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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


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


the geographical area over which a court or government body has the power and right to exercise authority


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


BTROR on fully taxable investment


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

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