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TAX REVIEWCh 1:1. History:a. Federal income tax is the dominant form of taxation in the USb. In addition, most states and some cities and counties also impose an income taxc. Both individuals and corporations are subject to such taxesd. Prior to 1913 the federal government relied predominantly on custom duties and excise taxes to finance its operationse. First federal income tax on individuals was enacted in 1861 to finance the civil war but was repealed after the warf. 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 populationsg. Implied that different tax rates would apply to individual taxpayers depending on their states of residenceh. In 1895, the Supreme Court ruled that the tax was in violation of the US Constitutioni. Therefore it was necessary to amend the Constitution to permit the passage of federal income tax law.1. This was accomplished by the Sixteenth amendment which was ratified in 19132. Revenue Acts:a. Revenue Act of 1913 imposed a flat 1% tax on a corporations net incomeb. The rate varied from 1 to 7% for individuals, depending on the individuals personal income leveli. 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 1913c. In 1986, major changes were made to the tax law, and the basic tax law was redesignated as the Internal Revenue Code of 1986d. To accommodate the broadened tax base and to avoid tax collection problems, Congress enacted pay as you go withholding in 1943e. The federal income tax is changed on an incremental basis rather than a complete revision basisi. 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 areadded, changed, or deleted on an incremental basisf. Without question, one of the principal reasons for the complexity of the federal income tax today is the incremental nature of tax legislation3. Revenue Sources:a. The largest source of federal revenue is individual income taxesb. Other major revenue sources include Social Security (FICA) taxes and corporate income taxesc. 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 periodiii. Individual income taxes have remained fairly stable during the past 50 years4. 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 due1. Individuals tax base for the federal income tax is their taxable income2. Tax base for property tax is generally the fair market value of the property subject to taxii. Tax rate – merely the percentage rate applied to the tax base1. May be progressive, proportional, or regressive2. 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 isthe same for all taxpayers, regardless of the level of their tax basea. Generally used for real estate taxes, state and local taxes, personal property taxes, custom duties taxes, and excise taxes4. 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 whenmeasured against an income base5. Structure of Corporate Tax Ratesa. Corporations are separate entities and are subject to income taxb. Federal corporate income tax reflects a stair step pattern of progression that tends to benefit small corporationsc. Chart:d. PG 1-56. 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 added to the tax basei. Concept is useful for planning because it measures the tax effect of a proposed transactionii. Marginal tax rate measures the tax rate applicable to the next $1 of income or deduction for a taxpayer b. Average Tax Rate – is computed by dividing the total tax liability by the amount of taxable incomei. This represents the average rate of tax for each dollar of taxable incomec. Effective Tax Rate – the total tax liability divided by total economic incomei. Total economic income includes all types of economic income that a taxpayer has for the yearii. 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 taxesiv. Accordingly the effective tax rate is used by tax policy makers to determine the fairness of the income tax system7. Determination of Taxable Income and Tax Due:a. PG 1-78. Wealth Transfer Taxesa. US citizens are subject to taxation on certain transfers of property to another personb. 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 transferd. Gift tax – is an excise tax that is imposed on the donor for transfers of property that are considered to be a taxable gifti. Gift generally is a transfer made gratuitously or with a donative intente. Chart PG 1-8f. 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 deathi. Chart PG 1-99. Other Types of Taxes:a. Property taxes – based on the value of taxpayers property, which may include both real estate and personal propertyb. 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 goodsc. Sales tax – major source of revenue for state and local governmentsi. Sales taxes are imposed of retail sales of tangible personal propertyd. Employment Taxes – include Social Security (FICA) and federal and state

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