Chapter 1: Federal Income Overview Flashcards
The purpose of tax
To raise revenue to pay for government services
To promote social changes
To encourage or discourage certain economic behaviors
Definition of tax
An enforced involuntary contribution that is determined by law to provide revenue for federal and public purposes for no direct benefits are directly received
Adam Smiths standards of a good tax system
Equality: tax should based on the ability to pay
Certainty: it should be known when and how a tax is to be paid
Convince: tax should be paid when the funds are available
Economy: the costs incurred for complying should be minimal
Horizontal Equity
Two similarly situated taxpayers that are taxed the same
Vertical equity
Differently situated taxpayers are taxed differently but fairly
Marginal tax rate
The rate of tax on the next dollar of taxable income
Average tax rate
The rate equal to the total tax divided by the tax base
Effective tax rate
Total tax divided by economic income
Economic income: taxable + non taxable
Proportional tax rate
Average tax rate stays the same as the tax base the same
Average rate is equal to marginal rate
Regressive tax rate
Average tax rate decreases as the tax base stays the same
Marginal rate is below the average rate
Progressive Tax Rate
Average tax rate increases as the tax base increases
Marginal rate is above the average rate
Conduit entities
Are not tax entities - they do not file tax returns
Income from conduit entities
Income from a conduit entities is reported by the owners and taxed on the owners individual return
Income Tax
Taxes paid by individuals
Tax base is total income less any allowed deductions
Employment taxes
Paid by employee/employer
Tax bard is wages and salaries earned
Examples:
Social security tax “OASDI”6.2% on first 117,000) doubled for self employed
Unemployment Taxes “MHI” 1.45%, there is no limit
What social Security “OASDI” are not…
Social security taxes is not a funded system - that is current payments are for current benefits
For deductions
Amounts taken from gross income to get to AGI
From deductions
Deductions taken from “AGI “ to get to taxable income
Calculation for taxes due
Taxable income * tax rate= tax lability - prepayment/credits =tax (refund due )
Tax credit, for deductions, or from deductions????
You always want a tax credit as it is a dollar for dollar reduction of your tax
Facts about tax planning
If you owe taxes then defer as long as you legally can
Recognize income in years with lower marginal rate
Recognize deductions in year of higher marginal rate
Tax evasion
Occurs when a taxpayer uses illegal or deceptive methods to hide actual tax liability
Three elements if tax evasion
- Willingness from the taxpayer
- An underpayment of taxes
- Affirmative act by the taxpayer to evade the tax
