US Taxation - Outline: I. Types of Tax Rate Structures
US Taxation - Outline: I. Types of Tax Rate Structures
A. Legislative tax law sources include the Internal Revenue Code and Congressional
Committee Reports.
The procedures for enactment of tax legislation are the same as those for any other
federal legislation, with the exception that all revenue measures are constitutionally
required to be introduced in the House of Representatives. These procedures include
deliberations by the House Ways and Means Committee, the Senate Finance Committee,
and the Joint Conference Committee. The committee reports produced during these
deliberations are valuable sources of legislative intent used in governmental and taxpayer
interpretation of the enacted legislation.
The political process affects tax legislation as it proceeds through the House of
Representatives and the Senate towards the President's signature. The economic, social,
and revenue priorities of the legislators (and their constituencies) affect the final product.
Also, efforts to reduce the budget deficit in recent years have had an impact on annual tax
legislation.
C. Statute of Limitations
The normal statute of limitations (i.e. how long the IRS has to examine the
return) is three years from the due date of the return (or when the return is actually
filed if late). The statute of limitations is extended to six years if more than 25%
of gross income is omitted on the return. There is no statute of limitations if the
taxpayer committed fraud.
The applicable statute of limitations may be extended by mutual
agreement between the taxpayer and the government. Reticent taxpayers are
encouraged to extend the statute of limitations when the alternative is an
immediate unfavorable notice of deficiency. These varying lengths of statutes of
limitation also cause a record keeping problem for taxpayers. How does a
taxpayer disprove an IRS claim of fraud without keeping tax records indefinitely?
The tax research process involves determination of the facts, identification of the
problem, determination of the best solution, and communication to the client.
A. Tax Compliance and Procedure
The preparation of tax returns is still a major component of most tax
practices. Some major firms have a separate department to deal with tax
compliance.
B. Tax Research
The tax research process involves determination of the facts, identification
of the problem, determination of the best solution and communication to the
client.
D. Financial Planning
Some tax professionals are adding financial planning to their list of
services offered. Items analyzed include insurance coverage, investment
strategies, and retirement planning.
I. Individual Income Tax
A. Basic Formula (Table I:2-1, Example I:2-1; Question I:2-1; Problem I:2-29;
Figure I:2-1)
B. Definitions
Brief definitions of income, exclusions, gross income, deductions for
adjusted gross income, adjusted gross income, deductions from adjusted gross
income, itemized deductions, standard deduction, personal and dependency
exemptions, taxable income, tax rates, gross tax, and tax credits are presented
with references to detailed coverage later in the text.
A. Itemized Deductions
B. Standard Deduction
The full amount of the standard deduction (which varies with filing status,
age, and vision) may be claimed when it exceeds the taxpayer's itemized
deductions.
Additions to the standard deduction are available for taxpayers who are
older than 64 and/or blind. The 2007 additions are $1,050 for married taxpayers
and $1,300 for single taxpayers.
C. Personal Exemptions
D. Dependency Exemptions
2. In 2007, high income taxpayers will lose some of the benefit of personal
and dependency exemptions. These exemptions are generally phased out at a rate
of 2% for each $2,500 (or fraction thereof) of AGI above threshold amounts
varying with filing status. In 2007, the phaseout is reduced by 1/3.
E. Child Credit
1. In 2007, the child credit is $1,000 for each qualifying child (U.S.
citizen/national/resident under 17 who qualifies as the taxpayer’s
dependent descendent, stepchild, or foster child).
2. The total credit for all children is reduced by $50 for each $1,000
(or fraction thereof) of AGI over stated amounts:
Gross tax is determined by applying the tax table (Appendix A) or tax rate
schedule inside front cover to the taxpayer's taxable income.
In 2007, tax brackets of 10%, 15%, 25%, 28%, 33%, and 35% are applicable to
individual taxpayers. The income level covered by the five brackets varies with filing
status.
A. Joint Return
1. A joint return may be filed by a man and woman if they are considered
married for tax purposes on the last day of the tax year.
2. Taxpayers legally divorced at the end of the tax year may be treated
as married for tax purposes, if the divorce is considered a sham.
B. Surviving Spouse
2. The widow or widower may file jointly in the year of the spouse's death
with the cooperation of the executor of the estate. Both the surviving
spouse and the executor must sign any joint return. If either party does
not agree to file a joint return, then married-filing separately returns are
filed.
2. An individual could be legally married and still qualify as single for tax
purposes (see section F. below).
D. Single Taxpayer
A taxpayer who does not qualify for any other filing status must file under the
single status.
1. Married individuals may choose to file separate returns rather than one
joint return.
2. Separate returns will seldom provide the best overall tax results due to
the higher rates. However, every married couple's tax should be
computed using both the joint return rules and the separate return rules
to insure the lowest overall tax. (See section V.D. below).
F. Abandoned Spouse
2. For simplified situations, this "Kiddie Tax" can be reported and paid
with the parent's return(s).
1. In 2007, net long-term capital gains (holding period > one year) are
generally taxed at 15% (5% for taxpayers in the 10% or15% bracket).
Net short-term capital gains are taxed at ordinary income rates (up to
35%). Net capital losses offset a maximum of $3,000 of other income,
with an unlimited carryover for individuals.
B. Splitting Income
Creating additional taxpayers may reduce the overall tax burden, but
administrative costs will reduce the overall savings.
EXAMPLE: For 2007, a single taxpayer (under 65, not blind, not a dependent
on another return) must file a return when gross income exceeds $8,750 ($5,350
standard deduction plus $3,700 personal exemption).
Kenneth Royce Boykin v. CIR, 1984 PH T.C. Memo & 84,297, 48 TCM 267.
The taxpayer and his wife were divorced in February of 1979, but he continued to live
with his former wife and their children after the divorce in 1979 and 1980. '143 provides that the
"determination of whether an individual is married shall be made as of the close of his taxable
year." '143 further provides that an individual legally separated by divorce or a separate
maintenance decree is not considered married. The taxpayer was denied the filing status of
married, filing jointly because he was not married at the close of the tax years at issue. Texas
(state of residence) recognizes common law marriages that have the elements of mutual
agreement, cohabitation, and the holding out of themselves as married to the public. Their
cohabitation did not qualify because they had not mutually agreed to be remarried. However, he
was permitted "head of household" filing status because he met the requirements of Sec. 2(b).
He was not married at the close of the tax year and he maintained a household for over half of
the tax year for his dependent children.
Cassius L. Peacock, III v. CIR, 1978 PH T.C Memo & 78,030, 37 TCM 177.
Cassius L. Peacock, III had never been married in any formal ceremony to the woman,
Marie Jones, with whom he cohabited. Prior to the birth of their first child, however, he and his
"spouse" signed an agreement to raise their children together. He claimed her as a dependency
exemption on his 1974 federal tax return. The IRS disallowed this exemption on the grounds
that their relationship was in violation of local law.
The court held that Marie was not the taxpayer's spouse within the meaning of '151 and,
therefore, the taxpayer was not eligible to claim an exemption for her as his spouse. The court
further held that Marie was not a member of Mr. Peacock's household for exemption purposes
because "the relationship between such individual and the taxpayer is in violation of local law."
(See Sec. 152(b(5)). The state law of Arizona provided that a person who "lives in a state of
open and notorious cohabitation is guilty of a felony punishable by imprisonment in a state
prison for not more than three years
Relative Tax by Filing Status
Head of Household
Single
Capital Assets
Capital assets are defined in a negative manner under the Internal Revenue Code. Capital assets
are assets that are not:
• Inventory
• Copyrights
In the hands of the creator
• Literary, musical, or artistic compositions or a donee of the creator
• Letters or memorandums