Transcript Chapter 1- Instructor PowerPoint Slides. Summer, 2008

Chapter 1.
Federal Income Taxation—
An Overview
Instructor PowerPoint Slides
This file contains illustrative problems that
will be used in the lecture to illustrate
important concepts and procedures.
Updated August 26, 2014
Howard Godfrey, Ph.D., CPA
Professor of Accounting
©Howard Godfrey-2014
Part-1,2. Definition and evaluation of a
tax. Rate Structures.
Part-3. Major Types of Taxes.
Part-4. Sources of Federal Income Tax
Law.
Part-5. Federal taxation terminology.
Part-6. IRS audit and appeals in IRS.
Part-7. Individual tax calculations.
Part-8. Tax planning. Ethical principles
Definition and
Evaluation of a Tax
Definition of a Tax
Stds for Evaluating a Tax
Tax Rates & Structures
Major Types of U.S. Taxes
Income Taxes
Employment Taxes
Sales Tax
Property Taxes
Other Taxes
Sources of Federal Tax Law
Tax Terms, Steps
Income vs. Exclusion
Deductions & Expenses
Income Tax Rates
Prepayments and Credits
Filing Returns
IRS Audits & Appeals
Tax Return Selection
Types of Examinations
Settlement Procedures
Administrative Appeals
Income Tax Calculation
Deductions for
Adjust. Gross Income
Deductions from
Adjust. Gross Income
Personal & Dependency
Exemptions
Tax Planning
Tax Planning
Tax Evasion and
Tax Avoidance
Ethics in
Tax Practice
Chapter 1. Introduction
Definition and
Evaluation of a Tax
Definition of a Tax
Stds for Evaluating a Tax
Tax Rates & Structures
Definition of a Tax
• An enforced, involuntary
contribution
• Required and determined by law
• Providing revenue for public and
governmental purposes
• For which no specific benefits or
services are received
Purpose of a Tax
• Revenue
• Penalty
• Social changes
• Economic changes
• Equity
Adam Smith's Standards for a Good Tax
Equity
Tax should be based on the
taxpayer’s ability to pay.
Horizontal Equity: Two
similarly situated taxpayers
are taxed the same.
Certainty
Taxpayer should know when
and how a tax is to be paid.
Taxpayer should be able to
determine amount of tax.
Convenience
Tax should be levied when
taxpayer has funds to pay
Vertical Equity: Differently Economy
situated taxpayers are
taxed differently but fairly.
Costs of complying with
tax law should be minimal.
Tax Rates for Income Tax
• Marginal Tax Rate –
rate of tax on the next dollar of
taxable income
• Average Tax Rate –
rate equal to the total tax
divided by tax base.
• Effective Tax Rate –
rate equal to the total tax
divided by economic income
(taxable & nontaxable income).
Progressive Tax Rate System
• Tax rates increase as income increases
• In 1913 rates ranged from 1% to 7%
• To finance World War I, top rate was
increased to 77%
• In 1985, 15 tax brackets from 11% to 50%
• 2003 Tax Act reduced top rate from 38.6%
to 35% (rates now 10%, 15%, 25%, 28%,
33%, and 35%).
• 2012 Tax Act kept rates at 10%, 15%, 25%,
28%, 33%, and 35%, but added 39.6% rate.
Tax Foundation. In 2009, the top 1% of tax
returns earned 16.9 % of AGI and paid 36.7% of all
federal individual income taxes.
Top 5% earned 31.7% of AGI, but paid 58.7%.
Among tax returns with a positive AGI, taxpayers
with an AGI of $159,643 or more in 2009 were the
top 5 percent of income earners.
In 2009, around 59 million tax returns (of 137.98
million tax returns)used exemptions, deductions
and tax credits to completely wipe out their federal
income tax liability. The average tax rate in 2009
ranged from around 1.9% of income for the bottom
half of tax returns to 24.0% for the top 1%.
What is regressive?-1
Person A earning $30,000 per year
has a family including a spouse and
4 children.
The state has a 10% sales tax.
Suppose Person A spends $20,000
on clothing, auto and other items
subject to the sales tax.
(Continued)
What is regressive?-2
Person A will pay a sales tax of
$2,000 on the purchases of
$20,000.
That is 6.67% of gross income
that goes to sales tax.
What is regressive?-3
Person B earns $300,000 per yr &
has a family including a spouse & 4
children. The state has a 10% sales tax.
Person B will likely spend
proportionately less than Person A
on purchases subject to the sales tax–
measured as a percentage of gross
income?
What is regressive?-4
Person B may spend only $100,000
(or less) on consumer purchases. If
that is the case, what percentage of
this person’s gross income goes to
sales taxes?
Is the sales tax regressive?
What is Regressive-5 Person A
Salary
$30,000
Amount spent on
taxable purchases
$20,000
Sales Tax Rate
10%
Sales Tax Paid
Percentage of income
for Sales Tax
Is this a regressive tax?
Person B
$300,000
$100,000
10%
What is Regressive-5
A
B
Salary
$30,000 $300,000
Amount spent on
taxable purchases
$20,000 $100,000
Sales Tax Rate
10%
10%
Sales Tax Paid
$2,000 $10,000
Percentage of
income for Sales Tax 6.667% 3.333%
Is this a regressive tax?
What do you think?-1
Two persons are in the 35% marginal tax bracket
because of equal salaries.
A earns bonus of $20,000 taxed at a 35% rate.
B has $20,000 of capital gains
taxed at 15 percent.
A pays an additional $7,000 in tax.
B pays only $3,000 in tax on the additional
$20,000 of income.
Do we see horizontal equity, which dictates that
equal incomes should be taxed equally.
What do you think?-2
A wealthy person invests in municipal
bonds, and earned tax-exempt interest of
$100,000.
Her neighbor, who is not wealthy, earns a
salary of $100,000.
The working person may pay taxes at rates
up to 25 to 30 percent. Is this equitable?
Both taxpayers have the same inflow of
income, but one is able to avoid tax because
of his or her wealth and ability to invest in
tax-sheltered investments.
What do you think?-3
The individual investing in a municipal bond
may accept a market rate of interest of 4%,
passing up a market rate of interest of 6% on
corporate bonds which pay interest that is
taxable.
If the individual earned $100,000 on 4%
bonds, she could have earned $150,000 if
she had chosen 6% corporate bonds. You
could say that she has paid a tax, by
loaning money to a local government at a
low interest rate, accepting less interest.
Types of Taxes
Income Taxes
Employment Taxes
Sales Tax
Property Taxes
Other Taxes
The following four slides
have an introductory case,
which we can use as a basis
for discussing items later in
this chapter.
Please see how many of the
questions you can answer.
Jan Corporation (JanCorp.) Slide 1
Jan started a corporation [JanCorp] on Jan. 1, 2013.
JanCorp. bought a building containing 10 office suites.
JanCorp. rents these office suites to businesses.
Balances - 12-31-13
Cash
24,000
Building (see note - slide 2)
200,000
Accumulated Depreciation
4,000
Mortgage Payable - 10%
80,000
Common Stock ($10 Par)
100,000
Retained Earnings
Rent Revenue
60,000
Interest Expense
8,000
Depreciation Expense
4,000
Utilities and Property Taxes
8,000
$244,000
$244,000
Jan Corporation (JanCorp.) Slide 2
Ignore any allocation of acquisition cost to land.
Building was bought and fully rented on 1-1-13.
First. assume JanCorp does not pay income taxes.
1 How much did Jan invest in the corporation?
2 What was the net income in 2013?
3 What balance will be reported for
retained earnings at the end of 2013?
4 What is the book value of the building
at the end of 2013?
5 What is the estimated life of the building?
6 What is amount of rent per office, per month?
7 How many shares of stock were issued to Jan?
8 Now asssume you DO need to record federal
income tax payable. How much federal tax?
Jan Corporation (JanCorp.) Slide 3
Suppose a tenant came to Jan Corporation’s
office on 12-31-13 and gave a check for rent for
one office for 2014. Tenant paid for all of 2014.
This transaction was not recorded in the
accounts, shown on slide 1 for JanCorp.
Assume you make the appropriate entry for this
check received on 12-31-13.
How will your entry for this payment change the
list of accounts and balances shown on
Slide 1 for JanCorp? How will it change the
amount of federal income tax owed for 2013?
See Chapter 19 of Kieso-page 1001 (13th edition).
Jan Corporation (JanCorp.) Slide 4
Explain how you might compute the
tax owed by JanCorp for:
Sales tax.
Property tax.
Franchise tax.
Income tax.
(Ignore statement earlier that the corporation does not
pay income tax.)
Mary’s salary is $120,000
per year.
Her federal income tax
withheld is $21,000.
There is no state income
tax. What is her takehome pay for the year?
See following slide.
Mary-2014
Salary
Federal income tax withheld:
Maximum for Soc. Sec.
$117,000
Social Security base
117,000
Rate-Social Security
$120,000
(21,000)
6.20%
Social Security Tax
7,254
Medicare base
120,000
Rate-Medicare Tax
1.45%
Medicare Tax
1,740
FICA (Soc. Security & Medicare)
(8,994)
Take-home pay
$ 90,006
Sources of
Federal Income
Tax Law
Sources of Fed. Income Tax Law
• Legislative
– Law (Internal Revenue Code)
• Administrative
–Treasury Regulations
–IRS Pronouncements
• Judicial
–Supreme Court
–Other courts
Tax Terms, Steps
Income vs. Exclusion
Deductions & Expenses
Income Tax Rates
Tax Prepayments
Tax Credits
Filing Returns & SOL
Individual Tax Model-1.
Gross income- Less Excl.
Less:
Deductions for adjusted gross income
Equals: Adjusted Gross Income (AGI)
Less:
Deductions from AGI (greater of
itemized or standard deduction)
Less:
Exemptions (personal & dependency)
Equals: Taxable income (loss)
Individual Tax Model-2
Taxable income
Times: Tax rates
Equals: Gross income tax liability
Plus:
Additions to tax
Less:
Tax credits or prepayments
Equals: Tax owed or refund due
General Tax Formula ($000)
Gross Income - Form 1040-Pg 1
Deductions For A.G.I.
Adjusted Gross Income (AGI)
Exemptions
(6)
Regular Itemized Ded.
(15)
Misc. Itemized Ded.
(5)
Less 2% of AGI
2
Deductible Amount
(3)
Total Deductions From AGI
Taxable Income
$110
(10)
100
(24)
$76
Income
What is Gross Income?
What are Exclusions?
What is a Deferral?
GAAP vs. Tax
What are some
differences between
tax accounting rules
and GAAP Rules?
Deductions
What are some
types of
deductions?
Income Tax -2014-Joint
Rate
10%
15%
25%
28%
33%
35%
39.6%
Start
$0
$18,150.01
$73,800.01
$148,850.01
$226,850.01
$405,100.01
$457,600.01
End
$18,150
$73,800
$148,850
$226,850
$405,100
$457,600
Compute income tax
for married couple
with this information.
See next two slides
$125,000
Salaries
($25,000)
Deductions
Taxable Income
on Joint Return $100,000
Gross Income-Salary
Deductions
Taxable Income on Joint Return
2014
1st Layer
Layers
Rate
$0 $18,150 10.00%
Cumulative
$125,000
($25,000)
$100,000
Base
$18,150
Tax
$1,815.00
2nd layer
$18,150
$73,800 15.00%
$55,650
$8,347.50
3rd layer
$73,800 $148,850 25.00%
$26,200
$6,550.00
4th layer
$148,850 $226,850 28.00%
$0
$0.00
5th layer
$226,850 $405,100 33.00%
$0
$0.00
6th layer
$405,100 $457,600 35.00%
$0
$0.00
7th layer
$457,600
$0
$0.00
$100,000
$16,712.50
39.60%
Taxable Income and Income Tax
Tax Computation- Joint Return
See rates on book cover. (2014)
Base
Top layer
73,800
Amt above
26,200
Income
Total Tax
Rate
Tax
$10,162.50
25%
$6,550.00
100,000
$16,712.50
Deduction vs. Credit-Pg 22
• Mary spends $1,000 for child care
for her child. This is necessary for
Mary to have a job.
• Why would Mary prefer to treat
the expenditure as an income tax
credit rather than as an income tax
deduction?
Deduction vs. Credit-Pg 22
• Mary spends $1,000 for child care for her
child. Why would Mary prefer to treat the
expenditure as an income tax credit rather
than as an income tax deduction?
• A $1,000 credit reduces tax by
$1,000.
A deduction reduces taxable
income.
Filing Requirements
• Return must be filed annually
• Calendar-year individuals file and pay on
or before the 15th day of April
– May receive an extension of time to file but
not time to pay
• Corporate returns due 15th day of 3rd month
(March 15)
• Extensions of time to file
– Individuals: 6 months
– Corporations: 6 months
Statute of Limitations.
Period of time beyond which legal
actions or changes to the tax return
cannot be made by taxpayer or IRS
• Normally three years from filing date
• Extends to six years if income is underreported by 25% of gross income
• No limitation for fraud or if no return
is filed
Statute of Limitations
Tax Years
2012 2013
2014
2015 2016
Apr. 15
File 2012 Return
April 15, 2013
Jennifer - Statute of Limitations.
Identify the tax issue.
Jennifer did not file a tax return for
2007 because she honestly
believed that no tax was due.
In 2013, the IRS audits Jennifer and
the agent proposes a deficiency of
$500.
Jennifer - Statute of
Limitations. Solution: Will
Jennifer be required to pay
the $500 deficiency?
Does the statute of
limitations apply when no
tax return is filed?
Stewart - Statute of Limitations.
On his 2013 tax return, Stewart
inadvertently overstated
deductions in excess of 25 percent
of the adjusted gross income on
the return.
In 2013, the IRS audits Steward and
the agent proposes a deficiency of
$1,000.
Stewart - Statute of Limitations.
Solution: Can the IRS collect
the deficiency of $1,000?
Does the statute of
limitations prohibit the
assessment of additional tax?
Statute of Limitations
Refund claims must be initiated
by taxpayer within later of
–3 years of filing date for return
–2 years from date tax is paid
Statute of Limitations
Fred Wrong filed his 2012 income tax return on
March 15, 2013, showing gross income of
$60,000, and deductions of $40,000.
He mistakenly overstated deductions by $18,000.
What is the latest date the Internal Revenue Service?
may assert a notice of deficiency
a March 15, 2016 b April 15, 2016
c March 15, 2017 d April 15, 2017
e April 15, 2018
Statute of Limitations - Solution
Fred Wrong filed his 2012 income tax return on
March 15, 2013, showing gross income of
$60,000, and deductions of $40,000.
He mistakenly overstated deductions by $18,000.
What is the latest date the Internal Revenue Service?
may assert a notice of deficiency
a March 15, 2016 b April 15, 2016
c March 15, 2017 d April 15, 2017
e April 15, 2018
Susie Quick filed her 2013 income tax return
on February 15, 2014. She later discovered
that she failed to take an exemption for her
son on the 2013 tax return. Otherwise, the
tax return was correct. What is the latest
date by which she may file a claim for
refund for tax year 2013?
a. March 15, 2016.
b. April 15, 2016.
c. February 15, 2017. d. April 15, 2017.
e. April 15, 2020
Ans. d
Statute of Limitations
Susie filed her 2012 income tax return on
March 15, 2013, showing gross income of
$60,000, and deductions of $40,000.
She mistakenly understated income by $18,000.
What is the latest date the Internal Revenue Service?
may assert a notice of deficiency
a March 15, 2016 b April 15, 2016
c March 15, 2017 d April 15, 2017
e April 15, 2019
Jackson Corp., a calendar-year
corporation, mailed its 2013 tax return
to the IRS by certified mail on Friday,
March 11, 2014. The return, postmarked
March 11, 2014, was delivered to the IRS
on March 18, 2014. The statute of
limitations on Jackson's corporate tax
return begins on
a. Dec. 31, 2013.
b. March 11, 2014.
c. March 15, 2014. d. March 18, 2014.
CPA Nov. 1994
. Ans.
c
Keen, a calendar-year individual taxpayer,
reported a gross income of $100,000 on his 2008
income tax return. He inadvertently omitted from
gross income was a $40,000 commission that
should have been included in 2008. Keen filed his
2008 return on March 15, 2009. To collect the tax
on the $40,000 omission, the Internal Revenue
Service must assert a notice of deficiency no later
than
a. March 15, 2014.
b. April 15, 2014.
c. March 15, 2015.
d. April 15, 2015.
Ans. d
IRS Audits & Appeals
Tax Return Selection
24
Types of Examinations 25
Settlement Procedures 25
Administrative Appeals 25
Audit and Appeals Process
Selection for Audit
• Only about 2% of returns are
audited
• Procedures used
–Discriminant Function System
–Taxpayer Compliance Measurement
Program
–Document perfection & Information
matching
Types of Audits
–Correspondence audit – verify one
or two items in question by mail
–Office audit – requires some
analysis & IRS judgment through
interview
–Field audit – typically limited to
examination of business returns
Audit and Appeals Process
• Settlement Procedure
–Report of outcome of audit
–Waiver of assessment (Form 870)
–30-day letter
• Appeals
–Meeting with IRS Appeals Division
–90-day letter
Audits and Appeals
• 30-day letter
– 30 days to request conference
with Appeals Division
– Appeals officer can consider
hazards of litigation
Audits and Appeals
• 90-day letter (statutory notice of
deficiency)
– File petition with Tax Court within 90 days
– Pay the tax; can then go to court to sue
for refund
– Take no action and be subject to IRS
enforced collection procedures
Which of the following types of
IRS audits involves the least
extensive audit procedures?
a. Office audit
b. Field audit
c. Correspondence audit.
d. all are equally extensive
Ans. c
Audit and Appeals.
After an audit is concluded, a
taxpayer who does not agree with
the audit findings will receive a:
a. Letter Ruling
b. 30-day letter
c. 90-day letter
d. Revenue Ruling
Ans. b
Income Tax Calculation
Deductions for
Adjjusted Gross Income
Deductions from
Adjusted Gross Income
Personal & Dependency
Exemptions
Exclusions from Gross Income
(All Taxpayers)
•
•
•
•
•
Tax-exempt interest
Nontaxable stock dividends
Nontaxable stock rights
Proceeds of life insurance policies
Tax refunds to the extent no prior tax benefit
was received
• Disallowed and deferred gains and losses on
property transactions
• Unrealized gains and losses
Exclusions from Gross Income
(Individual Taxpayers Only)
•
•
•
•
•
Nontaxable part of pension plan distributions
Nontaxable portion of Social Security benefits
Damages awarded for physical injury
Gifts and inheritances
Welfare benefits (food stamps, workman’s
compensation and family aid)
• $250,000 or $500,000 gain on sale of personal
residence
• Scholarships
• Qualified employee fringe benefits
Deductions
• Corporations – all business expenses are
deductible if ordinary, necessary, and
reasonable (unless disallowed by law)
• Individuals
–Deductions for AGI
–Deductions from AGI – greater of
itemized deductions or standard
deduction
–Personal and dependency exemptions
Deductions For AGI – (Form 1040- Pg 1)
“Above-the-line” deductions
• Property losses on Schedule D - $3,000
• Contributions to pension & retirement plans
• Health savings account contributions
• Moving expenses
• One-half of self-employment taxes
• Self-employed health insurance premiums
• Penalty on early withdrawal of savings
• Tuition deduction ($4,000 limit)
• Student loan interest ($2,500 limit)
• Alimony paid
Itemized Deductions – Individuals (Sched. A)
• Medical (dental) expenses (in excess of 10% AGI)
• Taxes (state, local, and foreign income and property
taxes)
• Interest (mortgage and investment)
• Charitable contributions (up to 50% AGI)
• Casualty & theft losses (in excess of 10% AGI)
• Miscellaneous including unreimbursed employee
business expenses and investment expenses (in excess
of 2% AGI)
• Gambling losses (up to gambling winnings)
Standard Deduction & Exemptions
Standard Deductions - 2014
$6,200 single (unmarried) individual
$12,400 married filing a joint return
$12,400 surviving spouse
$9,100 head of household
$6,200 married filing separately
Personal & dependency exemptions
$3,950 taxpayer and dependent
In 2014, Mr. and Ms. Jones have
combined salaries of $60,000.
Their only expenditures affecting the
tax return are state income taxes of
$6,000, mortgage interest of $7,000
and real estate taxes of $1,000.
They have two small children whom
they support, and file a joint return.
What is their taxable income for 2014?
Mr. and Ms. Jones
Gross income
Deduct. for AGI
Adj. Gross Income
Less:
1a. Standard Ded.
1b. Itemized Ded.
2. Exemptions
Taxable Income
$60,000
60,000
Mr. and Ms. Jones
Gross income
Deduct. for AGI
Adj. Gross Income
Less:
1a. Standard Ded.
1b. Itemized Ded.
2. Exemptions
Taxable Income
Tax Before Credits
$60,000
60,000
12,400
14,000
3,950
15,800
(14,000)
(15,800)
$30,200
Laura Bush, age 48. No dependents.
Salary
Dividend income
Income from rents
She also has this information:
Contribution to IRA
Expenses relating to rents
Cost of stock market publications
Charitable contributions
Unreimbursed employee expenses
$38,000
$2,000
$16,000
$2,000
$9,000
$1,000
$1,500
$1,000
Her adjusted gross income is:
a. $42,000 b. $43,000 c. $45,000 d. $40,600
Laura Bush, age 48. No dependents.
Salary
Dividend income
Income from rents
Subtotal
She also has this information:
Contribution to IRA
Expenses relating to rents
Cost of stock publications
Charitable contributions
Employee expenses
Subtotal
Adjusted Gross Income (AGI)
Facts
Return
$38,000
$2,000
$16,000
$2,000
$9,000
$1,000
$1,500
$1,000
Laura Bush, age 48. No dependents.
Salary
Dividend income
Income from rents
Subtotal
She also has this information:
Contribution to IRA
Expenses relating to rents
Cost of stock publications
Charitable contributions
Employee expenses
Subtotal
Adjusted Gross Income
Facts
Return
$38,000 $38,000
$2,000
$2,000
$16,000 $16,000
$56,000
$2,000
$9,000
$1,000
$1,500
$1,000
$2,000
$9,000
$11,000
$45,000
Tax Planning
Tax Planning
Tax Evasion and
Tax Avoidance
Ethics in
Tax Practice
Taxes and Cash Flow
• Tax cost is the increase in tax for the
period and is a cash outflow
• Tax savings is a decrease in tax for a
period and is a cash inflow
–Expense payment generates an outflow,
but deduction generates a tax reduction
–Reducing income taxes paid is a pure
cash inflow because tax savings are not
taxable
Taxes and Cash Flows
• Cash flows in future years are
discounted to their present value so
they can be compared using
comparable dollars
• When marginal tax rates are expected
to change from year to year, timing of
transactions should be controlled to
minimize tax costs and maximize tax
savings
When to pay Expense - Slide 1
Cash basis company is considering
paying an expense in 2014 or 2015.
Amount of Expense
Tax rate in 2014
Tax rate in 2015
$20,000
45%
50%
Ignoring time value of money,
how much is saved by waiting
until 2015 to make the payment?
When to pay Expense - Slide 2
Expense
Tax rate - 2014
$20,000
45%
Tax rate - 2015
Tax Savings
$20,000
50%
$9,000
$10,000
When to pay Expense - Slide 3
Expense
Tax rate Tax rate -
$20,000
2014
2015
Tax Savings
$20,000
45%
50%
$9,000
$10,000
Discount at 12%
0.8930
Present value
$8,930
What is your decision?
Monico Corp., a cash basis calendar-year
taxpayer, is in the 25 percent marginal tax
bracket this year.
If it bills its customers at the beginning of
December, it will receive $5,000 of income
prior to year-end.
If it bills its customers at the end of
December, it will not receive the $5,000
until January of next year.
Monico Corp.
a. If it expects its marginal tax rate to remain 25
percent next year, when should it bill its
customers? Use a 6 percent discount factor to
explain your answer.
b. How would your answer change if Monico’s
marginal tax rate next year is only 15 percent?
Explain.
c. How would your answer change if Monico’s
marginal tax rate next year is 34 percent?
Explain.
Monico Corporation. Solution:
a. Monico should wait to bill its customers until
the end of December. If Monico’s marginal tax
rate is 25%, taxes paid this year would cost
$1,250 ($5,000 x 25%) resulting in an after-tax
cash inflow of $3,750 ($5,000 – $1,250).
When considering the time value of money, the
cost of the taxes that are deferred until next year
will have a present value (cost) of only $1,179
($1,250 x .943 PV factor) or $71 less ($1,250 $1,179).
Monico Corp.
a. bill customers late, receive
payment next year
Revenue
$5,000
Tax rate
25%
Tax payment next year
1,250
After tax cash flow
3,750
Tax payment next year
1,250
Present value factor
0.943
P.V. of tax payment
$1,179
Amount of reduction
$71.25
Monico Corp. Solution:
b. If Monico’s marginal tax rate is 15%
in year 2, then its after-tax cash inflow
would be $4,293 [$5,000 – ($5,000 x
15% x .943 PV factor)].
Monico should defer billing its
customers because this will result in a
$543 higher after-tax cash inflow
($4,293 - $3,750).
Monico Corp. (B)
Yr. 1
$5,000
25%
1,250
3,750
1,250
Revenue
Tax rate
Tax payment next year
After tax cash flow
Tax payment next year
Present value factor
P.V. of tax payment
Amount of reduction
After tax cash flow
3,750
After tax Present value $3,750
Difference
Assumes revenue has 100% PV
Yr 2
$5,000
15%
750
4,250
750
0.943
$707
$42.75
4,250
$4,293
$543
Monico Corp. Solution:
c. If Monico’s marginal tax rate is 34% in
year 2, then its after-tax cash inflow would
be $3,397 [$5,000 – ($5,000 x 34% x .943
PV factor)].
Monico should bill its customers in the
beginning of December because deferral
would result in a $353 after-tax cost
($3,397 - $3,750).
A single, wealthy investor earns net rental
income of about $400,000 per year. She
does not have significant itemized
deductions. She is considering giving some
rental property (that generates net rental
income of $20,000 per year) to her elderly
mother so that her mother will have income
she needs for her living expenses. The
investor expects that federal income taxes
will be saved with this plan.
Which tax planning concept applies here?
Ed's Repair Corporation. 1 of 6.
In 2014, Ed's business had:
Revenue
$90,000
Lease expense-truck & bldg.
10,000
Gas & other truck expense
6,000
Repair parts
4,000
Salary to Ed
None
1. Compute the corporate income tax.
2. How does this affect Ed’s Form 1040?
3. What if he takes salary of $50,000?
(First, ignore FICA, then consider it.)
4. What if he also takes $10,000 dividend?
Note: Ed is single, no dependent, takes Std. Ded.
Ed's Repair Corp. 2 of 6.
Revenue
Lease expense
Gas & other exp.
Repair parts
Salary to Ed
Total Expenses
Taxable Income
Facts Corporate Return
$90,000
10,000
6,000
4,000
None
Corporate Tax Amount
First Layer
Next Layer
Corporate Tax
50,000
Rate
15%
Ed's Repair Corp. 3 of 6.
Revenue
Lease expense
Gas & other exp.
Repair parts
Salary to Ed
Total Expenses
Taxable Income
Facts Corporate Return
$90,000
$90,000
10,000 10,000
6,000
6,000
4,000
4,000
None
20,000
70,000
Corporate Tax Amount
First Layer
Next Layer
Corporate Tax
50,000
20,000
Rate
15%
25%
$ 7,500
5,000
$ 12,500
Ed's Repair Corporation. 4 of 6.
Revenue
Lease expense
Gas & other exp.
Repair parts
Salary to Ed
Total Expenses
Taxable Income
Facts Corporate Return
$90,000
10,000
6,000
4,000
50,000
Corporate Tax Amount
First Layer
Next Layer
Corporate Tax
Rate
15%
25%
Ed's Repair Corporation. 5 of 6.
Revenue
Lease expense
Gas & other exp.
Repair parts
Salary to Ed
Total Expenses
Taxable Income
Facts Corporate Return
$90,000
$90,000
10,000 10,000
6,000
6,000
4,000
4,000
50,000 50,000
70,000
20,000
Corporate Tax Amount
First Layer
Next Layer
Corporate Tax
20,000
-
Rate
15%
25%
$ 3,000
$ 3,000
Ed's Corp or Proprietorship. 6 of 6.
Ed elects S status for the corp.
1. Compute the corporate income tax.
2. What is impact on Ed’s Form 1040?
3. What if he takes salary of $50,000?
(First, ignore FICA, then consider it.)
4. What if he also takes $10,000 dividend?
Note: Ed is single, no dependent, takes Std. Ded.
Ed operates as a proprietorship
1. What is impact on income reported
on Ed’s Form 1040?
2. Does Ed owe self-employment tax?
Professional Responsibilities
•Avoidance versus
evasion.
•What is the difference
between these terms?
Professional Responsibilities
• Preparer penalties
–Penalties may not be covered by
malpractice insurance
–Penalties are not deductible
–Penalties may result in an IRS
review of the preparer’s entire
practice
–Criminal tax evasion penalties
include fines and prison
Professional Responsibilities
• Tax professionals have
responsibilities to both tax system
and to clients
• Sources of Guidance
–Circular 230
–AICPA Code of Professional Conduct
–Statements on Standards for Tax Services
Sources of Guidance. -1
Name three sources of
guidance for tax
professionals.
Sources of Guidance. -2
(1) Treasury Circular 230: Regulations
Governing the Practice of Attorneys,
Certified Public Accountants, Enrolled
Agents, Actuaries and Appraisers before
the Internal Revenue Service.
(2) AICPA Code of Professional Conduct.
(3) Statements on Standards for Tax
Services. These contain guidelines for
tax professionals.
SSTS - No. 4 – Slide 1.
Statement on Standards for Tax
Services No. 4 states that a CPA
may use estimates in completing a
tax return.
When would using estimates be
appropriate in tax return
preparation?
SSTS - No. 4 – Slide 2.
Estimates are appropriate when
records are missing
(for example, a flood or fire
destroying records)
or precise information is not
available at the time of filing the
tax return.
End