Exam
· 30-40 question Multiple Choice
· 5 hour exam (3.5 hours to complete on average)
· Open Book (anything you want, notes, computer, books)
Tax Introduction
· General Introduction
o Tax is political science course of who will bear the burden of financing the gov’t and who will get the benefits
o Fundamental Policy Issues
§ Who bears the cost (said it many times in class)
o Tax Base: Key Term
§ What are we taxing
§ Must know what to tax before we decide how much to tax
· Theory and Policy
o Why Income Tax
§ Income Defined
· Tax system in United States is based on “Income”
o Income defined by tax code, statutory definition
· More “income” you have, more tax you pay
§ Many different ways to impose a tax
· Head Tax
o Equal amount of tax on each person à not fair to the poor
· Ability to Pay
o Tax based on your “ability” to pay, not necessarily your “income”
o Possibilities
§ Narrow View
· Tax based on liquid assets, like cash
· Encourages holding illiquid assets, like house and property
§ Broader View
· Tax based on material well-being, without regard to liquidity
§ Broadest View
· Tax based on ones ability or opportunity to earn wealth (education considered)
· Taxing opportunity doesn’t seem fair
o How to implement tax on “ability to pay”
§ Income, consumption and wealth as tax bases
o Tax Incidence
§ Party that bears the ultimate burden of the tax bears the tax incidence
· Tax corporation à corporation passes taxes onto consumers à consumers bear tax incidence
§ Individuals can rarely pass tax incidence onto someone else
o Inflation
§ Tax system does not make adjustments for the effects of inflation
· Therefore, inflation impacts ones taxes over time
§ Bracket Creep
· Increase in tax rates that occurs solely as a result of inflation
· $25K taxed at 20%, $50K taxed at 30%
· 10 years later, $50K has spending power of $25K, yet now taxed at 30%
§ Investment in Productive Property
· Property that depreciates over time must be considered for tax purpose
· Buy property for $100K
· Sell property for $100K 20 year later
· Seems like you came out even, but $100K worth less in 20 years (actually have loss
o Income Tax vs. Consumption Tax
§ Possibly base tax on consumption rather than income
· Taxed on what they took out of the pot rather than what they put in it
· Taxed on wealth they consume not on the wealth they created
§ Example: Basic IRA
· Amount saved is tax deductible
· IRA grows over time (income), but not taxed
· Amount consumed or used from IRA is taxed (consumption)
· Rate Structures
o Progressive Income Tax
§ Tax rises as income rises
§ Not just greater amount of money taxed ($100K vs $25K)
§ But also greater percentage of the income ($100K at 28%, $25K at 15%)
o Marginal Rates
§ Increases in tax rates apply to the increment in income
§ Example
· 15% on first $20K
· 25% on income over $20K
· Person making $30K would pay 15% on $20K ($3K), and 25% on $10K ($2500)
§ Important for tax planning
· General Process (Ordinary Income)
o 1) Identify Gross Income
§ All income from any source
o 2) Subtract Exclusions/Deductions (“Above the Line”)
§ Items that are, by definition in Tax Code, not included in gross income
§ Generally non-personal expenditures
§ Expenses related to Trade or Business
§ Alimony payments
§ Moving expenses
o 3) Result is Adjusted Gross Income
o 4) Subtract Personal Allowances (“Below
unt, for each person in the house
o Itemized Deduction
§ For persons who qualify by having deductions that add up to amount more than the standard deduction
§ Taxable Income
· Amount of income subject to tax
o Gross Income – Deductions à Adjusted Gross Income
o Adjusted Gross Income – Allowances à Taxable Income
§ Allowances = Personal Exemptions + Personal Deductions (standard/itemized)
· Adjusted Gross Income – Personal Exemption(s) – Personal Deductions (standard or itemized)
· Income subject to tax at two rates
o Ordinary Income: Marginal Rate
o Capital Gains: Lower Rate
§ Tax Due
· Determined by applying the taxable income amount to the marginal tax rate table
§ Tax Credits
· Credits are used to offset the taxes due
o Subtracted from Taxes Due
o Direct dollar for dollar reduction of tax owed
· Examples
o Money already paid to gov’t through employer withholdings
· If credit is less than tax due
o Owe money
· If credit is more than tax due
o Refund
o Capital Gain
§ Defined
· Essentially corporate earnings or other profits dispersed to individual
§ How to get it
· Capital gain or loss is gain or loss from sale or exchange of capital asset
§ Capital Asset
· Broad definition of “property” but subject to exceptions (few)
§ Capital Gain or Loss
· Buying capital asset then selling later for higher (gain) or lower (loss) amount