Transcript No Slide Title

Tax-1
HANDOUT
Federal Income Taxes
Corporations and Individuals
Tax-2
Income Taxes
Cliche - “There are only two things
certain in life - death and taxes.”
 This is one of most written about and
discussed topics in American life.
 There are many thousands of books,
articles, jokes and cartoons on the
subject.

Tax-3
Income Taxes
Tax-4
Income Taxes
The difference between the short and long income tax forms is
simple. If you use the short form, the government gets your
money. If you use the long form, the accountant gets your money.
A nervous taxpayer was unhappily conversing with the IRS
auditor who had come to review his records. At one point the
auditor exclaimed, Mr. Carr, we feel it is a great privilege to be
allowed to live and work in the USA. As a citizen you have an
obligation to pay taxes, and we expect you to eagerly pay them
with a smile. Thank God, returned Mr. Carr. I thought you were
going to want cash.
Even worse accounting jokes are available on the Web.
Tax-5
Income Taxes
The tax handout gives a broad overview
of corporate and individual taxes.
 Loyola offers three tax courses

One at undergraduate level
 Two in MBA program


Masters in Taxation is available in
Business Schools (MS)
 Law Schools (LLM)

Tax-6
Income Taxes

Tax law vs. GAAP

Who makes tax law?
a. IRS
b. Congress
c. Supreme Court
d. FASB
Tax-7
Income Taxes

Tax law vs. GAAP
Who makes tax law?
 Who makes GAAP?
 Two sets of books


CPAs and taxes
We are all experts in this field - NOT!

Tax avoidance vs. tax evasion
Which is illegal?

Where do you get copies of tax forms?
Tax-8
Who Pays And Who Does Not
Pay Income Taxes?

Pays
Corporations
 Individuals


Does not pay

Not-for-profit organizations
e.g., Loyola College

Proprietorships and Partnerships
• They file informational returns only.
• Then, how is the income taxed?
On the owners’ personal returns
Tax-9
Corporate Taxes
“Income Before Taxes” is a line on an
Income Statement prepared using GAAP.
 “Taxable Income” is a line on a tax return.

i.e., the amount on which the corp. pays tax.

Reasons why above amounts may differ
Certain corporate revenues and expenses
are excluded in computing taxable income.

These are known as “permanent” differences.
Timing of recognition of revenues and
expenses may differ.

Known as “temporary” differences.
Tax-10
Corporate Taxes
Tax Rates
Technically, corporate tax rates are not a
flat rate; they are graduated as with
individual’s rates.
 However, for corporations with taxable
incomes exceeding a relatively small
amount ($335,000 in 1991), the tax is flat.

Therefore, the effect is a flat tax
for most corporations.

Tax rates will be provided
on the test if needed.
Tax-11
Corporate Taxes

Loss Carrybacks and Carryforwards
Current year tax losses can be carried
back 3 years and forward 15 years.
 If the loss is not “used up” by the end of
the 15th year, what happens?

A loss carryback results in a tax refund
in the current year for taxes paid in
past year(s).
 A loss carryforward is applied against
taxable income in future years.

3
15
Tax-12
Corporate Taxes

Depreciation Methods
Depreciate me
Methods used for tax
purposes are quite different from those
used for financial statement purposes
 Therein lies a major reason for most
corporations keeping “two sets of books”


Key to understanding tax depreciation
“The depreciable period or useful life used
for tax purposes is based on law and has
no relationship to the actual useful life of
the asset; thus, no attempt is made to
match revenues and expenses.”
Tax-13
Corporate Taxes

Tax depreciation is based on MACRS
Modified Accelerated Cost Recovery System
 It is an accelerated method similar to the
double-declining-balance and sum-of-theyears digits methods.

Straight-line depreciation can
also be used for tax purposes.
 You are not responsible for
any depreciation calculations

Tax-14
Corporate Taxes

Income Tax Allocation (pp. 21-24)
This is how to account for taxes under
GAAP, not how to calculate taxes owed.
 Congress vs. FASB


Two reasons for differences in Taxable
Income (from tax return) and “Book”
Income (from income statement)
Permanent differences
 Temporary (or timing) differences

Income
Statement
Tax-15
Corporate Taxes
Permanent Differences

As previously mentioned, certain
corporate revenues and expenses
are excluded in computing taxable
income.
i.e., they are never shown on the
tax return

Permanent differences include
Nontaxable revenues
 Nondeductible expenses

Tax-16
Corporate Taxes
Permanent Differences

Nontaxable revenue examples
Life insurance proceeds on death of
key employee
 Interest received from state and local
bonds


Nondeductible expense examples
Premiums paid on life insurance
policies for key-employees
 Lobbying expenses

Tax-17
Corporate Taxes
Temporary Differences
These are differences between
taxable income and book
income caused by items that
affect both, but in different
periods.
Therefore, they are also called
timing differences.
Tax-18
Corporate Taxes
Temporary Differences
Temporary/timing differences include:

Revenues reported earlier on the tax
return than on the books
e.g., Revenue received in advance

Expenses reported later on the tax
return than on the books
e.g., Expenses based on estimates such as
uncollectible accounts expense

Expenses reported earlier on the tax
return than on the books
e.g., when different depreciation methods
are used for book and tax purposes.
Tax-19
Corporate Taxes
Temporary Differences
A reconciliation must be used to explain
why book and taxable income differ.
Reconciliation of Book Income to Taxable Income (p. 22)
per tax return
Tax-20
Corporate Taxes
Temporary Differences
All temporary differences require the
use of interperiod income tax
allocation.
Tax on the item causing the difference
will be reported in the period in which the
item is reported for accounting purposes,
regardless of when it is reported for tax
purposes. (i.e., there must be a “normal”
relationship between Pretax Income
and Income Tax Expense on the
Income Statement.)
Tax-21
Corporate Taxes
Temporary Differences
Page 23
[Per Tax Return]
* Note normal 15% relationship each year. This
would not be the case if the amount of tax paid
(i.e., amount on tax return) were reported as the
income tax expense on the income statement.
[Per Income Statement
*
Tax-22
Personal Income Tax
. .
. .
. .
.
Joe P.
Taxpayer
123 45 6789
Sally L.
Taxpayer
987 65 4321
123 Main Street
Anywhere, USA 55555-5555
X
X
2
X
Kenny Taxpayer
Posh
Taxpayer
Tinkie Winky Taxpayer
Son
Daughter
???
5
Tax-23
Personal Income Tax
Whether an individual needs to file a
tax return depends on whether their
income exceeds the sum of:
Their standard deduction amount, plus
 Their exemption amount

e.g., using 1998 rates, a single person would
not file unless their gross income
were greater than $6,950.
Tax-24
Personal Income Tax
Four Filing Statuses
Single
 Married filing jointly
 Married filing separately
 Head of household

Congress in it’s wisdom has seen fit to set
different tax rates for each.
Tax-25
Personal Income Tax
Taxable Income
Examples of Excluded Income
Flow Chart
for Determination
of Taxable
Gifts, inheritances,
interest on state bonds,
certain Social Security benefits.
(NOTE: These items are not deducted!
They
are justincome
never included.)
Also includes illegal
gambling
and other illegal income.
Income for Individual Taxpayer (p. 25)
Know the model!
Gross (Total) Income
Includes all income from whatever source derived
except for a few specifically excluded items.
Includes such items as wages, dividends, interest,
proprietorship earnings, taxpayer’s share of
partnership earnings, net rents.
Less
Tax-26
Personal Income Tax
Taxable Income
Examples: Individual Retirement Accounts (IRA)
and KeoghLess
plans.
Deductions From Gross Income
Consists of business expenses, payments to an
individual retirement arrangement, and a few other
minor items.
Equals
Adjusted Gross Income
Less
Tax-27
Personal Income Tax
Taxable Income
Standard Deduction - A specifiedLess
amount that is permitted by
tax law to be deducted in lieu of itemized deductions. It
changesStandard
each year or
because
it is Personal
indexed to Deductions
inflation.
Itemized
Deduct the higher of the standard deduction or
itemized personal deductions. Itemized deductions
consist of contributions, mortgage interest, certain
taxes levied directly against the taxpayer, limited
casualty and theft losses, limited medical
expenses and certain “nonbusiness” expenses.
The standard deduction for a single taxpayer for
1998 was $4,250.
Less
Tax-28
Personal Income Tax
Taxable Income
Less
Exemptions
One fixed amount (e.g., $2,700 for 1998)
for taxpayer, one for spouse and one for each
dependent. At certain levels of Adjusted Gross
Income, personal exemptions are phased out.
Equals
Taxable Income
Personal Income Tax
Subtractions
Types of Itemized Deductions
 Certain taxes including real estate and
state income tax
 Interest on principal residence and any
second residence
No longer deductible on consumer loans
 Charitable contributions to approved
educational, religious and other not-forprofit organizations
Tax-29
Personal Income Tax
Subtractions
Types of Itemized Deductions
 Medical expenses to the extent they
exceed 7.5% of Adjusted Gross Income
 Casualty losses subject to certain
complicated guidelines
(Which you do not need to know)
 Certain other deductions to the extent
that they exceed 2% of Adjusted Gross
Income
e.g., professional journals, union dues, tax
return preparation, business entertainment
Tax-30
Personal Income Tax
Tax-31
Subtractions
Exemption - A reduction in taxable
income because you “are” (i.e., you be).
 Exemptions are also available for
dependents.
 Dependents must meet 4 criteria.

Close relative or effectively a family member
 Had income < $2,150

The law makes exceptions for children under age
19 or full-time college students under age 24.
Got > half of support from taxpayer
 Did not file a joint return with a spouse

Personal Income Tax
Subtractions
Your taxable income is
understated. You cannot
claim Babe as an exemption!
Tax-32
Personal Income Tax
Rates
Marginal Tax Rate - The rate applied to
the next dollar of taxable income.
This relates to the fact that personal tax
rates are graduated.
 It means that while a single taxpayer with
taxable income of $50,000 is in the “31%
bracket”, he or she is taxed at that rate on
only $700. (See Rate Schedule on p. 29)
 It also means that the person who says “I
don’t want more income this year because
it will throw me into a higher tax bracket”
doesn’t have a clue!

Tax-33
Personal Income Tax
Rates
Effective Tax Rate - The average rate of
taxation on a given amount of taxable
income.
Effective
Tax Rate
=
Total Taxes Paid
Total Taxable Income
Tax-34
Tax-35
Personal Income Tax
Rates Example
Assume that a Tom (a single taxpayer) has
taxable income of $63,000. Using the rate
schedule in the handout, his tax liability,
marginal tax rate and average tax rate would
be determined as follows:
Tax on income up to $49,300
$11,158
Tax on income above $49,300
(31% x $13,700 [$63,000 - $49,300])
4,247
Tax Liability
$15,405
Marginal tax rate = 31%
Average tax rate = $15,405/$63,000 = 24.5%
Tax-36
Tax-37
.