This chapter presents information on the magnitude of federal taxes collected and on taxpayer obligations. Also, the history of U.S. federal taxation is briefly summarized followed by a review of the federal legislative process. Fundamental Aspects of Federal Taxation ¶1101 Sources of Revenue Types of federal taxes include (1) income taxes on corporations, individuals, and fiduciaries, (2) employment taxes, (3) estate and gift taxes, and (4) excise and customs taxes. Also, revenues are generated from state and local taxes. Consideration is given to the attractiveness of alternative systems—the value-added tax and flat tax. ¶1121 Tax Collection and Penalties Taxes are big business and figures are given to demonstrate just how vast and complex the federal revenue collection system has become. In 1989, the civil tax penalty provisions were extensively revamped to create a fairer, less complex and more effective penalty system. Changes were made in the (1) document and information return penalties, (2) accuracy-related penalties, (3) preparer, promoter, and protester penalties, and (4) penalties for failure to file or pay. ¶1131 Taxpayer Obligations A clear understanding of tax avoidance versus tax evasion is necessary to achieve good tax planning. Tax avoidance is legal and a legitimate pursuit of a business entity. Tax evasion requires the presence of a tax liability. There is a legal obligation to disclose a tax liability based on completed transactions and the refusal to report the tax liability is illegal.
Brief History of the Federal Income Tax The adoption of the Sixteenth Amendment to the Constitution enabled Congress to levy “taxes on income, from whatever source derived.” A brief chronological history of changes affecting the tax law from 1913 to the present is presented. 16th Amendment (2/15/1913) . Congress empowered itself to tax income. Revenue Act of 1913 . Imposed income tax on individuals, corporations and other entities, effective 3/1/1913. Internal Revenue Codes of 1939, 1954 and 1986. Recodified the numerical referencing format of legislative tax law after significant tax law revisions had occurred.
Steps in the enactment of a revenue bill are (1) origination in the House of Representatives Ways and Means Committee, (2) passage by the House, (3) passage by the Senate, (4) resolution of differences in House and Senate versions by the Joint Conference Committee, composed of members of both legislative bodies, (5) approval of the final version by both the House and the Senate, (6) approval or veto by the President, and (7) incorporation into the Internal Revenue Code. Both the Senate and the House must vote affirmatively by a two-thirds majority to override a veto.
Objectives of the Tax Law The federal income tax system is comprised of a complicated and continually evolving blend of legislative provisions, administrative pronouncements, and judicial decisions. The primary purpose of the tax law is obviously to raise revenue, but social, political, and economic objectives are also important. These various objectives, which frequently work at cross-purposes with the revenue-raising objective of the law, must be examined and understood to appreciate the rationale underlying the immense multipurpose body of law known as the federal income tax. ¶1175 Economic Factors Numerous provisions of the tax law have been employed to help stimulate the economy, to encourage capital investment, or to direct resources to selected business activities. Examples include the following: MACRS depreciation; the optional expensing election in lieu of depreciation; percentage depletion; special farming elections to expense rather than to capitalize expenses for soil and water conservation, land clearing, and fertilizers; the S corporation provisions; the Section 1244 stock loss provision; and the tax rate structure for regular corporations. ¶1181 Social Factors Numerous tax provisions can best be explained in light of their underlying social objectives. Examples include the following: the tax-free status accorded to employees on premiums paid by an employer on group-term insurance, accident and health plans, and medical benefit plans; and the tax-deferred status accorded to employees’ current income under deferred compensation plans. ¶1185 Political Factors Since the tax law is created by Congress, and Congress consists of several hundred elected officials, political factors play a major role in the development of tax legislation. Additionally, special interest groups and influential constituents have a definite impact on the legislative process. For example, depletion under the percentage depletion method is limited to 50% of “taxable net income before depletion” for all natural resource properties except oil and gas properties. For oil and gas properties, the limit is 100% of taxable net income before depletion.
Chapter 1 Exhibits 1. 4 Major Types of Federal Taxes 2. Tax Revenue Statistics 3. Tax Avoidance v. Tax Evasion 4. Brief History of Federal Income Tax 5. Tax Legislative Process 6. Objectives of the Tax LawChapter 1, Exhibit Contents CCH Federal Taxation Basic Principles 2 of 11
4 Major Types of Federal Taxes 1. Income taxes Individual income tax and corporate income tax . 2. Employment taxes FICA Social Security, FICA Medicare and FUTA. 3. Estate and gift taxes Taxes on transfers of property 4. Excise and custom taxes Taxes on transactions (taxes on the purchase of alcohol)Chapter 1, Exhibit 1 CCH Federal Taxation Basic Principles 3 of 11
Tax Revenue Statistics Source % Total Avg. Rev. Overall Audit Tax Revenue ($’s # Returns Revenue per Return Probability in billions (#’s in millions)Individual Income Tax 43.36% $ 5,766 1.1% $994 141.2Corporate Income Tax 9.56% $11,859 1.4% $180 6.9Excise and CustomsTaxes 2.41% $54,150 2.3% $ 45.3 0.84Estate and Gift Tax 1.00% $72,753 10.1% $ 18.8 0.3Employment 43.67% $27,528 0.2% $820.0 29.8Partnerships N/A N/A 0.4% N/A 3.5Other (mostlyDeclarations of 0.0 - - -Estimated Tax) 47.9Totals 100.0% $2,058.1 230.4Source: Compiled from Internal Revenue Service Data Books for 2010. Chapter 1, Exhibit 2a CCH Federal Taxation Basic Principles 4 of 11
Tax Revenue Statistics The General Accounting Office has reported that U.S. taxpayer compliance is the highest in the world, approximately 83 to 85 percent. Nevertheless, the IRS has acknowledged that the problem of tax evasion is a serious one. Each percentage point of noncompliance costs the government approximately $7 billion in lost revenue. The IRS has decreased its audit coverage of individual returns since the mid-1990s. The decrease is largely due to technology and upgraded IRS information systems.Chapter 1, Exhibit 2b CCH Federal Taxation Basic Principles 5 of 11
Tax Avoidance v. Tax Evasion Tax avoidance—Saving tax dollars through specific actions to avoid the tax liability prior to the time it would have occurred according to the law. Tax evasion—The taxpayer does not properly report income and expenses even though the taxpayer already has a tax liability and all actions are definitely complete.Chapter 1, Exhibit 3a CCH Federal Taxation Basic Principles 6 of 11
Tax Avoidance v. Tax Evasion What frequently distinguishes avoidance from evasion is the intent of the taxpayer. Some indications of taxpayer fraud are: Understatement of income Claiming of fictitious or improper deductions Accounting irregularities Allocation of income Acts and conduct of the taxpayerChapter 1, Exhibit 3b CCH Federal Taxation Basic Principles 7 of 11
Brief History of Federal Income Tax The Sixteenth Amendment was ratified on February 25, 1913. It gave Congress the power to directly or indirectly tax all income. The Revenue Act of 1913 (effective March 1, 1913) imposed a tax on the net income of individuals and corporations. This act is the basis for income tax laws in the US.Chapter 1, Exhibit 4 CCH Federal Taxation Basic Principles 8 of 11
Tax Legislative Process 1. The Constitution requires that all revenue legislation start in the House Ways and Means Committee. 2. The tax bill is sent to the House of Representatives for approval. The House debates the bill under a “closed rule” procedure (all amendments must be approved by the House Ways and Means Committee). 3. If approved by the House of Representatives, the bill is sent to the Senate Finance Committee. The Finance Committee may make amendments to the House bill.Chapter 1, Exhibit 5a CCH Federal Taxation Basic Principles 9 of 11
Tax Legislative Process 4. The bill is sent to the Senate for approval. Any senator may offer amendments from the floor of the Senate. Bill may be sent to a Joint Conference Committee if the House and Senate differ. The bill would then be sent back to House and Senate for consideration. At this point, no further amendments can be made. 5. Approved or vetoed by the President 6. Incorporated into the Code if approved by President or if veto is overridden.Chapter 1, Exhibit 5b CCH Federal Taxation Basic Principles 10 of 11
Objectives of the Tax Law Economic—to stimulate or control the economy Social—to encourage behavior (e.g., deduction for charitable contributions) or discourage behavior (e.g., illegal kickbacks are not deductible) Political—to benefit one’s own constituents or to discourage certain activitiesChapter 1, Exhibit 6 CCH Federal Taxation Basic Principles 11 of 11