the Tax Court versus other trial courts?
The major advantage of filing a case with the Tax Court is that the taxpayer need not pay the amount of disputed tax before filing a petition. Another advantage is that the Tax Court justices are tax law specialists. However, the second advantage can also be a disadvantage if the tax authority is not sufficiently on the taxpayer's side as might be the case if emotional or undue circumstances caused the deficiency.
Discuss the concept of statutory tax authority. Why is there a need for additional types of authority when statutory authority is the law?
The most common statutory tax authority is the Internal Revenue Code (IRC). The IRC is written by Congress and is considered the tax law. Other types of authority are necessary because statutory authority is often broad and lacks the detail to answer questions concerning the proper reporting of many different tax transactions. The administrative and judicial authorities (the IRS and the courts) provide interpretations of Congressional intent.
A change to a 17% flat tax could cause a considerable increase in many taxpayers' taxes and a considerable decrease in the case of others. Explain this statement in light of the statistics in Table 1-3.
Those with taxable income above $200,000 have average tax rates greater than 17%, those with taxable income below $200,000 have average tax rates less than 17%. Thus, on average, if a 17% flat tax were enacted, those with taxable income under $200,000 would see their tax liability go up and those with taxable income over $200,000 would have lower tax liability.
Explain why unemployment compensation is taxable.
Unemployment compensation is paid to an individual as a result of that person becoming unemployed. The compensation is, in effect, a substitute for taxable wages. Thus, it is taxable just as wages are taxable.
What are committee reports, and how can they help the taxpayer or tax preparer?
When a tax bill is discussed and voted on by the various congressional committees (Ways and Means, Senate Finance Committee, Joint Conference Committee), a report is produced for that committee. The committee reports set forth the "intent of Congress" as the tax legislation is written. The committee reports are especially useful to taxpayers and professionals because they provide guidance when a new tax law is passed or when there is minimal administrative or judicial authority to help interpret the law.
When taxpayers file a tax return, they will either pay an additional amount or receive a refund of excess taxes paid. Briefly explain how this "settling up" process works. Why might a taxpayer pay too much during the year?
When a tax return is filed, the taxpayer determines the total amount of tax liability. Normally, during the year, taxpayers pay this liability to the government through income tax withholdings. These withholdings (or other payments) are an estimate of the total tax liability that will be due at the end of the year. There will almost always be a difference between the actual amount due and the amount estimated. The amount due or overpaid is determined when the final tax return is filed. A taxpayer will pay too much during the year if he or she estimates a higher tax liability than is actually due. Sometimes taxpayers choose to pay "too much" as a method of forced savings.
(Longer Answer) What is the difference between a Revenue Ruling and a Revenue Procedure? How does the level of authority of a ruling or procedure compare with regulations and statutory authority?
With a Revenue Ruling, the IRS reacts to an area of the tax law that is confusing to many taxpayers. Revenue Rulings are usually issued after numerous taxpayers have requested guidance through Private Letter Rulings on a particular tax situation. The IRS usually issues Revenue Procedures to illustrate the manner in which it wants something reported. In other words, a Revenue Procedure is usually proactive. Revenue Rulings and Procedures carry less authoritative weight than regulations and statutory authority. However, they are considered strong tax authority. When a tax professional is researching a tax issue, Rulings and Procedures are an especially useful source of information because they reference other tax authorities (law, court cases, etc.) as part of the justification for the position of the IRS.
(Longer Answer) What is a Treasury Regulation? What are the four types of regulations and how do they differ?
A Treasury Regulation is written by the IRS (the IRS is a division of the U.S. Treasury Department). A Treasury Regulation is the strongest administrative authority and is the IRS's direct interpretation of the IRC. The four types of regulations are: Legislative - written under a direct mandate from Congress and have the full effect of law. General or Final Regulations - written by the IRS under its general authority to interpret the IRC. Temporary Regulations - the IRS issues these regulations to give taxpayers immediate guidance on the effect of a new law. They expire three years after they are issued. Proposed Regulations - the IRS writes these regulations during the hearing process concerning general regulations. The purpose of these regulations is to generate discussion and/or criticism of the IRS's interpretation of the IRC.
When would a taxpayer want to sue the government in a district court versus the Tax Court?
A U.S. District Court allows jury trial. A judge who is a tax specialist decides Tax Court cases. Therefore, if the taxpayer's case is an emotional issue but the tax law is not totally favorable towards his or her position, a trial by a jury may produce a more positive outcome.
Why might a district court's opinion regarding a tax decision be more likely to be reversed on appeal?
A district court ruling may be decided by a jury or by a judge that is not a tax specialist. Upon appeal, the tax authority is weighted more heavily and emotional reasons for a verdict are more likely to be disregarded.
What is a progressive tax? Why do you think the government believes it is a more equitable tax than, say, regressive tax or proportional tax?
A progressive rate structure is a structure where the tax rate increases as the tax base increases. The progressive rate structure is viewed as more equitable because the amount of tax paid varies with the ability to pay. For example, the government believes that as an individual makes more income, a smaller percentage of that income is needed to buy necessary living supplies and thus more income is available to pay taxes.
Explain what is meant by regressive tax. Why is the social security tax considered a regressive tax?
A regressive tax rate is one where the tax rate decreases as the tax base gets larger. The social security tax is assessed on the first $118,500 of wages (in 2015). Thus, the social security tax rate is 6.2% (12.4% if self-employed) on the first $118,500 of wages and 0% on wages above $118,500.
What is administrative authority, and who publishes it?
Administrative authority is the IRS's interpretation of the IRC. It is developed and published by the IRS.
After the Court of Appeals, does the taxpayer have any additional avenue for appeals? If so, what are the taxpayer's probabilities of receiving an appeal after the Court of Appeals? Why?
All of the Court of Appeals cases can be appealed to the U.S. Supreme Court. However, the Supreme Court hears few tax cases each year. The only tax cases the Supreme Court usually agrees to rule on are cases where a conflict occurs between the rulings of several different courts.
A paid preparer must not a. Cash a client's IRS check. b. Charge a reasonable fee. c. Inform a client if the preparer makes a mistake on the client's tax return. d. Provide a client with a copy of his or her return.
Answer: a
The most complex individual income tax return is a Form: a. 1040. b. 1040A. c. 1040C. d. 1040EZ.
Answer: a
Wage income is reported to a taxpayer on a Form: a. W-2. b. 1099-G. c. 1099-W. d. 1099-INT.
Answer: a
Which of the following is a statutory source of tax authority? a. Internal Revenue Code. b. Regulations. c. Revenue Rulings. d. Tax Court decision.
Answer: a
Which of the following is an example of a progressive tax? a. Federal income tax. b. State and local taxes levied on property. c. Sales tax. d. Social Security tax.
Answer: a
Which of the following refers to an income tax regulation? a. Reg. §1.162-5. b. Reg. §20.2032-1. c. Reg. §25.2503-4. d. Reg. §31.3301-1.
Answer: a
If a taxpayer loses a case against the IRS in one of the three trial courts, does the taxpayer have any avenue for appeals?
Any of the trial courts' decisions may be appealed to the U.S. Court of Appeals.
A married taxpayer has taxable income of $47,861. You have calculated tax liability using the tax tables and using the tax rate schedules. What can you say about the two figures? a. Tax liability determined using the tax tables will be more than tax liability determined using the tax rate schedules. b. Tax liability determined using the tax tables will be less than tax liability determined using the tax rate schedules. c. Tax liability determined using the tax tables will be the same as tax liability determined using the tax rate schedules. d. The answer cannot be determined with the information provided.
Answer: a Feedback: The tax rate schedules determine tax using a taxable amount of $47,861. The tax tables are based on a midpoint amount of $47,875 (the midpoint of the $47,850 to $47,900 range). In this case, the tax tables are based on a slightly larger taxable income, thus the tax liability will be slightly larger as well.
A tax rate that decreases as the tax base decreases is an example of what kind of tax rate structure? a. Progressive. b. Proportional. c. Regressive. d. Recessive.
Answer: a.
Sandra, a single taxpayer, has taxable income of $89,238. Using the tax tables, she has determined that her tax liability is: a. $18,476. b. $18,078. c. $16,604. d. $13,849.
Answer: b
Which of the following types of IRS Regulations have the greatest strength of authority? a. General or Final Regulations. b. Legislative Regulations. c. Proposed Regulations. d. Temporary Regulations.
Answer: b
Which of the following would disqualify a taxpayer from filing Form 1040EZ? a. The taxpayer is married. b. The taxpayer is age 66. c. The taxpayer received unemployment compensation. d. The taxpayer had adjusted gross income (line 4 of Form 1040EZ) of $101,000.
Answer: b Feedback: answer d is not a disqualifying item because the limitation is $100,000 of taxable income, not adjusted gross income.
Margaret earned $15,000 and paid $1,500 of income tax; Mike earned $50,000 and paid $5,000 of income tax. The tax rate structure they are subject to is: a. Progressive. b. Proportional. c. Regressive. d. Recessive.
Answer: b Feedback: $1,500 / $15,000 = 10% average rate for Margaret. $5,000 / $50,000 = 10% average rate for Mike. Both had the same average rate with differing amounts of income so the tax rate structure is proportional.
Eddie, a single taxpayer, has W-2 income of $32,288. Using the tax tables, he has determined that his tax liability is: a. $2,361. b. $2,825. c. $3,914. d. $4,378.
Answer: b. Feedback: Subtract the $10,350 permitted deduction from W-2 income to get taxable income which is used for the tax tables.
A paid preparer must: a. Ignore a conflict of interest when representing a client before the IRS. b. Charge a contingent fee. c. Sign all tax returns he or she prepares. d. Provide records requested by the IRS in all circumstances.
Answer: c
A preparer tax identification number must be obtained by a. Only CPA's, attorneys, and enrolled agents. b. Only individuals who are not CPA's, attorneys or enrolled agents. c. Any individual who is paid to prepare a tax return. d. Only individuals who prepare a Form 1040EZ.
Answer: c
A tax rate that decreases as the tax base increases is an example of what kind of tax rate structure? a. Progressive. b. Proportional. c. Regressive. d. Recessive.
Answer: c
On a Form 1040EZ, the amount of the permitted deduction from income for taxpayers filing a joint return is: a. $1,500. b. $10,350. c. $20,700. d. $31,050.
Answer: c
Jennifer and Paul, who file a joint return, have taxable income of $93,925 and the following tax liability: $18,550 × 10% = $ 1,855.00 ($75,300 − $18,550) × 15% = 8,512.50 ($93,925 − $75,300) × 25% = 4,656.25 Total tax liability $15,023.75 Their average tax rate is: a. 10%. b. 15%. c. 16%. d. 25%.
Answer: c Feedback: $15,023.75 / $93,925 = 16% (rounded)
Elizabeth determined that her tax liability was $3,942. Her employer withheld $3,492 from her paychecks during the year. Elizabeth's tax return would show: a. a refund of $450. b. a refund of $3,492. c. tax due of $450. d. tax due of $3,942.
Answer: c Feedback: $3,942 liability - $3,492 withholdings = $450 remaining tax due.
Benito is age 29 and single. During all of 2016, he did not have qualifying health coverage nor was he eligible for an exemption. His household income was $47,650. What is the amount of shared responsibility payment he must report on his 2016 income tax return? a. $0 b. $695.00 c. $932.50 d. $1,191.25
Answer: c Feedback: The payment is the greater of • [$47,650 - $10,350] X .025 = $932.50 • $695
Jake earned $15,000 and paid $1,500 of income tax; Jill earned $40,000 and paid $3,500 of income tax. The tax rate structure they are subject to is: a. Progressive. b. Proportional. c. Regressive. d. Recessive.
Answer: c Feedback: $1,500 / $15,000 = 10% average rate for Jake. $3,500 / $40,000 = 8.75% average rate for Jill. Jill had a lower rate for higher income so the tax rate structure is regressive.
Interest income is reported to a taxpayer on a Form: a. W-2. b. W-2-INT. c. 1099-G. d. 1099-INT.
Answer: d
Which of the following is (are) primary sources of tax authority? a. Statutory sources. b. Administrative sources. c. Judicial sources. d. All of the above.
Answer: d
Which of the following is an example of a regressive tax? a. Federal income tax. b. State and local taxes levied on property. c. Sales tax. d. Social Security tax.
Answer: d
Which of the following trial court(s) hear tax cases? a. U.S. Tax Court. b. U.S. district courts. c. U.S. Court of Federal Claims. d. All of the above.
Answer: d
Jennifer and Paul, who file a joint return, have taxable income of $93,925 and the following tax liability: $18,550 × 10% = $ 1,855.00 ($75,300 − $18,550) × 15% = 8,512.50 ($93,925 − $75,300) × 25% = 4,656.25 Total tax liability $15,023.75 Their marginal tax rate is: a. 10%. b. 15%. c. 16% d. 25%.
Answer: d Feedback: Marginal rate is the rate on the last dollar of income, which is 25% in this case.
What is a Proposed Regulation? Can a taxpayer rely on a Proposed Regulation as authority on how to treat a certain tax item?
The IRS writes proposed regulations during the hearing process leading up to the issuance of final or general regulations. The purpose of proposed regulations is to generate discussion and/or criticism of the IRS's interpretation of the IRC. The taxpayer can rely on a proposed regulation absent any other contradictory tax authority. However, proposed regulations do not have the effect of law so the tentative position may be overturned. Reliance on a proposed regulation is treated as authority for possible imposition of a negligence penalty (the reversed tax position would not be subject to a negligence penalty).
What is the purpose of a Joint Conference Committee? Its reports are considered more important or carry weight that is more authoritative. Why?
The Joint Conference Committee is composed of members of both the House Ways & Means Committee and the Senate Finance Committee. It is formed when the House and the Senate have passed different versions of a tax bill. The purpose of the joint committee is to resolve any conflicts between the two versions. Thus, the committee reports from the Joint Conference Committee are the last reports and contain the discussion of the intent regarding the final bill sent to the President for signature.
Define and compare these terms: average tax rate and marginal tax rate.
The average tax rate is the total tax liability divided by the taxable income (or tax base). The marginal tax rate is the tax rate applied to the last dollar (or, more accurately, the next dollar) of taxable income. In a progressive rate structure, the average tax rate is always the same as or is lower than the marginal tax rate.
What type of tax rate structure is the U.S. federal income tax? Explain your answer.
The federal income tax is a progressive tax. As the tax base increases, the rate of tax increases. Tax rates range from a low of 10% to a high of 39.6%.
(Introduction) Give a brief history of the income tax in the United States.
The first federal income tax was enacted in 1861 to help finance the Civil War and was discarded soon thereafter. In 1894, another income tax was promulgated by Congress to raise additional tax revenue and to expand the sources of revenue. In 1895, the Supreme Court ruled that the federal income tax was unconstitutional. In 1913, the sixteenth Amendment to the U.S. Constitution was enacted. This amendment gave Congress the power to levy and collect taxes. In 2014, the federal government collected about $1.36 trillion in individual income taxes.
What is the Income Tax Formula, in simplified form?
The income tax formula is the methodology used to determine the amount of tax owed by a taxpayer. In its most simplified form, the income tax formula is: Income − Permitted deductions from income ------------------------------------------------ = Taxable income × Appropriate tax rates -------------------------------- = Tax liability − Tax payments and tax credits --------------------------------- = Tax refund or tax due with return
What is the most common way taxpayers pay their income tax liability during the year?
The vast majority of taxpayers pay their annual tax liability through income tax withholding deducted from their paychecks by their employer and remitted to the government on behalf of the taxpayer.
What type of tax is a sales tax? Explain your answer.
The sales tax is a proportional tax. A proportional tax is a tax where the tax rate remains the same regardless of the tax base. Most county or state sales tax rates are the same regardless of the amount of sales upon which the tax is levied. With a proportional tax, the marginal tax rate and average tax rate are always the same.
What is the definition of tax base, and how does it affect the amount of tax levied?
The tax base is the dollar amount upon which the tax rate is applied in order to determine the actual tax. Income, dollar sales, and property value are the more common tax bases in the United States.
List at least five items that paid preparers must do to comply with Circular 230.
The text lists nine items that a paid preparer must do. An appropriate answer would include any five from the list. The list is: • Sign all tax returns they prepare. • Provide a copy of the returns to clients. • Return records to clients. • Exercise due diligence. • Exercise best practices in preparing submissions to the IRS. • Disclose all non-frivolous tax positions when such disclosure is required to avoid penalties. • Promptly notify clients of any error or omission on a client tax return. • Provide records and information requested by the IRS unless the records or information are privileged. • Inform a client if the client has made an error or omission in a document submitted to the IRS.
List at least five items that paid preparers must not do to comply with Circular 230.
The text lists seven items that a paid preparer must not do. An appropriate answer would include any five from the list. The list is: • Take a tax position on a return unless there is a "realistic possibility" of the position being sustained. • Charge a fee contingent on the outcome of the return or any position, except in certain limited situations. • Charge an "unconscionable fee." • Unreasonably delay the prompt disposition of any matter before the IRS. • Cash an IRS check for a client for whom the return was prepared. • Represent a client before the IRS if the representation involves a conflict of interest. • Make false, fraudulent or coercive statements or claims or make misleading or deceptive statements or claims. In part, this item pertains to claims made with respect to advertising or marketing.
In what courts are disputes between the IRS and a taxpayer heard?
The three trial courts that hear tax disputes between the IRS and taxpayers are the U.S. District Courts, the U.S. Tax Court, and U.S. Court of Federal Claims.