South-Western Federal Taxation, 2009 Edition

Comprehensive Volume
ISBN: 0324660529

Chapter 1
An Introduction to Taxation and Understanding the Federal Tax Law
Ad valorem tax. A tax imposed on the value of property. The most common ad valorem tax is
that imposed by states, counties, and cities on real estate. Ad valorem taxes can be imposed on
personal property as well.
Correspondence audit. An audit conducted by the IRS by mail. Typically, the IRS writes to the
taxpayer requesting the verification of a particular deduction or exemption. The completion of a
special form or the remittance of copies of records or other support is all that is requested of the
taxpayer.
Death tax. A tax imposed on property transferred by the death of the owner.
Employment taxes. Employment taxes are those taxes that an employer must pay on account of
its employees. Employment taxes include FICA (Federal Insurance Contributions Act) and FUTA
(Federal Unemployment Tax Act) taxes. Employment taxes are paid to the IRS in addition to
income tax withholdings at specified intervals. Such taxes can be levied on the employees, the
employer, or both.
Estate tax. A tax imposed on the right to transfer property by death. Thus, an estate tax is levied
on the decedents estate and not on the heir receiving the property.
Excise tax. A tax on the manufacture, sale, or use of goods; on the carrying on of an occupation
or activity; or on the transfer of property. Thus, the Federal estate and gift taxes are, theoretically,
excise taxes.
FICA tax. An abbreviation that stands for Federal Insurance Contributions Act, commonly
referred to as the Social Security tax. The FICA tax is comprised of the Social Security tax (old
age, survivors, and disability insurance) and the Medicare tax (hospital insurance) and is
imposed on both employers and employees. The employer is responsible for withholding from
the employees wages the Social Security tax at a rate of 6.2 percent on a maximum wage base of
$97,500 (for 2007) and the Medicare tax at a rate of 1.45 percent (no maximum wage base). The
employer is required to match the employees contribution.
Field audit. An audit conducted by the IRS on the business premises of the taxpayer or in the
office of the tax practitioner representing the taxpayer.
Flat tax. In its pure form, a flat tax would eliminate all exclusions, deductions, and credits and
impose a one-rate tax on gross income.

Franchise tax. A tax levied on the right to do business in a state as a corporation. Although
income considerations may come into play, the tax usually is based on the capitalization of the
corporation.
FUTA tax. An employment tax levied on employers. Jointly administered by the Federal and
state governments, the tax provides funding for unemployment benefits. FUTA applies at a rate
of 6.2 percent on the first $7,000 of covered wages paid during the year for each employee. The
Federal government allows a credit for FUTA paid (or allowed under a merit rating system) to
the state. The credit cannot exceed 5.4 percent of the covered wages.
Gift tax. A tax imposed on the transfer of property by gift. The tax is imposed upon the donor of
a gift and is based on the fair market value of the property on the date of the gift.
Inheritance tax. A tax imposed on the right to receive property from a decedent. Thus,
theoretically, an inheritance tax is imposed on the heir. The Federal estate tax is imposed on the
estate.
National sales tax. Intended as a replacement for the current Federal income tax. Unlike a value
added tax (VAT), which is levied on the manufacturer, it would be imposed on the consumer
upon the final sale of goods and services. To keep the tax from being regressive, low-income
taxpayers would be granted some kind of credit or exemption.
Occupational tax. A tax imposed on various trades or businesses. A license fee that enables a
taxpayer to engage in a particular occupation.
Office audit. An audit conducted by the IRS in the agents office.
Personalty. All property that is not attached to real estate (realty) and is movable. Examples of
personalty are machinery, automobiles, clothing, household furnishings, inventory, and personal
effects.
Realty. Real estate.
Revenue neutrality. A description that characterizes tax legislation when it neither increases nor
decreases the revenue result. Thus, any tax revenue losses are offset by tax revenue gains.
Sales tax. A state- or local-level tax on the retail sale of specified property. Generally, the
purchaser pays the tax, but the seller collects it, as an agent for the government. Various taxing
jurisdictions allow exemptions for purchases of specific items, including certain food, services,
and manufacturing equipment. If the purchaser and seller are in different states, a use tax usually
applies.
Severance tax. A tax imposed upon the extraction of natural resources.
Statute of limitations. Provisions of the law that specify the maximum period of time in which
action may be taken on a past event. Code 65016504 contain the limitation periods

applicable to the IRS for additional assessments, and 65116515 relate to refund claims by
taxpayers.
Sunset provision. A provision attached to new tax legislation that will cause such legislation to
expire at a specified date. Sunset provisions are attached to tax cut bills for long-term budgetary
reasons in order to make their effect temporary. Once the sunset provision comes into play, the
tax cut is rescinded and former law is reinstated. An example of a sunset provision is the one
contained in the Tax Relief Reconciliation Act of 2001 that relates to the estate tax. After the
estate tax is phased out in 2010, a sunset provision reinstates the estate tax as of January 1, 2011.
Use tax. A sales tax that is collectible by the seller where the purchaser is domiciled
Value added tax (VAT). A national sales tax that taxes the increment in value as goods move
through the production process. A VAT is much used in other countries but has not yet been
incorporated as part of the U.S. Federal tax structure.
Wherewithal to pay. This concept recognizes the inequity of taxing a transaction when the
taxpayer lacks the means with which to pay the tax. Under it, there is a correlation between the
imposition of the tax and the ability to pay the tax. It is particularly suited to situations in which
the taxpayers economic position has not changed significantly as a result of the transaction.