10-1 Direct tax ---- Individual Income Tax. Direct tax. Income tax Individual income tax Corporate income tax Property tax (Estate tax) Inheritance tax Gift tax. Main points. The history of individual income tax The calculation of income tax( progressive tax rate)
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Direct tax • Income tax Individual income tax Corporate income tax • Property tax (Estate tax) • Inheritance tax • Gift tax
Main points • The history of individual income tax • The calculation of income tax( progressive tax rate) • Federal income tax • State income tax
Income Tax----FederalState History… • Federal income tax Birthed in the Civil War. • Very unpopular, Administrative nightmare • 1872—Repealed • 1894 -- Unsuccessful attempt to revive (protectionists v. anti-protectionists), resentment of wealth accumulation • Reenacted in 1893 to lift depression-era revenues • Declared unconstitutional – not apportioned based on population
Income Tax----FederalState History 1913 U.S. Constitution Amended to allow income taxation (16th Amendment) – Income tax enacted • Current income taxes are imposed under these constitutional provisions and various sections of Subtitle A of the Internal Revenue Code of 1986. • As amended, including 26 U.S.C.§ 1 (imposing income tax on the taxable income of individuals, estates and trusts) and (imposing income tax on the taxable income of corporations).
Income Tax----State History… • Predates federal history • 1911—Wisconsin enacts first real state income tax • Earlier unsuccessful experiments in other states • Administrative problems • Wisconsin introduced source documentation, central state-level administration • Adoption in other states quickly followed • By 1919 – 9 additional states • By 1940, 33 state personal income taxes (Alaska repealed their income tax in 1979) • MN enacted tax in 1933, rates from 1% to 5% • Philadelphia enacted first local income tax in 1939 to combat real estate property devaluation
Income Tax---Other Attributes… • Broad base means “High-powered money” – small rate increases yield significant revenue gains • Base corresponds to “Ability to Pay”, though not perfectly • Source documents mean cost-effective administration • Progressive base and rates result in high revenue elasticity (though diminished by bracket indexing). • Some state, like MN does not allow local governments to have a personal Income tax • Most states’ tax base is linked to the federal base • Linkage to the federal system promotes simplicity and ease of administration, but can create state revenue losses when the feds restrict their tax base (requires MN to monitor federal legislation, identify state fiscal impacts of federal changes, promote conformity)
Internal Revenue Service (IRS) • The Internal Revenue Service (IRS) is the United States federal government agency that collects taxes and enforces the internal revenue laws. The official U.S. Treasury regulations provide (in part): • The Internal Revenue Service is a bureau of the Department of the Treasury under the immediate direction of the Commissioner of Internal Revenue. • The Commissioner has general superintendence of the assessment and collection of all taxes imposed by any law providing internal revenue. • The Internal Revenue Service is the agency by which these functions are performed.
Income tax in the United States • The federal government of the United States imposes a progressive tax on the taxable income of individuals, partnerships, companies, corporations, trusts, and certain bankruptcyestates. • Some state and municipal governments also impose income taxes.
Income tax basics • While U.S. tax law is very complex, the underlying idea is relatively easy to understand. • Simplifying greatly, gross income is all income from all sources less any exclusions. • An exclusion is something that Congress has effectively said a taxpayer need not include in his or her income for tax purposes, such as employer-paid health insurance or interest from tax-exempt bonds.
For individuals, Adjusted Gross Income (AGI) is gross income less any above-the-linedeductions. • Above-the-line deductions are listed in and include trade or business deductions, alimony, and moving expenses • Taxable income is AGI less: (1) itemized deductions or the applicable standard deduction, whichever is greater (2) a deduction for any allowable personal exemptions for the taxpayer, the taxpayer's spouse (if filing jointly), and the taxpayer's dependents.
Types of Individual Income for Tax Purposes • Ordinary income *Compensation for personal services such as wages and salaries * Business profit * Dividends from stock shares * Interest income from invested funds • capital gain *Capital gain generally comes from the sale of investment property.
Year 2007 income brackets and tax rates • Six tax brackets for ordinary income (ranging from 10% to 35%) • Four classifications: *Single *Married filing jointly (qualified widow or widower) *Married filing separately, * Head of Household
Example of a tax computation • Income tax for year 2007: • $40,000 (taxable income) • $7,825 × 0.10 = $782.50 • ($31,850 - $7,825) × 0.15 = $3,603.75 • ($40,000 - $31,850) × 0.25 = $2,037.50 • Total income tax = $6,423.75 (16.06% of income assuming no deductions, exemptions or credits are taken)
Note that in addition to income tax, a wage earner would also have to pay (payroll) tax (and an equal amount of FICA tax must be paid by the employer): • $40,000 (adjusted gross income) • $40,000 × 0.062 = $2,480 (Social Security portion) • $40,000 × 0.0145 = $580 (Medicare portion) • Total FICA tax = $3,060 (7.65% of income) • Total federal tax of individual = $9,483.75 (23.71% of income)
Short-term capital gains are taxed as ordinary income rates as listed above. Long-term capital gains have lower rates corresponding to an individual’s marginal ordinary income tax rate, with special rates for a variety of capital goods.
Tax rates in history • History of top rates • In 1913 the tax rate was 1% on taxable net income above $3,000 ($4,000 for married couples), less deductions and exemptions. It rose to a rate of 7% on incomes above $500,000. • During World War I the top rate rose to 77%; after the war, the top rate was scaled down to a low of 25%. • During the Great Depression and World War II, the top income tax rate rose again. In the Internal Revenue Code of 1939, the top rate was 75%. The top rate reached 94% during the war and remained at 91% until 1964.
History of top rates • In 1964 the top rate was decreased to 70% (1964 Revenue Act), then to 50% in 1981 (Economic Recovery Tax Act or ERTA). • The Tax Reform Act of 1986 reduced the top rate to 28%, at the same time raising the bottom rate from 11% to 15% (in fact 15% and 28% became the only two tax brackets). • During the 1990s the top rate rose again, standing at 39.6% by the end of the decade. • The top rate was cut to 35% and the bottom rate was cut to 10% by the Economic Growth and Tax Relief Reconciliation Act of 2001.
History of progressivity in federal income tax • The federal income tax rates in the United States have varied widely since 1913. For example, in 1954 the Congress imposed a federal income tax on individuals, with the tax imposed in layers of 24 income brackets at tax rates ranging from 20% to 91% (for a chart, see Internal Revenue Code of 1954). • Here is a partial history of changes in the U.S. federal income tax rates for individuals (and the income brackets) since 1913:
State income taxes • No state income tax in red: Washington, Nevada, Wyoming, South Dakota, Texas, Florida • States that tax only interest and dividend income in yellow: Tennessee, New Hampshire
State and territorial income taxes • Income tax may also be levied by individual U.S. states and are on top of the federal income tax. • In addition, some states allow individual cities to impose an additional income tax. • Some state and local taxes are deductible for federal tax purposes. Through this deduction, the federal government effectively subsidizes a portion of an individual's state income tax.
Individual Income Tax Minnesota’s Individual Income Tax Federal taxable income + MN additions – MN subtractions Minnesota taxable income X tax rates (5.35%, 7.05%, 7.85%) Minnesota gross tax – tax credits (refundable, nonrefundable) Net Minnesota individual income tax
Individual Income Tax Federal “Tax Expenditures” Cost MN $4.39 billion
Individual Income Tax Minnesota “Tax Expenditures” Cost MN $294 million Minnesota Tax Expenditure Report, Feb. 2008
Individual Income Tax Taxable Share of Gross Income