An Introduction

to Taxation
Chapter 1

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AN INTRODUCTION TO
TAXATION (1 of 2)
History

of taxation in the U.S.

Types of tax rate structures
Other types of taxes
Criteria for a tax structure
Entities in federal income tax system
Tax law sources
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AN INTRODUCTION TO
TAXATION (2 of 2)
Enactment

of a tax law
Administration of the tax law and
tax practice issues
Components of a tax practice
Computer applications in tax
practice
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History of Taxation
Early Periods

First

federal income tax in 1861

Repealed after Civil War
Reinstated in 1894
Supreme Court ruled
unconstitutional in 1895
16th Amendment on March 1, 1913
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History of Taxation
Revenue Acts

Rev.

acts prior to codification in 1939

How tax law is changed or modified
Federal

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
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History of Taxation
Revenue Sources
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

Individual
FICA
Corporate
Other

1960

1975

1994

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Types of Tax Rate

Structures
Structure

of individual income tax

rates
Structure of corporate tax rates
Marginal, average, and effective
tax rates for taxpayers
Determination of taxable income
and tax due
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Structure of Individual
Income Tax Rates (1 of 2)
[Tax

base] x [Tax rate] = Tax due

Tax

Base

E.g.,

individuals tax base for federal

income is taxable income,
Tax base for property tax generally FMV
of property subject to tax
Tax

Rate

Percentage(s)

applied to tax base

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Structure of Individual
Income Tax Rates (2 of 2)
Progressive
Rate

increases as tax base increases

E.g.,

individual income tax

Proportional
E.g.,

or flat tax

sales tax

Regressive
Rate

decreases as tax base increases

E.g.,

FICA tax
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Structure of Corporate
Income Tax Rates (1 of 2)
Stair-step
Tends

pattern of progression

to benefit small corporations

Benefit

of graduated tax rates

phased out between $100K and
$335K, and $15M and $18.33M

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Structure of Corporate
Income Tax Rates (2 of 2)
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
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Marginal, Avg., & Effective

Tax Rates for Taxpayers
Marginal

tax rate

Tax

rate applied to incremental amount

of taxable inc that is added to tax base

Average
[Total

tax rate

tax liab.] / [Taxable income]

Effective
[Total

tax rate

tax liab.] / [Total economic inc.]

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Determination of Taxable
Income and Tax Due
Gross Income
- Deductions for AGI
AGI
- Deductions from AGI
Taxable Income
x Individual Tax Rate
Gross Tax Due
- Credits & Payments
Tax or Refund Due

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Other Types of Taxes

State

and local taxes

State and local franchise taxes
Wealth transfer taxes
Gift

tax levied on donor

Estate tax levied on decedents estate
Unified

Other

credit applies to gift & estate tax

types of taxes

Prop.,

excise, sales, & employment taxes

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Criteria for a Tax

Structure (1 of 4)
Equity
Vertical

equity
Horizontal equity
Certainty
Stable

source of government
revenues
Amount of liability for taxpayers
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Criteria for a Tax

Structure (2 of 4)
Convenience
Easily

assessed, collected, and

administered

Simplicity
Should

not be overly complex

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Criteria for a Tax

Structure (3 of 4)
Economy
Minimal

compliance and
administration costs

Businesses

spent (in 2005) $148B to

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

Cost

to individuals $111B
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Criteria for a Tax

Structure (4 of 4)
Objectives

of federal inc. tax law

Economic

objectives
Encouragement of certain activities
and industries
Social objectives
Income tax reform proposals
Simplified

Income Tax Plan (SITP)

Growth and Investment Tax Plan (GITP)
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Economic Objectives
Raise

Revenues for Government

Operations
Stimulate Private Investment
Reduce Unemployment
Mitigate Effects on Inflation

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Entities in Federal
Income Tax System (1 of 2)
Taxpaying

entities

Individuals
C

corporations

Double

taxation of C corp earnings

Trusts
Hybrid
May

entity

be taxpaying entity or flow-through

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Entities in Federal
Income Tax System (2 of 2)
Flow-through
Sole

entities

proprietorship

Also

known as a Schedule C business

Partnerships
S

Corporations
LLC (Limited Liability Company)
LLP (Limited Liability Partnership)
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Tax Law Sources

(1 of 2)

Legislative
Internal

Revenue Code
Congressional Committee reports
Executive

(administrative)

Income

tax regulations
Revenue Rulings
Revenue Procedures
Letter Rulings
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Tax Law Sources

(2 of 2)

Judicial
Court
Trial

decisions
courts

District

Court, Tax Court, U.S. Court of

Federal Claims

Appeals

courts

Circuit

Courts

Supreme

Court
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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)
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Enactment of a Tax Law

(2 of 4)

3.

Voted on by HW&MC
Forwarded

to House of Representatives for

a vote if approved by HW&MC

4.

Voted on by House of Reps

If

approved, sent to Senate Finance

Committee (SFC)

5.

Voted on by SFC
If approved, sent to Senate for a
Bill may be different than House
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Enactment of a Tax Law

(3 of 4)

Senate considers bill and may

add amendments
7. Voted on by Senate
6.

If

approved, sent to Joint Conference

Committee (JCC) to reconcile bill

8.

JCC produces final bill

Sent

back to House and Senate to vote

on final bill
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Enactment of a Tax Law

(4 of 4)

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
9.

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Administration of the Tax Law

and Tax Practice Issues
Organization

of the IRS
Enforcement procedures
Selection of returns for audit
Statute of limitations
Interest
Penalties
Administrative appeal procedures
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Selection of Returns for

Audit (1 of 2)
Tax

system based on self

assessment & voluntary
compliance
Enforcement

necessary to maintain
integrity of tax system

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Selection of Returns for

Audit (2 of 2)
Discriminant

Function System (DIF)

DIF

system generates score for return

based on return for addl tax revenue

Returns

manually screened by IRS

Decide

which returns to examine further

Less

than 1% of all individual returns are

selected for examination each year
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Statute of Limitations
General

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
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Components of a Tax
Practice
Tax

compliance and procedure

Tax research
Tax planning and consulting
Financial planning

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Computer Applications in
Tax Practice
Tax

return preparation
Tax planning applications
E.g.,

Tax

project depreciation

research applications

RIA

Checkpoint
CCH Tax Research Network
IRS web site
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END
Chapter 1

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