Ch 1 1 History TAX REVIEW In addition most states and some cities and counties also impose an income tax a Federal income tax is the dominant form of taxation in the US b c Both individuals and corporations are subject to such taxes d Prior to 1913 the federal government relied predominantly on custom duties and excise taxes to finance its operations e First federal income tax on individuals was enacted in 1861 to finance the civil war but was repealed after the war Federal income tax was reinstated in 1894 however that was challenged in the courts because the US constitution required that an income tax be apportioned among states in proportion to their populations Implied that different tax rates would apply to individual taxpayers depending on their states of residence In 1895 the Supreme Court ruled that the tax was in violation of the US Constitution f g h i Therefore it was necessary to amend the Constitution to permit the passage of federal income tax law in 1913 1 This was accomplished by the Sixteenth amendment which was ratified 2 Revenue Acts income level a Revenue Act of 1913 imposed a flat 1 tax on a corporations net income b The rate varied from 1 to 7 for individuals depending on the individuals personal i However very fewer individuals paid federal income taxes because a 3 000 personal exemption was permitted as an offset to taxable income These amounts were greater than the incomes of most individuals in 1913 In 1986 major changes were made to the tax law and the basic tax law was redesignated as the Internal Revenue Code of 1986 c d To accommodate the broadened tax base and to avoid tax collection problems Congress enacted pay as you go withholding in 1943 e The federal income tax is changed on an incremental basis rather than a complete revision basis i Under instrumentalism when a change in the tax law is deemed necessary by congress the entire law is not changed but specific provisions of the tax law are added changed or deleted on an incremental basis f Without question one of the principal reasons for the complexity of the federal income tax today is the incremental nature of tax legislation 3 Revenue Sources a The largest source of federal revenue is individual income taxes b Other major revenue sources include Social Security FICA taxes and corporate income taxes c Two notable trends are i Gradual increase in social security taxes from 1960 to 2010 ii Gradual decrease in corporate income taxes for the same period iii Individual income taxes have remained fairly stable during the past 50 years 4 Structure of Individual Income Tax Rates a Virtually all tax structure are composed of two parts i Tax base amount to which the tax rate is applied to determine the tax due Individuals tax base for the federal income tax is their taxable income 1 2 Tax base for property tax is generally the fair market value of the property subject to tax ii Tax rate merely the percentage rate applied to the tax base 1 May be progressive proportional or regressive 2 Progressive one where the rate of tax increases as the tax base increases Federal Income Tax 3 Proportional sometimes called a flat tax is one where the rate of tax is the same for all taxpayers regardless of the level of their tax base a Generally used for real estate taxes state and local taxes personal property taxes custom duties taxes and excise taxes 4 Regressive rate decreases with an increase in the tax base Social Security FICA a Sales tax which is levied by many states is also regressive when measured against an income base 5 Structure of Corporate Tax Rates a Corporations are separate entities and are subject to income tax b Federal corporate income tax reflects a stair step pattern of progression that tends to 6 Marginal Average and Effective Tax Rates for Tax Payers a Marginal tax rate the rate applied to an incremental amount of taxable income that is benefit small corporations c Chart d PG 1 5 added to the tax base transaction deduction for a taxpayer taxable income i Concept is useful for planning because it measures the tax effect of a proposed ii Marginal tax rate measures the tax rate applicable to the next 1 of income or b Average Tax Rate is computed by dividing the total tax liability by the amount of i This represents the average rate of tax for each dollar of taxable income c Effective Tax Rate the total tax liability divided by total economic income i Total economic income includes all types of economic income that a taxpayer has for the year ii Economic income is much broader than taxable income iii Basic purpose of calculating the effective tax rate is to provide a broad measure of taxpayers ability to pay taxes iv Accordingly the effective tax rate is used by tax policy makers to determine the 7 Determination of Taxable Income and Tax Due fairness of the income tax system a PG 1 7 8 Wealth Transfer Taxes a US citizens are subject to taxation on certain transfers of property to another person b The tax law provides a unified transfer tax system that imposes a single tax on transfers of property taking place during an individual s lifetime gifts and at death estates c Both the gift and estate taxes are wealth transfer taxes levied on the transfer of the property and are based on the fair market value of the transferred property on the date of the transfer d Gift tax is an excise tax that is imposed on the donor for transfers of property that are considered to be a taxable gift i Gift generally is a transfer made gratuitously or with a donative intent Estate Tax is part of the unified transfer tax system that is based on the total property transfers an individual makes both during his or her lifetime and at death e Chart PG 1 8 f i Chart PG 1 9 9 Other Types of Taxes a Property taxes based on the value of taxpayers property which may include both real estate and personal property b Federal excise taxes and Customs duties on imported goods have declined in relative importance over the years but remain significant sources of revenue i Federal excise tax imposed on alcohol tobacco gasoline telephone usage production of oil and gas and many other types of goods c Sales tax major source of revenue for state and local governments i Sales taxes are imposed of retail sales of tangible personal property d Employment Taxes include Social Security FICA and federal and state unemployment compensation taxes e Employers are required to pay federal and state unemployment taxes to fund the payment of