Chapter 1 & 3 Flashcards
What is the proportional tax system
what is another word for this tax
- constant tax rate throughout the tax base, as base increases so does taxes paid
- also known as flat rate
what are examples of proportional tax rates
corporate tax rate, and sales tax
for a proportional tax system, the marginal rate equals the …
average rate
the proportional tax system satisfies..
vertical equity by $ but not rate
What is the progressive tax system
imposes an increasing marginal tax rate as the tax base increases
what are examples of progressive taxes
federal and state income taxes
for the progressive system how does the marginal tax rate compare to the average tax rate
the marginal tax rate will always be more or equal to the average rate
progressive tax system satisfies…
vertical equity by rate and dollar
What is the regressive tax system
the marginal tax rate decreases as the tax base increases
what are examples of regressive taxes
social security tax and state unemployment taxes (because they are capped at a certain amount)
What tax system is sales tax viewed to follow?
if we look at it as a marginal/average tax it follows the proportional tax system
if we look at the effective tax it is regressive because the more base you have the less of it is going towards the flat tax
What are the 4 characteristics of a good tax
- Equity
- Economy
- Certainty
- Convienence
what does a sufficiency mean in terms of a good tax
it means assessing the amount of tax revenues a system must generate and ensuring that it provides them
what is the income effect
it predicts that when taxpayers are taxed more they will work harder to generate the same after-tax dollar
therefore they work more to increase their pre-tax income
what is the substitution effect
predicts that when taxpayers are taxed more, rather than working more, they will substitute nontaxable activities like leisure for taxable ones
what are the income effect and substitution effect relevant to?
determining how tax payers may respond to tax changes in order to forecast sufficient revenue
What does it mean that a tax needs to be equitable to be good
it means that the tax is based on the taxpayers ability to pay, in other words more able to pay more taxes paid
-tax payer has to be able to pay it
what is horizontal equity
two taxpayers with the same tax situation pay the same amount
vertical equity
means that the taxpayer with the greater ability to pay pay more tax relative to taxpayers with a lesser ability to pay tax
What does it mean that a tax must be certain
tax payers should be able to determine when to pay the tax, where to pay the tax, and how to determine the tax
What does it mean that a tax must be convenient
it means that a tax system should be designed to facilitate the collection of tax revenues without being too difficult for the taxpayer or the government
what does economy mean in relation to a good tax system
the system should minimize the compliance and administration costs associated with the tax system
What is the marginal tax rate
the tax rate that applies to the next additional increment of a taxpayer’s taxable income (or to deductions).
how much your next dollar will be taxed at
what is the marginal tax rate equation
tax/taxable income
also (old - new tax)/(old - new income)
what is the marginal tax rate good for in terms of tax planning?
tax planning
What is average tax
the tax rate that applies to the next additional increment of a taxpayer’s taxable income (or to deductions).
historical
What is the equation for the average tax
total tax/taxable income
what is the average tax good for in terms of tax planning
It is good for budgeting tax expenses as a portion of income
What is the effective tax rate
represents the average rate of taxation on each dollar of income
What is the effective tax rate equation
total tax/ (taxable income)=
What is the effective tax rate good for in terms of tax planning
gives us the best look at what the taxpayer’s tax burden is in relation to all income (taxable and nontaxable)
what taxes are external users most interested in when evaluating if a company is good at tax planning
effective tax
What are explicit taxes
taxes that are directly imposed by the government
what are implicit taxes
indirect taxes that are not directly paid to the government, that result from the government granting tax-favorable options
*reduced before tax return
what does tax-favored mean
that the income is either excluded from tax base (deductable) or the tax rate is lower
why is there an implicit tax
due to demand for tax favorable options it leads to lower pre-tax return
what are the ways to find the implicit tax
- Difference between tax-favored before-tax rate of return and taxed before-tax rate of return
- (Pre-tax rate of return of taxable - pre tax-favored) / pretax return of taxable
what is the tax rate for dividend income
maximum of 20%
what is the tax rate for long-term capital gains
20%
what is the medicare surtax
2.9 split 50/50 among employer/employee
What is the tax treatment for C Corps
double taxed at an entity and shareholder level
pay a flat 21%
how are sole proprietorships taxed?
business deductions and income reported at the owner’s tax rate
- losses a business faces can offset personal income
How are partnerships taxed?
flow through entity
losses offset partners income and
tax free withdrawals
how are S corporations taxed
flow-through entity
losses offset shareholders’ income
tax-free withdrawals
LLC and LLP
flow-through entity
what does flow through entity mean
that business doesn’t pay tax but flows through to owners who then pay the tax
What are different tax planning strategies
- shift income & deductions across time
- Shift income and deductions across jurisdictions
- Shift income across entities
- Shift among character
What does it mean to shift income across time
means you want to delay revenue recognition and accelerate expenses
how does shifting the time you pay taxes benefit a tax payer
In PV terms, tax costs decrease and cash flows increase when a tax liability is deferred until a later year
when do after cash flows increase in terms of Time
after-tax cash flows increase if income is recognized in the low-tax year and deductions taken in the high-tax year
What does tax planning in terms of jurisdiction mean?
the state in which the income is taxed or the country in which it is taxed
what jurisdiction do you want to have taxes in
one with a lower tax rate
What does it mean to shift tax to a different entity in terms of planning
shifting income to a different entity, such as a family member or different business entity owned by the taxpayer
What does shifting tax among character mean in terms of tax planning
shifting the character of your income can affect how it is taxed
-different things are taxed different
when considering cash inflows and outflows do you want higher or lower PV
outflows: low PV
cash inflows: high pv
what is ordinary income and how is it taxed
income generated by routine operations and investments and are taxed at regular rates
what is capital income and how is it taxed
generated by sale of capital assets and is subject to a lower tax rate
What is the business purpose doctrine
The IRS can disallow business expenses for transactions with no underlying business motivation
what is the step transaction doctrine
a company might break apart or lump transactions for tax purposes but the IRS can disallow if the think it’s necessary
what is the substance over form doctrine
IRS can tax on substance vs how company made something look
what is the economic substance doctrine
has to have meaning and be an economical transaction
