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90 terms

Tax Accounting Exam 1

STUDY
PLAY
Tax
A mandatory assessment levied under the authority of a political entity for the purpose of raising revenue to be used for public or governmental purposes
Average Tax Rate (ATR)
Tax liability / taxable income
Effective Tax Rate (ETR)
Tax liability / economic income
Marginal Tax Rate (MTR)
Change in tax liability / change in income
Qualified dividends
Dividends received from U.S. corporations
Long-term capital gains
Gains on disposition of capital property held more than one year
Income effect
tax rates increase, less pocket money for taxpayers, they spend less
Tax neutrality
best achieved by broadening the tax base, lowering overall tax rates, and promoting tax-inelastic goods
Internal Revenue Code (IRC)
compilation of all tax laws in force; highest statutory authority; passed by Congress
The President
introduces tax policy changes to Congress
Treasury department
interprets and enforces tax law
legislative regulations
have the full force and effect of law
proposed regulations
preview of forthcoming regulations with a comment period
temporary regulations
issued immediately where guidance is important
revenue rulings
issued by IRS; provide specific examples of how IRS would apply the law to specific fact situations
revenue procedures
issued by IRS; provide guidance on practice and procedure; help increase taxpayer compliance
private letter ruling
applies only to the requesting taxpayer; regarding prospective transactions
technical advice memorandum (TAM)
letter ruling regarding past transactions
District courts
only courts where a jury trial is possible (over 95)
Appellate courts
13 judicial circuits; 11 geographical, DC, Federal
Steps in the research process
Determine the facts > Identify the issues > locate applicable authorities > evaluate the authorities (and conflicting authorities) > analyze the facts in terms of applicable authorities > communicate conclusions and recommendations to client
File memorandum
internal communication; written for fellow tax practitioners who are well versed in the tax law
Client letter
external communication; purpose is to educate the client
Policy-oriented research
conducted to formulate tax policy; used by economists to assess effects of government policy
Client-oriented research
conducted to determine tax consequences of transactions to specific taxpayers
Closed-fact situation
facts occurred; advisor determines appropriate tax treatment; fairly straightforward, least amount of flexibility
Open-fact situation
facts not occurred; advisor plans them to produce favorable tax result; flexibility to structure transactions to accomplish client's objective
Tax planning objectives
1. maximize after-tax cash inflows 2. minimize after-tax cash outflows
Reduce tax base
convert income from taxable to tax-exempt; convert expenditures from non-deductible to deductible
Reduce tax rate
convert income or gain from taxed at regular rates to taxed at preferential rates; convert expense or loss deductions from tax saved at preferential rates to tax saved at regular rates
Shift income to lower bracket
lower-bracket entity; lower-bracket tax year; lower-bracket jurisdiction
Shift deductions to higher bracket
higher-bracket entity; higher-bracket tax year; higher-bracket jurisdiction
Tax planning steps
consider all affected tax years > consider all affected parties > consider all affected tax jurisdictions > consider implicit as well as explicit taxes > consider non-tax costs as well as tax costs
Tax planning stops
1. assignment of income doctrine 2. business purpose doctrine 3. substance over form and step transaction doctrines 4. related party loss rules 5. implicit taxes 6. kiddie tax
Assignment of Income doctrine
whoever earns the income, pays the tax on it
Business Purpose doctrine
cannot structure transactions solely to reduce federal income taxes
Current Model Investments (Formula)
ATA = AT$ Invested [1 + R(1-t)]^n
Deferred Model Investments (Formula)
ATA = AT$ Invested [(1+R)^n*(1-t) + t]
Pension Model Investments (Formula)
ATA = BT$ Invested [(1+R)^n *(1-t)]
Exempt Model Investments (Formula)
ATA = AT$ Invested (1+R)^n
BT$ (Formula)
BT$ = AT$ / (1-t)
AT$ (Formula)
AT$ = BT$ * (1-t)
BTROR (Formula)
R = r / (1-t)
ATROR (Formula)
r = R * (1-t)
Tax return positions
realistic possibility that the position will be unheld on audit
Answers to questions
obligation to have client answer all applicable questions on a tax return
Procedural aspects
obligation to examine/verify supporting documents
Use of estimates
taxpayer must provide estimates
Knowledge of error in return preparation
Must inform taxpayer and recommend correction
Classic criteria of a good tax
Equity (Fairness), Certainty (Stability), Convenience (Simplicity), Economy (Cost-Effectiveness)
Horizontal equity
Taxpayers in equal economic circumstances should pay equal taxes
Vertical equity
Taxpayers in unequal circumstances should be taxed differently in some appropriate manner
Streamlined Sales Tax Project (SSTP)
seeks to standardize 50 separate state-by-state sales and use tax systems and reduce the costs and burdens of sales tax compliance for businesses
Nexus
the degree of business activity in a jurisdiction
Activities that create nexus:
physical presence in jurisdiction, incorporated in jurisdiction, doing business in jurisdiction
Activities that do not create nexus:
selling only tangible goods in jurisdiction, sending salespeople to solicit orders in jurisdiction, running ad campaigns in jurisdiction, maintaining a display room for less than 2 weeks in jurisdiction
Jurisdiction
the geographical area over which a court or government body has the power and right to exercise authority
UDITPA
Income taxable in jurisdiction = (total taxable business income) * (average rate)
Average rate (Formula)
[(sales factor) + (payroll factor) + (property factor) / 3]
Sales factor (Formula)
(gross sales in jurisdiction) / (total business gross sales)
Payroll factor (Formula)
(total payroll in jurisdiction) / (total business payroll)
Property factor (Formula)
(total cost of property located in jurisdiction) / (total cost of business property)
Economic income
=Consumption + Change in wealth
Financial accounting income
= Earned and realized income
Tax income
= Realized and recognized income
Unrealized income
an increase in wealth without an external transaction
Realized income
an increase in wealth with an external transaction
Earned income
income from labor or business activities
Unearned income
Income from capital investments
Flow-through (Conduit) entities (Definition)
income earned by entity is allocated to owners > the income is reported on their own tax returns
Flow-through (Conduit) entities (Examples)
Sole proprietorships, partnerships, S Corporations, Limited Liability Companies
Partial flow-through (Fiduciary) entities
Trusts, Estates
Tax-exempt entities
charitable organizations, civic organizations, scientific organizations, educational organizations
Taxable entities
C Corporations, Individuals
Self-employment tax (SE tax)
an employment tax paid to the Department of Labor, but administered through the income tax system; funds OASDI & HI
Employed taxpayers
paid 1/2 of their employment taxes via wage withholdings
Self-employed taxpayers
compute employment taxes and pay them in quarterly estimated payments (prepayments) along with quarterly estimates of income tax
SE Income
= net earnings from sole proprietorship, partner's share of partnership income & guaranteed payments from partnership, royalties, director's fees, research grants
Net earnings from SE
= SE income * .9235
SE tax components
1. Social Security (OASDI) & 2. Medicare (HI)
Parallel income tax system
taxpayer computes tax under regular system and then under AMT system and pays the greater
Purpose of AMT
to ensure a minimum amount of taxation for approximately 150 super-rich taxpayers
AMT rates
26& on first $175,000 of AMT base and 28% on excess
AMT credits
non-refundable personal credits; foreign tax credit; AMT paid in prior years on incentive stock options
Implicit tax (formula)
IT = Rb - Re
Implicit tax rate (formula)
tI = (Rb - Re) / Rb
Rb
BTROR on fully taxable investment
Re
BTROR on tax favored investment
Nonrefundable credit
A credit that can only zero out the tax liability; cannot make the tax liability negative
Tax preferences (examples)
excess of accelerated depreciation over straight line on real property: some tax-exempt interest; gains excluded on sales of small business stock