Chapter 1: An Introduction to Taxation and Understanding the Federal Tax Law

Question 1

Ad valorem taxes

Answer 1

A tax imposed on the value of property. The most common ad valorem tax is that imposed by states, counties, and cities on real estate. Ad valorem taxes can be imposed on personal property as well.

Question 2

Correspondence audit

Answer 2

An audit conducted by the IRS by the U.S. mail. Typically, the IRS writes to the taxpayer requesting the verification of a particular deduction or exemption. The remittance of copies of records or other support is requested of the taxpayer.

Question 3

Employment taxes

Answer 3

Taxes that an employer must pay on account of its employees. Employment taxes include FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes. Employment taxes are paid to the IRS in addition to income tax withholdings at specified intervals. Such taxes can be levied on the employees, the employer, or both.

Question 4

Estate tax

Answer 4

A tax imposed on the right to transfer property by death. Thus, an estate tax is levied on the decedent’s estate and not on the heir receiving the property.

Question 5

Excise taxes

Answer 5

A tax on the manufacture, sale, or use of goods; on the carrying on of an occupation or activity; or on the transfer of property. Thus, the Federal estate and gift taxes are, theoretically, excise taxes.

Question 6

FICA tax

Answer 6

An abbreviation that stands for Federal Insurance Contributions Act, commonly referred to as the Social Security tax. The FICA tax is comprised of the Social Security tax (old age, survivors, and disability insurance) and the Medicare tax (hospital insurance) and is imposed on both employers and employees. The employer is responsible for withholding from the employee’s wages the Social Security tax at a rate of 6.2 percent on a maximum wage base and the Medicare tax at a rate of 1.45 percent (no maximum wage base). The maximum Social Security wage base for 2016 is $118,500 and for 2015 is $118,500.

Question 7

Field audit

Answer 7

An audit conducted by the IRS on the business premises of the taxpayer or in the office of the tax practitioner representing the taxpayer.

Question 8

Flat tax

Answer 8

In its pure form, a flat tax would eliminate all exclusions, deductions, and credits and impose a one-rate tax on gross income.

Question 9

Franchise tax

Answer 9

A tax levied on the right to do business in a state as a corporation. Although income considerations may come into play, the tax usually is based on the capitalization of the corporation.

Question 10

FUTA tax

Answer 10

An employment tax levied on employers. Jointly administered by the Federal and state governments, the tax provides funding for unemployment benefits. FUTA applies at a rate of 6.0 percent on the first $7,000 of covered wages paid during the year for each employee in 2015. The Federal government allows a credit for FUTA paid (or allowed under a merit rating system) to the state. The credit cannot exceed 5.4 percent of the covered wages.

Question 11

Gift tax

Answer 11

A tax imposed on the transfer of property by gift. The tax is imposed upon the donor of a gift and is based on the fair market value of the property on the date of the gift.

Question 12

Indexation

Answer 12

A procedure whereby adjustments are made by the IRS to key tax components (e.g., standard deduction, tax brackets, personal and dependency exemptions) to reflect inflation. The adjustments usually are made annually and are based on the change in the consumer price index.

Question 13

Inheritance tax

Answer 13

A tax imposed on the right to receive property from a decedent. Thus, theoretically, an inheritance tax is imposed on the heir. The Federal estate tax is imposed on the estate.

Question 14

National sales tax

Answer 14

Intended as a replacement for the current Federal income tax. Unlike a value added tax (VAT), which is levied on the manufacturer, it would be imposed on the consumer upon the final sale of goods and services. To keep the tax from being regressive, low-income taxpayers would be granted some kind of credit or exemption.

Question 15

Occupational fee

Answer 15

A tax imposed on various trades or businesses. A license fee that enables a taxpayer to engage in a particular occupation.

Question 16

Office audit

Answer 16

An audit conducted by the IRS in the agent’s office.

Question 17

Personalty

Answer 17

All property that is not attached to real estate (realty) and is movable. Examples of personalty are machinery, automobiles, clothing, household furnishings, and personal effects.

Question 18

Realty

Answer 18

Real estate.

Question 19

Revenue neutrality

Answer 19

A description that characterizes tax legislation when it neither increases nor decreases the total revenue collected by the taxing jurisdiction. Thus, any tax revenue losses are offset by tax revenue gains.

Question 20

Sales tax

Answer 20

A state- or local-level tax on the retail sale of specified property. Generally, the purchaser pays the tax, but the seller collects it, as an agent for the government. Various taxing jurisdictions allow exemptions for purchases of specific items, including certain food, services, and manufacturing equipment. If the purchaser and seller are in different states, a use tax usually applies.

Question 21

Severance taxes

Answer 21

A tax imposed upon the extraction of natural resources.

Question 22

Statute of limitations

Answer 22

Provisions of the law that specify the maximum period of time in which action may be taken concerning a past event. Code §§ 6501-6504 contain the limitation periods applicable to the IRS for additional assessments, and §§ 6511-6515 relate to refund claims by taxpayers.

Question 23

Sunset provision

Answer 23

A provision attached to new tax legislation that will cause such legislation to expire at a specified date. Sunset provisions are attached to tax cut bills for long-term budgetary reasons to make their effect temporary. Once the sunset provision comes into play, the tax cut is rescinded and former law is reinstated. An example of a sunset provision is contained in the Tax Relief Reconciliation Act of 2001 that related to the estate tax. After the estate tax was phased out in 2010, a sunset provision called for the reinstatement of the estate tax as of January 1, 2011.

Question 24

Use tax

Answer 24

A sales tax that is collectible by the seller where the purchaser is domiciled in a different state.

Question 25

Value added tax (VAT)

Answer 25

A national sales tax that taxes the increment in value as goods move through the production process. A VAT is much used in other countries but has not yet been incorporated as part of the U.S. Federal tax structure.

Question 26

Wherewithal to pay

Answer 26

This concept recognizes the inequity of taxing a transaction when the taxpayer lacks the means with which to pay the tax. Under it, there is a correlation between the imposition of the tax and the ability to pay the tax. It is particularly suited to situations in which the taxpayer’s economic position has not changed significantly as a result of the transaction.