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Chapter 1. Introduction to Taxation, the Income Tax Formula, and Form 1040EZ “Taxes, after all, are dues that we pay for the privileges of membership in an organized society.” -- Franklin D. Roosevelt. LO #1 Understand progressive, proportional, and regressive tax structures.

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Chapter 1

Chapter 1

Introduction to Taxation, the Income Tax Formula, and Form 1040EZ

“Taxes, after all, are dues that we pay for the privileges of membership in an organized society.”

-- Franklin D. Roosevelt


Lo 1 understand progressive proportional and regressive tax structures

LO #1 Understand progressive, proportional, and regressive tax structures

  • Taxes are levied by multiplying a tax rate (the rate of tax) by a tax base (the amount taxed).

    • May be multiple rates on multiple bases (see Table 1-2)


Lo 1 understand progressive proportional and regressive tax structures1

LO #1 Understand progressive, proportional, and regressive tax structures

  • Progressive tax structure:

    • The tax rate increases as the tax base increases.

    • Example is the U.S. income tax system

  • Proportional tax structure:

    • The tax rate remains the same regardless of the tax base.

    • Example is state or local sales taxes


Lo 1 understand progressive proportional and regressive tax structures2

LO #1 Understand progressive, proportional, and regressive tax structures

  • Regressive tax structure:

    • the tax rate decreases as the tax base increases.

    • Example is social security tax system


Lo 1 understand progressive proportional and regressive tax structures concept check 1 1

LO #1 Understand progressive, proportional, and regressive tax structures – Concept Check 1-1

1. The three types of tax rate structures are ________, _________, and _________.

Progressive, proportional, and regressive

2. The tax rate structure for which the tax rate remains the same for all levels of the tax base is the __________ rate structure.

Proportional

3. The federal income tax system is an example of a ________ tax structure.

Progressive


Lo 2 marginal and average tax rates

LO # 2 Marginal and Average Tax Rates

  • Average tax rates is the total tax paid for a certain amount of taxable income

    Total tax / taxable income = average tax rate

  • Marginal tax rates are the rate of tax that will be paid on the next dollar of income.

    • Determined with reference to tax tables

    • For example, a married couple will pay a marginal rate of 15% on their $35,000th dollar.


Lo 2 the income tax formula

LO # 2 The Income Tax Formula

Income

− Permitted Deductions from Income

--------------------------------

= Taxable Income

× Appropriate Tax Rates

--------------------------------

= Tax Liability

− Tax Payments and Tax Credits

---------------------------------

= Tax Refund or Tax Due with Return


Lo 2 the income tax formula concept check 1 2

LO # 2 The Income Tax FormulaConcept Check 1-2

1. The marginal tax rate is the rate of tax imposed on the next dollar of taxable income.

True

2. What is the marginal tax rate for a married couple with taxable income of $64,510?

25%


Lo 2 the income tax formula concept check 1 21

LO # 2 The Income Tax FormulaConcept Check 1-2

3. Average tax rate and marginal tax rate mean the same thing.

False

4. Complex tax returns do not follow the basic (or simplified) income tax formula.

False


Lo 3 components of form 1040ez

LO #3 Components of Form 1040EZ

  • Taxpayers annually file a tax return using either

    • Form 1040

    • Form 1040A

    • Form 1040EZ

  • All follow the basic income tax formula

  • Form 1040EZ is the simplest form


Lo 3 components of form 1040ez1

LO #3 Components of Form 1040EZ

  • To use a 1040EZ taxpayer must meet all:

    • Single or married

    • Under age 65 and not blind

    • No dependents

    • Taxable income < $100,000

    • Income only from wages, unemployment compensation or interest less than $1,500

    • Claim no credits except EIC


Lo 3 components of form 1040ez concept check 1 3

LO #3 Components of Form 1040EZConcept Check 1-3

1. Almost all taxpayers can file a Form 1040EZ.

False

2. Max, who is 74 years old and single, is eligible to file Form 1040EZ if his taxable income is under $100,000.

False

3. Erma, a 28-year-old single taxpayer with no dependents, has wage income of $40,000. She is eligible to file a Form 1040EZ.

True


Lo 3 components of form 1040ez2

LO #3 Components of Form 1040EZ

  • Wages include salaries, tips, commissions, bonuses, severance pay, sick pay, meals and lodging, fringe benefits, etc.

    • Employees receive a Form W-2 indicating total wage income in box 1

  • Interest income is taxable unless specifically exempt

    • Interest income reported on Form 1099-INT


Lo 3 components of form 1040ez3

LO #3 Components of Form 1040EZ

  • Unemployment compensation is taxable

    • Reported on Form 1099-G

  • Permitted deductions are shown on line 5

    • $8,450 for single, $16,900 for married

  • Total income minus permitted deductions equal Taxable Income (line 6)


Lo 3 components of form 1040ez concept check 1 4

LO #3 Components of Form 1040EZConcept Check 1-4

1. There are only three types of income that can be reported on a Form 1040EZ.

Wages, unemployment comp., interest

2. Unemployment compensation is reported to the taxpayer on a Form ______.

Form 1099-G

3. To be able to use a Form 1040EZ, a taxpayer must either be filing status _______ or filing status __________.

Married filing jointly or single


Lo 4 calculation of tax

LO #4 Calculation of Tax

  • For taxable income up to $100,000, use tax tables (printed in the back of the book)

  • Tax rate schedules used for higher income

  • Tax tables calculate tax at the midpoint of the range on the table

  • Tax rate schedules calculated precisely


Lo 4 calculation of tax concept check 1 5

LO #4 Calculation of TaxConcept Check 1-5

1. Taxpayers eligible to use Form 1040EZ must calculate their tax liability using the tax tables.

True

2. Refer to the tax tables. What is the tax liability of a married couple with taxable income of $89,262?

$15,434

3. Using the tax rate schedules in Table 1-2, determine the tax liability (to the nearest penny) for a married couple with taxable income of $89,262.

$15.430.50


Lo 3 tax payments

LO #3 Tax Payments

  • Tax liability is generally paid throughout the year through withholding tax payments deducted from wages

    • Also reported on W-2

  • Low income taxpayers may be eligible for the Earned Income Credit


Lo 3 tax payments1

LO #3 Tax Payments

  • A tax return is also used to “settle up” with the IRS at the end of the year.

  • When filing a tax return, taxpayers will either

    • Owe the IRS (tax liability > payments)

    • Receive a refund (tax liability < payments)


Lo 3 tax payments concept check 1 6

LO #3 Tax PaymentsConcept Check 1-6

1. Taxpayers pay all of their tax liability when they file their tax returns.

False

2. Bret’s tax liability is $15,759. His employer withheld $16,367 from his wages. When Bret files his tax return, will he be required to pay or will he get a refund? What will be the amount?

Refund, $608

3. An Earned Income Credit will increase the amount of tax liability.

False


Lo 5 tax authority

LO #5 Tax Authority

  • Tax authority is the body of law, regulation, and precedent that guide taxpayers, the IRS, and the courts in the proper application of tax law.

  • Three types of primary tax authority:

    • Statutory sources

    • Administrative sources

    • Judicial sources


Lo 5 tax authority1

LO #5 Tax Authority

  • Statutory sources of tax authority

    • 16th amendment to the U.S. Constitution

    • Internal Revenue Code (IRC)

      • Passed by Congress and signed into law by the president

    • Committee reports from tax law process


Lo 5 tax authority concept check 1 7

LO #5 Tax AuthorityConcept Check 1-7

1. The committee charged considering tax legislation in the House of Representatives is called the ________________ Committee.

Ways and Means

2. The most commonly relied-on statutory authority is _________________.

The Internal Revenue Code


Lo 5 tax authority concept check 1 71

LO #5 Tax AuthorityConcept Check 1-7

3. All tax legislation must pass both the House of Representatives and the Senate and be signed by the president of the United States in order to become law.

True


Lo 5 tax authority2

LO #5 Tax Authority

  • Administrative sources of tax authority, in order of strength

    • Treasury Regulations (IRS Regulations)

    • Revenue Rulings

    • Revenue Procedures

    • Private Letter Rulings

    • IRS Notice


Lo 5 tax authority concept check 1 8

LO #5 Tax AuthorityConcept Check 1-8

1. Administrative tax authority takes precedence over statutory tax authority.

False

2. IRS Revenue Procedures are applicable only to the taxpayer to whom it is issued.

False

3. The administrative tax authority with the most strength of authority is_______.

IRS Treasury Regulations


Lo 5 tax authority3

LO #5 Tax Authority

  • Judicial sources of tax authority

    • Courts resolve disputes between taxpayers and IRS.

    • Initial court of jurisdiction is either

      • Tax Court

      • U.S. District Court

      • U.S. Court of Federal Claims


Lo 5 tax authority4

LO #5 Tax Authority

  • Tax Court and District Court rulings can be appealed to the U.S. Court of Appeals and then to the Supreme Court

  • U.S. Court of Federal Claims rulings can be appealed to the U.S. Court of Appeals and then to the Supreme Court.


Lo 5 tax authority concept check 1 9

LO #5 Tax AuthorityConcept Check 1-9

1. The U.S. Supreme Court does not accept appeals of tax cases.

False

2. A taxpayer who does not agree with an assessment of tax by the IRS has no recourse.

False

3. A taxpayer who does not want to pay the tax assessed by the IRS prior to filing a legal proceeding must use the ___________ Court.

Tax Court


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