Chapter 1 Flashcards
Marginal Tax Rate
Rate of tax that will be paid or saved on the next dollar of income.
Used in tax planning.
Average Tax Rate
(total federal income tax / taxable income)
Effective Tax Rate
(total federal income tax / economic income)
Tax Rate Type used in Tax Planning
Marginal Tax Rate
3 Tax Rate Structures
Proportional
Regressive
Progressive
Proportional Tax
Flat tax (average tax rate remains same as tax base increases). Example: sales tax, corporate tax rate at 21%
Regressive Tax
Average tax rate decreases as tax base increases.
Example: Social Security Tax ceiling
Progressive Tax
Average tax rate increases as tax base increases. Consistent with “ability to pay” component of tax.
Example of Proportional Tax
Sales Tax, corporate tax rate at 21%
Example of Regressive Tax
Social Security Tax ceiling
Example of Progressive Rate Structure
federal income tax
Oregon income tax
2 numbers needed to compute a tax
Tax Base x Tax Rate
4 Criteria of a Tax
- Paid to government, required by law
- Pursuant to legislative power
- Used for general public purposes
- No special benefit received
Income
Includes taxable & nontaxable income
Gross Income
Income - items excluded from income
Exclusions
Increases in wealth that Congress has decided not to tax
Gain
Difference between selling price of an asset and its original cost
4 Criteria to Evaluate a Tax
- Equity
- Certainty
- Convenience
- Economy
Horizontal Equity
Similar taxpayers in similar situations pay similar levels of tax
Vertical Equity
Taxpayers in different situations pay different levels of tax, but equitable in ability to pay
Transaction Loss
Asset is sold for less than its cost
Annual Loss
Excess of deductions over income (business)
What is another name for the Tax Base?
Taxable Income
Why does the IRS publish a new tax rate schedule every year?
For cost of living/inflation increases
Which is better, a tax credit or deduction? Why?
Credit, because it is a dollar-for-dollar reduction in tax. Deductions decrease taxable income.
What is the normal statute of limitations for a tax return?
3 years from due date of the return
In what situation is the statute of limitations on a tax return 6 years?
Omitting gross income in excess of 25%
What is the normal statute of limitations for a tax return?
3 years from due date of the return or date it was filed, whichever is later
Why are you likely to be audited if you have very low/no AGI?
refundable Earned Income Credit
Information Matching
Method the IRS uses to review/check tax returns. Example: W2 and 1099 reporting.
Document Perfection Program
IRS checking for mathematical errors on tax returns
Discriminant Function System (DIF)
Profiles IRS uses to compare likely deductions against certain incomes
What is the goal of tax planning?
To maximize after-tax wealth
How does tax planning use time value of money?
- Defer income, or
2. Accelerate expenses
How does tax planning use the marginal tax rate?
Recognizes income in year of lower MTR, recognizes deductions in year of higher MTR, shifts income to taxpayer with lower MTR
Tax Avoidance
Using legal methods to minimize tax liability
Tax Evasion
Illegal or fraudulent behavior to hide actual tax liability
3 elements of Tax Evasion
- Willfulness/intent
- Underpayment
- Action/concrete steps
