Exam 1 Flashcards
1
Q
Define “Exclusions” and give some examples
A
- Items that are specifically removed from the tax base by law
- It reduces the amount that a tax filer reports as their total, or gross, income
Ex. Academic scholarships, portions of retirement income, combat zone
2
Q
Define “Deduction” and give some examples
A
- Items that are explicitly subtracted in deriving the tax base, reducing their tax liability
- Lowers a person’s tax liability by lowering his taxable income
Ex. Business expenses, charitable donations, contributions to pension accounts
3
Q
Define “Tax Base”
A
- The net quantity on which any particular tax is levied
- The remaining amount after considering both exclusions and deductions
- The total amount of assets or income that can be taxed
- Your taxable income/estate/gifts
4
Q
Define “Tax Rate”
A
- A specified percentage or series of percentages in the case of a progressive tax, which the law stipulates as the appropriate multiplier in the determination of the gross tax liability
- The percentage at which an individual or corporation is taxed
5
Q
Define “Tax Credits”
A
- Any specifically authorized reduction in gross tax liability
- An amount of money that taxpayers can subtract from taxes owed to their government
- Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed
- Used to incentivize, to protect the environment there’s a credit for the cost of purchasing solar panels for use in your home, credits for adopting children
6
Q
Define “Flat Tax”
A
- One single rate is applied to the entire tax base regardless of income bracket
7
Q
Define “Progressive Tax”
A
- The marginal rates get higher as the tax base increases in amount
- A tax that imposes a lower tax rate on low-income earners
- A tax based on the taxpayer’s ability to change
8
Q
Define “Property taxes” and name the two property tax categories
A
- Taxes imposed on the mere ownership of property.
- Typically based on the value of the property
- Two categories: realty and personalty
9
Q
Define “Real property taxes”
A
- All real property is subject to this tax which is imposed at the local level
- Easy to impose a property tax on real estate because it cannot be concealed and is immobile
10
Q
Define “Personal property taxes”
A
- Difficult tax to enforce because property is easily concealed and moved
- Only common personal property tax is imposed on vehicles and is easy to enforce because it is necessary to register them`
11
Q
Define “Sales tax”
A
- A tax typically applied by the state with an additional small amount imposed at the city level
- Imposed by the government on the sale of goods and services
- Only charged to the end user of a good or service, not manufactures
12
Q
Define “Use tax”
A
- Used to prevent the avoidance of a sales tax
- It’s a sales tax on purchases made outside one’s state of residence for taxable items that will be used, stored or consumed in one’s state of residence on which no tax was collected in the state of purchase
- Imposed at the same rate as a sales tax, on the use or consumption of personal property
13
Q
Define “Excise tax”
A
- Imposed as a result of the sale of goods, but it only applies to the sale of a specific good or service (tires, cigarettes, gasoline)
- An indirect tax, the IRS levies the tax on the producer or merchant who passes it onto the consumer by including it in the product’s price
14
Q
Define “Transfer tax” and give two categories of it
A
- Imposed on the right to transfer property either by gift or inheritance
- Imposed on the donor not the donee
- Two categories are gift tax and estate tax
15
Q
Define “Gift tax”
A
- Imposed on the intervivos (living) transfer of property
- Gifts are allowed a $15,000 ($30,000 if gifts are given jointly with spouse) per year per donee exclusion
- Unlimited marital deduction and contribution to charity
16
Q
Define “Estate tax”
A
- A tax levied on an heir’s inherited portion of an estate if the value of the state exceeds an exclusion limit of $11,200,000
17
Q
What are the two components of FICA taxes?
A
- Social security tax (old age, survivors, and disability insurance) and Medicare tax
- The employee pays a specified percentage of wage base and the employer matches it
18
Q
What are the rates on social security and Medicare?
A
- Social security: 6.2% up to $128,000
- Medicare: 1.45% for an unlimited wage base, .9% tax on earned income above $200,000 fir single people and $250,000 for married filing jointly
19
Q
What are the self-employment tax rates?
A
- Tax is the same as the FICA tax but applied to those who are self-employed
- 15.3% tax on income up to $128,400 and 2.9% on income in excess of $128,400
20
Q
Tax avoidance versus tax evasion
A
- Legitimate means of reducing taxes are known as tax avoidance
- Illegal means to the same end are called tax evasion
- Minimizing taxes vs. not paying taxes
21
Q
What are the three sources of tax law?
A
- Statutory
- Administrative
- Judicial
Sources may be classified as secondary or primary.
- Primary: issued by some branch of government in an official capacity
- Secondary: carry no official weight as far as the IRS is concerned (ex. textbooks)
22
Q
Statutory sources of tax law
A
- The Internal Revenue Code (IRC) is the statutory source of tax law
- The “Code” represents laws passed by Congress and signed into law by the President
23
Q
Administrative sources of tax law
A
- Issuances from the Department of the Treasury (The IRS)
- The most importance source here is Regulations, which clarify or elaborate on the Code sections passed by Congress
24
Q
Judicial authority sources of tax law
A
- Taxpayers who disagree with the IRS’s interpretation of the law may take their case to federal court-perhaps all the way to the Supreme Court
- The legal decisions handed down provide clarification and insight into the correct implementation of the tax law
25
Describe the entity variable
- The entity variable is about which entity undertakes the transaction
- Individuals and regular corporations are the two primary taxpaying entities
- Partnerships (including LLCs and LLPs) and S-Corporations are not taxpaying entities
26
Explain the Assignment of Income Doctrine
- The taxpayer cannot assign income to someone else
- If the taxpayer retains ownership of the property, then the taxpayer is taxed on the income derived from the property
- In place to avoid tax evasion
27
Describe the time period variable
- The Time period variable is which tax year or years the transaction occurs
- The tax cost or savings depends on the year in which the transaction occurs
- Assuming equal marginal tax rates and costs across time periods, a dollar paid in tax in the current year costs more than a dollar paid in a later year
- A dollar saved in this year is worth more than a dollar of tax saved in some future period
- Examples are waiting several years before selling stock or investing in retirement plans
28
Describe the Jurisdiction variable
- The jurisdiction variable is about which taxing jurisdiction the transaction occurs
- Tax costs decrease when income is generated in a jurisdiction with a low tax rate
- Common tax havens include Luxembourg, Caymen Islands, Isle of Man, Jersey, Ireland, Bermuda, and the Bahamas
- Populations are generally increasing in low tax states such as Texas and Florida (no income tax) and leaving high tax states such as NJ, New York, and Connecticut
29
Describe the Character variable
- The character variable is about what the tax character of the income from the transaction is
- Every item of income is ultimately characterized for tax purposes as either ordinary income or capital gain
30
When are you entitled to receive a long-term capital gain?
- Taxpayers with ordinary income tax rates of 10% or 12% have long term capital gain rates and qualified dividend rates of 0%
- The other two rates for long term capital gains and qualified dividends are 15% and 20%
31
How do you decide between taxable or municipal bond interest?
```
Yt = Ym / (1-mtr)
Yt = Equivalent taxable yield
Ym = Current yield on municipal bonds
mtr = Marginal tax rate
```
If the investor's equivalent yield (Yt) is greater than the yield currently available on taxable bonds of comparable risk, the municipal bonds should be purchased. If it's less, then taxable bonds should be purchased.
32
Define "Capital gain"
- A rise in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price
- The gain is not realized until the asset is sold
- A capital gain may be short-term (one year or less) or long-term (more than one year) and must be claimed on income taxes
33
Summary of the four basic tax planning maxims
1. Tax costs decrease when income is generated by an entity subject to a relatively low tax rate
2. Tax costs decrease when a tax liability is deferred until a later taxable year
3. Tax costs decrease when income is generated in a jurisdiction with a relatively low tax rate
4. Tax costs decrease when income is taxed at a preferential rate because of its character
34
Define "Municipal bond"
- A debt security issued by a state, municipality or county to finance its capital expenditures (ex. highways, bridges, schools)
- Exempt from federal taxes and most state and local taxes making them especially attractive to people in high income tax brackets
