pope phft2014 ind pp 01

1-1©2014 Pearson Education, Inc.

An Introduction

to TaxationChapter 1

AN INTRODUCTION TO TAXATION (1 of 2)

History of taxation in the U.S.Types of tax rate structuresOther types of taxesCriteria for a tax structureEntities in federal income tax

systemTax law sources

©2014 Pearson Education, Inc. 1-2

AN INTRODUCTION TO TAXATION (2 of 2)

Enactment of a tax lawAdministration of the tax law

and tax practice issuesComponents of a tax practiceComputer applications in tax

practice©2014 Pearson Education, Inc. 1-3

History of TaxationEarly PeriodsFirst federal income tax in 1861Repealed after Civil WarReinstated in 1894Supreme Court ruled

unconstitutional in 189516th Amendment on March 1,

1913©2014 Pearson Education, Inc. 1-4

History of TaxationRevenue ActsRev. acts prior to codification in

1939How tax law is changed or

modifiedFederal income tax is changed on

an incremental basis rather than a complete revision

The tax law has been referred to as a quiltwork of tax law


History of TaxationRevenue Sources

1960 1975 1994 20120%5%10%15%20%25%30%35%40%45%50%

IndividualFICACorporateOther


Types of Tax Rate StructuresStructure of individual

income tax ratesStructure of corporate tax

ratesMarginal, average, and

effective tax rates for taxpayers

Determination of taxable income and tax due


[Tax base] x [Tax rate] = Tax dueTax Base

E.g., individual’s tax base for federal income is taxable income,

Tax base for property tax generally FMV of property subject to tax

Tax RatePercentage(s) applied to tax base

Structure of Individual Income Tax Rates (1 of 2)


ProgressiveRate increases as tax base increases

E.g., individual income taxProportional or flat tax

E.g., sales taxRegressive

Rate decreases as tax base increasesE.g., FICA tax

Structure of Individual Income Tax Rates (2 of 2)


Structure of CorporateIncome Tax Rates (1 of 2)Stair-step pattern of

progressionTends to benefit small

corporationsBenefit of graduated tax

rates phased out between $100K and $335K, and $15M and $18.33M©2014 Pearson Education, Inc. 1-10

Structure of CorporateIncome Tax Rates (2 of 2)

1-11©2014 Pearson Education, Inc.

First $50K 15 % of Taxable Inc> $50K But Not > $75K $7,500 + 25% of Taxable Inc> $75K But Not > $100K 13,750 + 34% of Taxable Inc > $75K

> $100K But Not > $335K $22,250 + 39% of Taxable Inc > $100K> $335K 34% of Taxable Inc> $10M But Not > $15M 3.4M + 35% of Taxable Inc > $10M

> $15M But Not > $18,333,333 $5.150M + 38% > $15M> $18,333,333 35% of Taxable Inc

Marginal, Avg., & Effective Tax Rates for TaxpayersMarginal tax rate

Tax rate applied to incremental amount of taxable inc that is added to tax base

Average tax rate[Total tax liab.] / [Taxable income]

Effective tax rate[Total tax liab.] / [Total economic

inc.] ©2014 Pearson Education, Inc. 1-12

Determination of Taxable Income and Tax DueGross Income

- Deductions for AGI AGI

- Deductions from AGI Taxable Income

x Individual Tax Rate Gross Tax Due

- Credits & Payments Tax or Refund Due


Other Types of TaxesState and local taxesState and local franchise taxesWealth transfer taxes

Gift tax – levied on donorEstate tax – levied on decedent’s

estateUnified credit applies to gift & estate

taxOther types of taxes

Prop., excise, sales, & employment taxes


Criteria for a Tax Structure (1 of 4)

EquityVertical equityHorizontal equity

CertaintyStable source of government

revenuesAmount of liability for

taxpayers©2014 Pearson Education, Inc. 1-15

ConvenienceEasily assessed, collected, and

administeredSimplicity

Should not be overly complex




EconomyMinimal compliance and

administration costsBusinesses spent (in 2005)

$148B to comply with federal tax law and $80B to comply with state and local taxes

Cost to individuals $111B©2014 Pearson Education, Inc. 1-17


Objectives of federal inc. tax lawEconomic objectivesEncouragement of certain

activities and industriesSocial objectivesIncome tax reform proposals

Simplified Income Tax Plan (SITP)Growth and Investment Tax Plan

(GITP) ©2014 Pearson Education, Inc. 1-18

Economic ObjectivesRaise Revenues for Government

OperationsStimulate Private InvestmentReduce UnemploymentMitigate Effects on Inflation


Entities in Federal Income Tax System (1 of 2)

Taxpaying entitiesIndividualsC corporations

Double taxation of C corp earningsTrusts

Hybrid entityMay be taxpaying entity or flow-

through©2014 Pearson Education, Inc. 1-20

Entities in Federal Income Tax System (2 of 2)

Flow-through entitiesSole proprietorship

Also known as a Schedule C business

PartnershipsS CorporationsLLC (Limited Liability

Company)LLP (Limited Liability

Partnership)©2014 Pearson Education, Inc. 1-21

Tax Law Sources(1 of 2)

LegislativeInternal Revenue CodeCongressional Committee

reportsExecutive (administrative)

Income tax regulationsRevenue RulingsRevenue ProceduresLetter Rulings©2014 Pearson Education, Inc. 1-22

Tax Law Sources(2 of 2)

JudicialCourt decisions

Trial courtsDistrict Court, Tax Court, U.S. Court

of Federal ClaimsAppeals courts

Circuit CourtsSupreme Court


Enactment of a Tax Law (1 of 4)

1. House of Representatives responsible for initiating new tax legislation

President may make proposal to Congress with studies on needed tax reform prepared by Treasury

2. Referred to the House Ways and Means Committee (HW&MC)©2014 Pearson Education, Inc. 1-24


3. Voted on by HW&MCForwarded to House of Representatives

for a vote if approved by HW&MC4. Voted on by House of Reps

If approved, sent to Senate Finance Committee (SFC)

5. Voted on by SFCIf approved, sent to Senate for a voteBill may be different than House

version ©2014 Pearson Education, Inc. 1-25


6. Senate considers bill and may add amendments

7. Voted on by SenateIf approved, sent to Joint

Conference Committee (JCC) to reconcile bill

8. JCC produces final billSent back to House and Senate to

vote on final bill©2014 Pearson Education, Inc. 1-26


9. If JCC bill approved, sent to President for approval or veto

10. Presidential veto may be overturned by 2/3 vote in both House & Senate

11. Committee reports prepared by staff of HW&MC, SFC, and JCC


Administration of the Tax Law and Tax Practice IssuesOrganization of the IRSEnforcement proceduresSelection of returns for auditStatute of limitationsInterestPenaltiesAdministrative appeal

procedures©2014 Pearson Education, Inc. 1-28

Selection of Returns for Audit (1 of 2)

Tax system based on self assessment & voluntary complianceEnforcement necessary to

maintain integrity of tax system


Selection of Returns for Audit (2 of 2)

Discriminant Function System (DIF)DIF system generates “score” for

return based on return for add’l tax revenue

Returns manually screened by IRSDecide which returns to examine

furtherLess than 1% of all individual

returns are selected for examination each year


Statute of LimitationsGeneral rule 3 years from later of

the date tax return was actually filed or due date

Six years if taxpayer omits items of gross income that in total exceed 25%

Indefinite if fraudulent return filed or no return filed©2014 Pearson Education, Inc. 1-31

Components of a Tax PracticeTax compliance and

procedureTax researchTax planning and consultingFinancial planning


Computer Applications in Tax PracticeTax return preparationTax planning applications

E.g., project depreciationTax research applications

RIA CheckpointCCH Tax Research NetworkIRS web site


ENDChapter 1


pope phft2014 ind pp 01

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