Our Favorite Uncle: Sam

History of Taxation

• First Federal income tax in 1861
• Repealed after Civil War
• Reinstated in 1894
• Supreme Court ruled unconstitutional in 1895
• 16^th Amendment on March 1, 1913
• Revenue acts prior to codification in 1939

Manner in Which Tax Law is Changed Or Modified

• Federal income tax is changed on an incremental basis rather than a complete revision.
• The tax law has been referred to as a quiltwork of tax law.

1913 Tax Form

• 1% on amount over %%EDITORCONTENT%%nbsp; 20,000 and not exceeding %%EDITORCONTENT%%nbsp; 50,000
• 2% on amount over %%EDITORCONTENT%%nbsp; 50,000 and not exceeding %%EDITORCONTENT%%nbsp; 75,000
• 3% on amount over %%EDITORCONTENT%%nbsp; 75,000 and not exceeding $100,000
• 4% on amount over $100,000 and not exceeding $250,000
• 5% on amount over $250,000 and not exceeding $500,000
• 6% on amount over $500,000

3 Types of Income Tax Rates

• Progressive
  • Rate increases as tax base increases
  • Individual income tax
• Proportional or flat tax
  • E.g., sales tax
• Regressive
  • Rate decreases as tax base increases
  • E.g., FICA tax

Marginal and Effective Tax Rates

• Marginal tax rate (Tax Bracket)
  • Tax rate applied to incremental amount of taxable inc that is added to tax base
• Effective tax rate
  • Total tax liability divided by total income

Determination of Taxable Income and Tax Due

Example of Calculating Tax Due

Married Filing Joint with a total wage of $250,000
1st $18,550 x 10% = $1,855.00
+
($75,300-$18,551) x 15% = $8,512.35
+
($151,900-$75,301) x 25% = $19,149.75
+
($231,450-$151,901) x 28% = $22,273.72
+
($250,000-$231,451) x 33% = $6,121.17
Total Tax Due = $57,911.99

This is why tax deductions and credits are a crucial part of our tax system!

Tax Deductions and Credits

• Deductions are expenses that lower your taxable income. It is subtracted “off-the-top” from the amount of money you made throughout the year. Once all deductions are subtracted, this amount is known as your adjusted gross income or AGI.
• Credits are dollar-for-dollar reductions that are subtracted from your tax liability.

Common Deductions

• Job Hunting Expenses
  • To deduct job-hunting expenses, you must be looking for a job in your present line of work (i.e., you’re not changing professions or looking for your first job). Some expenses include but are not limited to:
    • Resume preparation
    • Employment agency fees, Executive recruiters’ fees
    • Career counseling to assist you in improving your position
    • Legal and accounting fees you pay in connection with employment contract negotiations and preparation
    • Transportation costs to job interviews
• Uniforms and Gear
  • Protective clothing and gear
  • Uniforms (except if you’re full-time active duty in the armed forces)
  • Dry cleaning costs for your uniforms or protective clothing (not for your everyday clothing, though)
  • Specialized clothing designed for your job, as long as it’s not suitable for everyday wear
  • Safety equipment, such as hard hats, safety glasses, safety boots, and gloves
• Real estate expenses:
  • Mortgage interest
  • Mortgage prepayment penalties
  • Penalties of early withdrawals
  • Points on principal residence financing
  • Real estate taxes
• Auto registration fees
• Charitable contributions (cash and non-cash) made to qualified U.S. charities.
• Investment expenses:
  • Accounting fees (preparation of tax return)
  • Brokerage fees
  • Investment fees
  • Legal fees
  • Safe deposit box rental
  • Interest on margin accounts
• Casualty and theft Losses
• Taxes
  • Ad valorem tax
  • Certain special assessments
  • Foreign taxes
  • Income tax (state and local)
  • Occupational taxes
  • Personal property tax
  • Real property tax
  • Withholding taxes
• Qualified Medical Expenses
  • Generally, you can only deduct the excess over 10% of Adjusted Gross Income, and then only if you can itemize on Schedule A.

Common Credits

• Credit for Overpaid Social Security Taxes
  • If you had more than one employer and earned over $106,800 in combined salary, you almost certainly had too much Social Security tax withheld.
• Dependent Child Credit
  • If you had at least one dependent child who was under age 17 at the end of last year, the credit is $1,000 per qualifying child. Unfortunately, this break is phased out starting at high adjusted gross incomes.
• Dependent Care Credit
  • If you pay someone to take care of your under-age-13 child so you can work, you could be eligible for the dependent care credit. (If you’re married, your spouse must also work or be going to school.)
• American Opportunity and Lifetime Learning Credits
  • The American Opportunity and Lifetime Learning Credits are credits for attending an accredited higher education institution (college or university).
• Adoption Credit
  • If you adopt an under-age 18 child, you may qualify for a tax credit to offset your adoption expenses. If you are married, you must file a joint return to qualify.
• Energy Efficiency Tax Credit
  • The energy efficiency tax credit is offered to individuals who install energy-efficient home improvements. The credit is capped for windows, insulation, heating, non-solar water heating systems, air conditioning, ventilation, doors, metal and asphalt roofs and biomass stoves.
• Earned Income Tax Credit
  • The earned income credit is a refundable tax credit designed for lower income working families and individuals.
• Retirement Savings Contribution Credit
  • The Retirement Savings Contribution Credit is a federal tax credit designed to encourage low- and modest-income individuals to save for retirement. The credit is a percentage of savings, from 10% to 50%.

Administration of the Tax Law

Selection of returns for audit

• 2.5% per year at random
  • Statute of limitations
    • General rule 3 years from later of the date  tax return was actually filed or due date
    • Six years if taxpayer omits items of gross income that in total exceed 25%
    • Indefinite if fraudulent return filed or no return filed