Federal Taxation

8/11/2019 Federal Taxation

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THE TAX COLLEGE

Educational Series

Federal Income

Tax Course 2014

Volume

1


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E D U C A T I O N A L S E R I E S - V O L U M E 1

Federal Income Tax Course 2014

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HOW TO USE OUR INCOME TAX COURSE

QUESTIONS, COMMENTS, AND NOTES :

Our course is intentionally designed with a wide left margin to allow space for yourquestions, comments, and notes.

ICON AND COLOR KEY:

The following icon and color coding is used in our Side Bars and Tips:

I C O N T Y P E D E S C R I P T I O N

T A X Q U O T E Tax Quotes appear in boxes with a lavender background. S I D E B A R Side Bars appear in boxes with a light yellow background.

T A X T I P Tax Tips appear in boxes with a light blue background.

T A X P L A N N I N GT I P

Tax & Financial Planning Tips appear in boxes with a light

green background.

T A X P R A C T I C ET I P

Tax Practice Tips appear in boxes with a light grey

background.

HOW TO COMPLETE YOUR STUDIES QUICKLY

If you are taking our course because you need to obtain your IRS Continuing Education

hours quickly to renew your PTIN; or you are starting a job at a tax preparation office and

you need to learn the material quickly before the tax season starts; you can skip reading the

Tax Quotes, Sidebars, Tax Tips, Tax Planning Tips and Tax Practice Tips. The informationdiscussed in them is not covered on the quizzes or final exam. You can return next summer

when you have more time and read them at that time.

However, if you are not in a hurry we strongly recommend that you read all of the above as

they will enhance your knowledge of the tax laws and expand your understanding of the

topics covered in this course.


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KEY TAX NUMBERS 2013

Adoption Credit

Child with special needs $12,970Other adoptions, qualified expenses Up to $12,970

Alternative Minimum Tax

Exemptions

Married Filing Jointly $80,800

Married Filing Separately $40,400

Single or Head of Household $51,900

Tax Rates

First $179,500 ($89,750 MFS) of AMTI 26%

Over $179,500 of AMTI 28%

Capital Gains (Long Term) and Qualifying Dividends Tax Rates10% or 15% Tax Bracket 0%More Than 15% But Less Than 39.6% Tax Bracket 15%

39.6% Tax Bracket 20%

Un-recaptured Section 1250 Gains 25%

Capital Gains on Collectibles 28%

Domestic Production Activities Deduction 9%

Earned Income Tax Credit

Single, Head of Household, Qualifying Widow Maximum Earnings Maximum EITC

No Children $14,340 $487One Child $37,870 $3,250

Two Children $43,038 $5,372

Three Children $46,227 $6,044

Married Filing Jointly

No Children $19,680 $487

One Child $43,210 $3,250

Two Children $48,378 $5,372

Three Children $51,567 $6,044

EducationAmerican Opportunity Credit $2,500

Coverdell ESA $2,000

Lifetime Learning Credit $2,000

Student Loan Interest Deduction $2,500

Tuition and Fees Deduction Tier 1 $4,000


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Tuition and Fees Deduction Tier 2 $2,000

Elective Deferrals Limits

401(k), 403(b), 457 plans $17,500

Salary Reduction SEP $17,500Additional Contribution Age 50 or Older $5,500

SIMPLE IRA $12,000

Additional Contribution Age 50 or Older $2,500

Employer Provided Transportation Exclusion

Transit Passes and Commuter Vehicles $245 per month

Qualified Parking $245 per month

Qualified Bicycle Commuting $20 per month

Exemptions

Personal and Dependent $3,900

Estate $600Simple Trust $300

Complex Trust $100

Exemption and Itemized Deduction Phase-out's (beginning at)

Single $250,000

Married Filing Jointly or Qualifying Widow(er) $300,000

Married Filing Separately $150,000

Head of Household $275,000

Filing Requirements

IF you're filing status isAND at the end of 2013

you were

THEN you

should file a

return if your

gross income

was at least

SingleUnder 65 $10,000

65 or older $11,500

Married Filing Jointly

Under 65 (both spouses) $20,000

65 or older (one spouse) $21,200

65 or older (both

spouses)

$22,400

Married Filing Separately Any age $3,900

Head of HouseholdUnder 65 $12,850

65 or older $14,350

Qualifying Widow(er)Under 65 $16,100

65 or older $17,300


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Foreign Earned Income Exclusion $97,600

Gift Tax

Exclusion $14,000

Spouse UnlimitedNon-U.S. Citizen Spouse $143,000

Health Savings Accounts (HSAs)

Maximum Annual Contribution Limits

Self-Only Coverage $3,250

Family Coverage $6,450

Additional Over Age 55 $1,000

Minimum Deductible

Self-Only Coverage $1,250


Maximum Out of PocketSelf-Only Coverage $6,250


IRA Contributions

Traditional $5,500

Age 50 or Older $6,500

Roth $5,500

Age 50 or Older $6,500

Kiddie Tax

Age Limit 18Unearned Income Limitation $2,000

Long Term Care Premiums (deductible)

Age 40 or Under $360

Age 41 to 50 $680

Age 51 to 60 $1,360

Age 61 to 70 $3,640

Age 71 and Over $4,550

Medical Savings Accounts (MSAs)

Premium for High Deductible

Self Coverage $2,150-$3,200Family Coverage $4,300-$6,450

Maximum Out of Pocket

Self Coverage $4,300


Mileage Rates


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Business $0.565

Medical and Moving $0.24

Charitable $0.14

Section 179 Expense $500,000Social Security Payback

At full retirement age or older No limit on earnings

Under full retirement age$1 of benefits will be deducted for each $2

earned above $15,120

In the year full retirement is reached$1 of benefits will be deducted for each $3

earned above $40,080

Social Security Wage Base

Social Security Wage Base $113,700

Maximum Social Security Tax $7,049

Standard Deductions

Base Amount Add for Blind or > 65

Single $6,100 $1,500

Married Filing Jointly $12,200 $1,200

Married Filing Separately $6,100 $1,200

Head of Household $8,950 $1,500

Qualifying Widow(er) $12,200 $1,200

Dependent of Another $1,000 or Earned

Income + $350

$1,200 or $1,500 if

Single or HOH


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L E S S O N 1 - O U R F E D E R A L T A X S Y S T E M

1

Lesson

1Lesson 1 - Our Federal Tax System

In this lesson you'll learn about the history of our federal tax system and howit works today. The following topics are discussed in this lesson:

The Revolutionary War

Period

The Post-Revolutionary War

Period

The Civil War Period

The Post-Civil War Period

The 16th Amendment

The 1920s The 1930s

The Social Security Act

The World War II Period

The Post-World War II Period

The 1960s

Medicare

The Economic Recovery Tax

Act of 1981

The Tax Reform Act of 1986

IRSRRA of 1998

EGTRRA of 2001 JGTRRA of 2003

The Modern Income Tax

What are the different types

of taxes?

he federal tax system in the United States has been marked by

significant changes over the years in response to the ever changing

role of the government. While the law itself is complex, the concept isrelatively simple. Income from all sources is taxed, unless specifically

exempted by the law.

The types and amounts of tax collected are completely different than they

were 200 years ago. Some of these changes are traceable to specific events,

such as a war, or the passage of the 16th Amendment which gave Congress

T


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the power to levy a tax on personal income. Other changes were more

gradual, responding to changes in society, the economy, and in the role of

the federal government. For most of our country's history, individuals rarely

had any contact with the federal government as most of the government'stax revenues were derived from excise taxes, tariffs, and customs duties.

In 1765, the English Parliament needing funds to pay for its war against

France, passed the Stamp Act, the first tax imposed directly on the American

colonies. Colonists lacked representation in the English Parliament. This led

to the rallying cry of the American Revolution "taxation without

representation is tyranny" and established a persistent wariness regarding

taxation.

On December 16, 1773 a group of Americans disguised as Indians board a

ship and throw 342 chests filled with tea into Boston Harbor to protest

Englands tax on tea. The Boston Tea Party is perhaps the most famous

event in U.S. tax history.

Before the Revolutionary War, the federal government had only a limited

need for revenue, while each of the colonies had greater responsibilities and

revenue needs, which were met with different types of taxes. The south

taxed primarily imports and exports, the middle colonies imposed a

property tax and a "head" or poll tax levied on each adult male, and the

northern colonies taxed real estate, had excises taxes, and taxes based onoccupation.

The Revolutionary War PeriodTo pay the debts of the Revolutionary War, Congress levied excise taxes on

distilled spirits, tobacco and snuff, refined sugar, carriages, property sold at

auctions, and various legal documents.

The Articles of Confederation of 1781 reflected the American fear of a

strong federal government. The federal government had few responsibilities

and no tax. It relied solely on donations from the States. When theConstitution was passed in 1789, it was recognized that no government

could function if it relied entirely on other governments for its resources.

Therefore, the federal government was granted the authority to raise taxes.

Article I, Section 8, Clause 1 of the U.S. Constitution states Congress shall

have the power to impose "Taxes, Duties, Imposts and Excises,". However


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Article I, Section 9 requires that, "No Capitation, or other direct, tax shall be

laid, unless in Proportion to the Census or enumeration herein before

directed to be taken." Therefore, any taxes imposed had to be uniform

throughout the United States. The Constitution limited Congress' ability toimpose direct taxes, by requiring it to distribute taxes in proportion to each

state's population.

The table below shows how long it took the average American to prepare

his or her tax return in 2013.

All

Taxpayers 100% 12 6 2 4 1 $210

1040 68% 15 8 2 4 1 $280

1040A 19% 7 2 1 3 1 $90

1040EZ 13% 4 1 2 1 $30

Non-

business * 70% 7 3 1 3 1 $120

Business * 30% 24 13 4 5 2 $430

Table: Time it takes to prepare return

* Taxpayers are considered business filers if they file one or more of the following with

Form 1040: Schedule C, C-EZ, E, F, Form 2106 or 2106-EZ. Taxpayers are considered

nonbusiness filers if they did not file any of those schedules or forms with Form 1040 or

if they file Form 1040A or 1040EZ.

Source:Internal Revenue Service

Major forms filed:

Type of Taxpayer:

Percent-

age of

Returns

Major

Form Filed

or Type of

Taxpayer

Average Time Burden (Hours)

Total

Time

Tax

Planning

Form Comp-

letion &

Submission

All

Other

Average

Cost

Record

Keeping

T a x Q u o t e"It would be thought a hard government that should tax its people one

tenth part."

Benjamin Franklin (1706-1790) Founding Father of the United States


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The Post-Revolutionary War PeriodAfter the Revolutionary War the citizens had representation, but many still

opposed taxes. From 1791 to 1802, the federal government was supported

by taxes on distilled spirits, carriages, refined sugar, tobacco and snuff,property sold at auction, corporate bonds, and slaves. In 1794, farmers in

Pennsylvania opposed the tax on whiskey, forcing President Washington to

send federal troops to suppress the Whiskey Rebellion, and establishing the

important precedent that the federal government was determined to

enforce its revenue laws. On the other hand, The Whiskey Rebellion also

established that the resistance to taxes that led to the Declaration of

Independence and the Revolutionary War did not evaporate with the new

federal government.

To raise money for the War of 1812, Congress imposed additional excisetaxes, sales taxes on gold, silverware, jewelry, and watches, and raised

certain customs duties. Congress also raised money by issuing Treasury

notes. In 1817 Congress did away with those taxes, relying solely on tariffs

on imported goods, and for the next 44 years the federal government

collected no taxes.

T a x Q u o t e

"Our Constitution is in actual operation; everything appears to promise that

it will last; but in this world nothing is certain but death and taxes."

Benjamin Franklin (1706-1790) Founding Father of the United States

The Civil War PeriodThe Revenue Act of 1861, the first U.S. personal income tax, was imposed on

August 5, 1861. This tax on personal income was a new direction for a

federal tax system. It was amended on July 1, 1862. It taxed 3% of all

incomes from $600 to $10,000 per year. The standard deduction was $600.

Individuals with an annual income of more than $10,000 paid a 5% tax rate.

This tax was the forerunner of our modern personal income tax as it was

based on the concepts of graduated taxation and "withholding at the

source" by employers. An "inheritance" tax also made its debut.

The Act of 1862 established the office of Commissioner of Internal Revenue.

The Commissioner was given the power to assess, levy, and collect taxes,


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and the right to enforce the tax laws through seizure of property and

through prosecution.

By 1866, tax collections had reached their highest point in history. The

federal government collected more than $310 million. In 1867, heeding

public opposition to the income tax, Congress cut the tax rate. The need for

federal revenue declined sharply after the war and the personal income tax

was abolished in 1872.

The Post-Civil War PeriodWith the passage of The Wilson Tariff Act in 1894 Congress revived the flat

rate federal income tax at a rate of 2%. The Bureau of Internal Revenue was

created with an income tax division. However, the Supreme Court ruled the

law unconstitutional in Pollock v. Farmers' Loan & Trust Co. the followingyear. The Supreme Court ruled that taxes on rents from real estate, interest

income, dividend income, and from personal property were direct taxes on

property, and therefore had to be apportioned according to the population

of each state. Under the Constitution, Congress could impose direct taxes

only if they were levied in proportion to each State's population. Thus, a

federal income tax was impractical from the time of the Pollock decision

until ratification of the Sixteenth Amendment in 1913. What seemed to be a

straightforward limitation in the Constitution on the power of the Congress

proved inexact and unclear when applied to an income tax. The Bureau of

Internal Revenues income tax division was closed.

From 1896 until 1910 the Federal government relied heavily on high tariffs

for its revenues. The War Revenue Act of 1899 raised funds for the Spanish-

American War through the sale of bonds, taxes on recreational facilities, and

it doubled the tax on beer and tobacco. The War Revenue Act expired in

1902. From 1868 to 1913, 90% of all revenue was collected from excise

taxes on liquor, beer, wine and tobacco.

In 1909 the Payne-Aldrich Tariff Act enacted an income tax on the privilege

of conducting business as a corporation. It was affirmed by the Supreme

Court in Flint v. Stone Tracy Co. Sometuimes referred to as the Corporate

Income Tax Act of 1909, it was the United States's first corporate income tax

law. It layed the ground work for the 16th Ammendment - the individual

income tax.


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The table below shows how long Americans work each year to pay their

taxes:

Year

Number of Days PerYear Spent Working

to Pay Taxes

All Taxes as a

Percentage of Income

1900 22 5.9%

1910 19 5.0%

1920 44 12.0%

1930 43 11.7%

1940 55 17.9%

1950 91 24.6%

1960 102 27.7%

1970 110 29.6%

1980 112 30.7%

1990 113 30.8%

1997 119 32.5%

1998 122 33.2%

1999 122 33.3%

2000 125 34.0%

2001 121 33.0%2002 111 30.3%

2003 108 29.5%

2004 109 29.7%

2005 116 31.5%

2006 118 32.3%

2007 120 32.7%

2008 113 30.8%

2009 103 28.2%

2010 99 26.9%

2011 102 27.7%

2012 107 29.2%

Table: Total Effective Tax Rates

Source:www.taxfoundation.org


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The 16th AmendmentIn 1909 President Taft recommended that Congress propose a

constitutional amendment that would give the government the power to

tax incomes without apportioning the burden among the statespopulations.

The 16th amendment was ratified by Wyoming on February 3, 1913,

providing the three-quarter majority of states necessary to amend the

Constitution. It allowed the Federal government to tax the income of

individuals without regard to the population of each State. The 16th

Amendment states "The Congress shall have power to lay and collect taxes

on incomes, from whatever source derived, without apportionment among

the several States, and without regard to any census or enumeration". It

made the income tax a permanent fixture in the U.S. tax system andresulted in a revenue law that taxed incomes of both individuals and

corporations.

On October 3, 1913 President Woodrow Wilson signed into law the

Revenue Act of 1913, also known as the Tariff Act of 1913. Congress levied a

1% tax on net personal incomes above $3,000 - rising to 6% on incomes of

more than $500,000.

Less than 1% of the population was subject to the income tax in 1913. At

that time the average annual wage for a worker in the U.S. was under$1,300, so only the wealthy had to file a tax return. The $3,000 filing

threshold in 1913, when adjusted for inflation, is the equivalent of about

$69,573 in todays dollars. The income tax only applied to 358,000 high-

income taxpayers. By 1944 that number grew to 47.1 million, and today it

stands at nearly 150 million.

The Revenue Act of 1913 also lowered basic tariff rates from 40% to 25%,

the lowest rates since the Walker Tariff of 1857.

In 1913 the first Form 1040 appeared as the standard tax reporting form,and March 1st was the date specified as the filing deadline. The 1 page of

instructions for Form 1040 has since grown to 189 pages.

Payment was not sent with the first Form(s) 1040. The return was verified by

a field agent who then sent out tax bills on June 1st with payment due by

June 30th. See the top of the first Form 1040 below.


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Figure 1-0:Form 1040 page 1, circa 1913.

To view the entire 1913 Form 1040 see Appendix A orclick here.

Before the income tax most citizens were able to pursue their financial

affairs without any knowledge by the federal government. Individuals
http://www.thetaxcollege.com/pdfs/individual/form1040_1913.pdfhttp://www.thetaxcollege.com/pdfs/individual/form1040_1913.pdfhttp://www.thetaxcollege.com/pdfs/individual/form1040_1913.pdfhttp://www.thetaxcollege.com/pdfs/individual/form1040_1913.pdf


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earned their money and wealth was accumulated and dispensed with little

or no interaction with the federal government.

S id e B a rHow does a Bill become a Tax Law?

The U.S. Constitution specifically spells out how Congress must consider

and adopt tax legislation.

Most tax legislation begins with the president who consults with his

financial advisors and Treasury Department officials before sending a

plan to Congress. He can do this at any time, but he usually does it

shortly after the State of the Union address.

All tax legislation must originate in the House Committee on Ways and

Means. The panel which consists of the most senior and powerful

members of the House, holds hearings, makes changes, and forwards the

bill to the full House.

The bill that the House of Representatives gets from the Committee on

Ways and Means is then drafted into legislation and is accompanied by a

detailed report that gives the Committee's reasons for recommending

the bill. The IRS and the courts may later use this Committee report as an

interpretation of the legislation. If the House approves the bill it is sent tothe Senate Finance Committee.

The Senate Finance Committee is responsible for all Senate legislation

dealing with tax matters. They hold hearings and usually make changes

before sending the bill to the full Senate.

The Senate debates the bill and usually makes additional changes before

holding a vote before the full Senate. If the Senate approves an

unchanged version of the bill it received from the House, the bill goes to

the White House for the president's signature.

If the Senate makes changes in the bill it received from the House, it goes

to a conference committee whose members are appointed by the

Speaker of the House and the President of the Senate. This committee

combines the two versions into compromise legislation. The compromise

bill goes back to the full House and the full Senate, which each must


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S I D E B A RWhat is the Federal Reserve and what does it do?

In 1791 the U.S. Government chartered the first Bank of the United States toact as the U.S. central bank for 20 years. In 1811 Congress declined to renew

its charter as it was believed to be unnecessary. In 1816 the second Bank of

the United States was chartered for 20 years. In 1836 Congress declined to

renew its charter as it was also believed to be unnecessary.

The Panic of 1907 was started by a failed attempt to corner the stock of

United Copper. Subsequent bank and brokerage failures only halted when

J.P. Morgan convinced other trust company presidents to provide backing to

the Trust Company of America.

The Federal Reserve System (Federal Reserve) is the central bank of the

United States. It was created in 1913 with the enactment of the Federal

Reserve Act in response to a series of financial panics, especially the financial

Panic of 1907.

In the Federal Reserve Act Congress established three key objectives for

monetary policy - maximum employment, stable prices, and moderate long-

term interest rates. The first two objectives are sometimes referred to as the

Federal Reserve's dual mandate.

The Federal Reserves duties include administering the nation's monetarypolicy, supervising and regulating banks, maintaining a stable financial

system and providing banking and monetary services to depository

institutions, the U.S. government, and foreign institutions.

The United States entry into World War I greatly increased the need for

revenue. One problem with the income tax law was how to define

"lawful" income. Congress responded by passing the 1916 Revenue Act.

It deleted the word "lawful" from the definition of income.

Consequently, all income, regardless of how it was obtained, became

subject to tax. The Supreme Court would subsequently rule the Fifth

Amendment could not be used by bootleggers and others who earned

income through illegal activities to avoid paying income taxes. As a

result, many who broke various laws and were able to escape

prosecution for those crimes were convicted on tax evasion charges.


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The 1916 Act raised the lowest tax rate from 1% to 2% and raised the top

rate to 15% on taxpayers with incomes in excess of $1.5 million. The 1916

Act also imposed taxes on estates and excess business profits.

The income tax fundamentally changed the relationship between the

citizens and the federal government by giving the federal government the

right and the need to know all about an individuals or business's financial

life. Consequently, in 1916 Congress required that information from income

tax returns be kept confidential.

Needing still more tax revenue, the War Revenue Act of 1917 lowered

exemptions and greatly increased income tax rates. Tax revenues increased

from $809 million in 1917 to $3.6 billion in 1918.

The Revenue Act of 1918, passed to raise even greater sums for the World

War I effort, increased income tax rates once again, this time raising the

lowest rate to 6%. The top rate of income tax rose to 77%. The Revenue Act

of 1918 codified all existing tax laws and pushed the filing deadline forward

to March 15th where it remained until 1954 when it was moved ahead to

April 15th. In 1918, 5% of the U.S. population paid income taxes, as

compared to just 1% five years earlier. By 1939 that number would rise to

6%, and six years later by the end of World War II it would stand at 75%.

Today the federal income tax affects 90% of all Americans.

The 1920s

The Prohibition Unit was established to enforce the National Prohibition Act

of 1919, commonly known as the Volstead Act, which, under the 18th

Amendment to the Constitution prohibited the manufacture, sale, and

transportation of alcoholic beverages. When it was first established in 1920,

the Prohibition Unit was a division of the Bureau of Internal Revenue. On

April 1, 1927 it became an independent entity within the Department of the

Treasury, changing its name from the Prohibition Unit to the Bureau of

Prohibition.

The tax rates dropped sharply after World War I. During the 1920s, with a

booming economy, Congress cut taxes five times returning the lowest tax

rate to 1% and lowering the highest rate to 25%. As tax rates and tax

collections declined, the economy got even stronger.


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To show by-standers that everything was under control, the two men in

street clothes were "arrested" and came out with their hands up, led by the

two phony uniformed cops.

Al Capone, the Chicago gangster, had orchestrated the most notorious

gangland killing of the 20th century - the St. Valentine's Day Massacre. The

massacre was Capone's effort to dispose of Bugs Moran, who, as it turned

out, wasnt in the garage at the time. Moran, spotting the police cars

outside, had decided to keep walking. No one was ever arrested for the

crime.

The economy grew steadily during most of the 1920s. It was a golden age

as innovations such as radio, automobiles, aviation, and the telephone

became popular. On August 24, 1921, the Dow Jones Industrial Average

stood at 63.9. By September 3, 1929 it had risen more than six fold to 381.2.

During the summer of 1929 it became clear that the economy was

contracting and that the stock market would soon go through a series of

unsettling price declines.

When the New York Stock Exchange opened on the morning of October 24,1929, nervous traders sensed something was wrong. By 11:00 AM the

market was plunging. At noon a group of powerful bankers met secretly at

J.P. Morgan & Co., next door to the New York Stock Exchange, and agreed

to spend $240 million of their own funds to stabilize the stock market.

On a cold wintry morning in February, 1929

two cars; a Cadillac sedan and a Peerless,

both outfitted to look like Chicago Police

detective sedans, pulled up to the SMCCartage Company garage at 2122 North

Clark Street in the Lincoln Park

neighborhood on Chicago's North Side that

served as the headquarters of Bugs Morans

North Side Gang. Four gunmen, two

disguised as police officers and toting

Thompson submachine guns, killed seven

men in a storm of seventy machine-gun

bullets and two shotgun shells.

Figure 1-1: George "Bugs" Moran


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This strategy worked for a few days but the panic broke out again the

following Tuesday, October 29, 1929, and there was no stopping it. The

stock market crashed. Within three months the stock market lost 40% of its

value. $26 billion of wealth disappeared. AT&T lost one-third of its value.General Electric lost one-half of its value. RCA's stock fell by three-quarters

within a matter of months. It would take 25 years for the stock market to

return to its pre-crash level.

The Great Depression began and over the next few years:

Unemployment exceeded 25%

10,000 banks failed

The Gross National Product

declined from $105 billion in 1929to $55 billion in 1933

Compared to 1920's levels, net new

business investment was minus $5.8

billion in 1932

Wages paid to workers declined

from $50 billion in 1929 to $30

billion in 1932

Figure 1-2: Chart of the US Gross

National Product from 1926 to 1934.

As the economy shrank, government tax receipts also fell dramatically.

S id e B a rHow do taxes affect the economy?

Seventy-two percent of our economy is based on consumer spending.

Raising taxes takes money from consumers and dampens the economy,

because consumers have less money to spend. This results in less retail

and home sales and lower investment and savings rates. However, raising

taxes can increase public-sector jobs, provided the increased revenues

are spent that way. It also helps decrease government debts which

dampen the economy. During wartime government spending is much

higher and it boosts all phases of the economy.

Lowering taxes puts extra money in consumers' pockets. Consumers can

then spend this money, boosting retail and home sales and investment

and savings rates. However, the extent of this boost depends on how

large the tax cut is, and which taxes are cut. Cuts for middle-income and


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low-income people tend to put more money into the economy because

these taxpayers are more likely to spend their extra cash right away, on

purchases or renovations they have been putting off. Cuts for high-

income taxpayers tend not to have the same effect, because this groupalready has enough money to buy everything they need. High-income

taxpayers tend to save their extra money, so cuts for these taxpayers end

up being used for investments and savings. Cuts for high-income

taxpayers improve the outlook on Wall Street. Cuts in corporate and

business taxes give businesses more money to spend, often creating jobs

and boosting the bottom line.

In 1932, the federal government collected only $1.9 billion in taxes,

compared to $6.6 billion in taxes in 1920. In the face of rising budgetdeficits which reached $2.7 billion in 1931, Congress followed the prevailing

economic wisdom of the time and passed the Tax Act of 1932 which

dramatically increased tax rates. This further improved the government's

finances while further weakening the economy. In retrospect, Congress

should have lowered tax rates instead of raising them. By 1936 the lowest

personal income tax rate had risen to 4% and the highest tax rate had risen

to 79%.

S id e B a r

How does the federal budget process work?

On or before the first Monday in February of each year, the President is

required by law to submit to the Congress a budget proposal for the

fiscal year that begins the following October. The budget plan sets forth

the Presidents proposed receipts, spending, and the surplus or deficit for

the Federal Government. The plan includes recommendations for new

legislation as well as recommendations to change, eliminate, and add

programs. After receiving the Presidents proposal, the Congress reviews

it and makes changes. It first passes a budget resolution setting its owntargets for receipts, outlays, and the surplus or deficit. Next, individual

spending and revenue bills that are consistent with the goals of the

budget resolution are enacted.


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Flowchart: Federal Income and Expenses

S id e B a r

Herbert Hoover Presidential Library and Museum

Further information about The Great Depression is available inGallery Six

of the Herbert Hoover Presidential Library and Museum.

The 1930s

Figure 1-3: Alphonse Gabriel

Capone a.k.a. "Scarface Al"

During a routine warehouse raid in Chicago

in 1931 by the Treasury Departments

Bureau of Prohibition, agents Eliot Ness and

The Untouchables discovered what was

clearly a crudely coded set of accounts in a

desk drawer. They, and Frank Wilson, an

undercover agent in the Bureau of Internal

Revenues Intelligence Unit, then

concentrated on gathering evidence and

pursuing Public Enemy No. 1, Al Capone, for

his failure to pay income tax on this

substantial illegal income.

Capone had always done his business through front men and it was

previously believed he had no books or accounting records in his own

name. Even his mansion was in his wife's name.

Capone was tried in federal court in 1931. Capone was found guilty on five

of 22 counts of tax evasion for the years 1925, 1926, and 1927, and willful

failure to file tax returns for 1928 and 1929. Capone's legal team offered to

pay all outstanding income taxes plus interest and told their client to expect

a severe fine. On October 17, 1931 the judge sentenced Capone to eleven

years in a federal prison and one year in the county jail, as well as an earliersix-month contempt of court sentence. He ultimately served only six and a

half years because of time off for good behavior. He also had to pay fines

and court costs totaling $80,000. Capones isolation from his associates and

the repeal of Prohibition ended his criminal career.
http://hoover.archives.gov/exhibits/Hooverstory/gallery06/index.htmlhttp://hoover.archives.gov/exhibits/Hooverstory/gallery06/index.htmlhttp://hoover.archives.gov/exhibits/Hooverstory/gallery06/index.htmlhttp://hoover.archives.gov/exhibits/Hooverstory/gallery06/index.html


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Other notable tax evaders:

On October 10, 1973, Spiro T. Agnew, the 39th Vice President of the

United States, resigned and then pleaded nolo contendere (no

contest) to criminal charges of tax evasion and money laundering;

Soviet spy Aldrich Ames earned more than $2 million for his

espionage and was also charged with tax evasion as none of the

money was reported on his income tax returns. Ames attempted to

have the tax evasion charge dismissed on the grounds his espionage

profits were illegal, but the charges stood. The $2 million remains to

this day in an undisclosed bank account. Russian intelligence has

refused to disclose this bank account information in order for the

United States to seize it, arguing that that money was rightfully

earned by Ames;

Leona Helmsley the billionaire New York City hotel operator and real

estate investor nicknamed "The Queen of Mean." She was convicted

of federal income tax evasion in 1989 and served 19 months in

prison, after receiving an initial sentence of 16 years;

Irwin A. Schiff, a prominent member of the group which refers to

itself as the tax honesty movement, and which has been referred to

by the Internal Revenue Service and other government agencies as

the tax protester movement. Schiff is known for writing and

promoting literature that claims the United States income tax is

applied incorrectly. He has lost several civil cases against the federal

government and has a record of multiple convictions for various

federal tax crimes. Schiff is serving a 13-plus year sentence for tax

crimes as Inmate #08537-014 at the Federal Correctional Institution

at Fort Worth, Texas. His projected release date is July 26, 2017.

S id e B a rWho was J.K. Lasser?

Jacob Kay Lasser was born in Newark, NJ in 1896. He took night classes in

accounting at New York University from 1915-1917 and became a

Certified Public Accountant practicing in New York City in 1923. In 1938

the publishing house Simon & Schuster commissioned him to author an


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income tax guide. Its first publication in 1939 sold 23,000 copies and hit

the best sellers list. Mr. Lasser became an adjunct professor at New York

University in 1942 and served as the Institute on Taxations chairman until

his death. Mr. Lasser revised the tax guide each year and by 1946 sevenmillion copies were sold. His books on taxation were used as texts in

more than 160 colleges and universities. He died from a heart attack at

the age of 57 in 1954. His best selling tax guide, J .K. Lassers Your Income

Taxis in its 75thyear of continuous publication and today is published by

John Wiley & Sons, Inc.

We strongly recommend that you purchase a copy of J.K. Lassers Your

Income Taxeach year. You can do so from Lesson 30 on the Homework

Page. The Tax College is not affiliated with the J.K. Lasser Institute.

T a x Q u o t e

"Anyone may arrange his affairs so that his taxes shall be as low as

possible; he is not bound to choose that pattern which best pays the

treasury. There is not even a patriotic duty to increase one's taxes. Over and

over again the Courts have said that there is nothing sinister in so

arranging affairs as to keep taxes as low as possible. Everyone does it, rich

and poor alike and all do right, for nobody owes any public duty to pay

more than the law demands."

Judge Learned Hand - (1872-1961), Judge, U. S. Court of Appeals for the

2nd Circuit Gregory v. Helvering 69 F.2d 809, 810 (2d Cir. 1934), aff'd, 293

U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935)

The Social Security Act

In 1935 Congress passed the Social Security Act.

President Franklin D. Roosevelt signed the program

into law on Aug. 14, 1935. This law providespayments to the aged, the needy, the handicapped,

and to certain minors. These programs were initially

financed by a 2% tax, one-half of which was

withheld directly from an employee's paycheck and

one-half of which was collected from employers.

The tax was levied on the first $3,000 of the


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employee's salary or wages.

Figure 1-4:Ernest Ackerman

Under the original 1935 law,

monthly benefits were to start in

1942 (which was subsequently

changed to 1940). From 1937 until

1940, Social Security paid benefits to

retirees in the form of a single,

lump-sum refund payment. The

earliest reported applicant for a

lump-sum refund was a retired

Cleveland motorman named Ernest

Ackerman, who retired one day after

the Social Security program began.

During his one day of participation in the program, a nickel was withheld

from Mr. Ackermans pay for Social Security, and, upon retiring, he received

a lump-sum payment of 17 cents. The average lump-sum payment during

this period was $58.06. The smallest payment ever made was for 5 cents.

Ida May Fuller of Ludlow, Vermont filed her retirement claim on November

4, 1939. While running an errand she dropped by the Rutland, VT Social

Security office to ask about possible benefits. She would later say: "It wasn't

that I expected anything, mind you, but I knew I'd been paying forsomething called Social Security and I wanted to ask the people in Rutland

about it."

Her claim was taken by Claims Clerk Elizabeth Corcoran Burke and

transmitted to the Claims Division in Washington, D.C. for adjudication. The

case was reviewed and sent to the Treasury Department for payment. In

those days claims were grouped in batches of 1,000 and a Certification List

for each batch was sent to the Treasury Department. Miss Fuller's claim was

the first one on the first Certification List.


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On January 31, 1940, Ida May Fuller popped

open her mailbox and found Social Security

check number 00-000-001 payable to her in

the amount of $22.54. Though hardly afortune, the check was nonetheless a

milestone: it was the first monthly

retirement payment made under the Social

Security Act.

Ida May Fuller had worked for three years

under the Social Security program. Figure 1-5:Ida May Fuller

The accumulated taxes on her salary during those three years were a total of

$24.75. Her initial monthly check was $22.54. She didnt do too badly under

Social Security - during her remaining thirty-five years she collected a total

of $22,888.92 in Social Security benefits nearly 1,000 times more than she

contributed. Miss Fuller lived to be 100 years old, dying in 1975.

Soon after it was passed in 1935, Social Security morphed from a fully

funded pension system into a pay-as-you-go system where every

generation (except for Ernests and Ida Mays) pays into the system to

support the currently-retired generation and relies on the next generation

to pay its Social Security benefits.

When Ida May Fuller retired, 40 workers were paying taxes to support each

Social Security recipient. In 1960, there were 4.9 workers paying Social

Security taxes for each person receiving benefits. Today, there are 2.8

workers for each beneficiary, a ratio that will drop to 1.9 workers by 2035,

according to projections by the Congressional Budget Office.

In 1940, when the Social Security Administration mailed Ida May Fuller the

first monthly retirement payment, the retirement age was 65. At that time,

workers who survived to age 65 had a remaining life expectancy of 12.7

years for men and 14.7 years for women. By 2011, life expectancy at age 65was 18.7 years for men and 20.7 years for women, an increase of six full

years for both. In 20 more years, life expectancy at age 65 for men is

expected to be more than 20 years and more than 22 years for women.

In 1940, 220,000 people received Social Security benefits, out of a total

population of 132 million. At that time, .1666 percent of the total population


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received benefits. In 2012, 57 million people received Social Security

benefits, out of a total population of 315 million. Today, about 18 percent of

the total population receive benefits. These figures dont include some 8.3

million people who receive payments under Supplemental Security Income,a program aimed primarily at the blind and disabled that launched in the

1970s.

S id e B a rFast Facts & Figures About Social Security

Fast Facts & Figures About Social Security answers the most frequently

asked questions about the programs the Social Security Administration

administers. To get your copyclick here.

In 1939, Congress again codified the income tax laws and all subsequent tax

legislation until 1954 amended the 1939 tax code.

The World War II PeriodThe Revenue Act of 1942 was hailed by President Franklin Roosevelt as "the

greatest tax bill in American history". It increased taxes and the number of

Americans subject to the income tax, created deductions for medical

expenses and investment expenses, and reduced the personal exemptionamount from $1,500 to $1,200 for married couples. The exemption amount

for each dependent was reduced from $400 to $350 and a 5% Victory tax

on all individuals with incomes over $624 was created, with postwar credit.

The top tax rate reached 94% during the World War II and remained at 91%

until 1964.

In 1943 Congress re-introduced payroll withholding, as had been done

during the Civil War, with the Current Tax Payment Act. This greatly eased

the collection of the tax for the Bureau of Internal Revenue. It also greatly

reduced the taxpayer's awareness of the income tax by increasing itstransparency, which made it easier to raise taxes in the future.
http://www.thetaxcollegelessons.com/redirects/social_security.htmlhttp://www.thetaxcollegelessons.com/redirects/social_security.htmlhttp://www.thetaxcollegelessons.com/redirects/social_security.htmlhttp://www.thetaxcollegelessons.com/redirects/social_security.html


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Figure 1-6:Form W-2 - Statement of Income Tax Withheld on Wages, circa 1943. Payroll

withholdings are reported to the employee and the IRS on Form W-2.

Tax withholding was also introduced in the Tariff Act of 1913, but repealed

by the Income Tax Act of 1916. The Current Tax Payment Act required

employers to withhold taxes from employees' wages and pay them directly

to the government on the workers' behalf quarterly.

In 1944 Congress passed the Individual Income Tax Act, which created the

standard deductions on Form 1040, raised individual income tax rates, and

repealed the Victory Tax. It standardized the value of personal exemptions

at $500 per person. There were about 60 million taxpayers.

The Post-World War II PeriodPresident Eisenhower reorganized the Bureau of Internal Revenue in 1953

and replaced its patronage system with career, professional employees. The

IRS commissioner and chief counsel are selected by the president and

confirmed by the Senate. The Bureaus name was changed to the Internal

Revenue Service to stress the "service" aspect of its work.

On August 16, 1954 the Internal Revenue Code of 1954 was enacted by

Congress, succeeding the Internal Revenue Code of 1939. The Codetemporarily extended the Revenue Act of 1951's 5% increase in corporate

tax rates through March 31, 1955, increased depreciation deductions by

providing additional depreciation schedules, and created a 4% dividend tax

credit for individuals. References to the Internal Revenue Code subsequent

to 1954 generally mean Title 26 of the United States Code, as amended. The

basic structure of Title 26 remained the same until the enactment of the


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comprehensive revisions contained in Tax Reform Act of 1986, although

individual provisions of the law were changed regularly.

The Social Security system remained basically unchanged until 1956. In 1956

Social Security began an evolution and more and more benefits were

added, beginning with Disability Insurance benefits. In 1958, benefits were

extended to dependents of disabled workers. In 1967, disability benefits

were extended to widows and widowers.

By 1959, the IRS had become the world's largest accounting, collection, and

forms processing organization. Computers were introduced to automate

and streamline its work and to improve service to taxpayers. In 1961,

Congress passed a law requiring individual taxpayers to use their Social

Security numbers on tax forms.

The 1960sThe Revenue Act of 1964 was signed by President Lyndon Johnson on

February 26th, 1964. It reduced individual income tax rates from 91% to

70%, and reduced the top corporate rate from 52% to 48%. A minimum

standard deduction of $300 plus $100 per exemption was created.

S id e B a rDoes raising income tax rates increase revenues to the federal

government?

Although conventional wisdom holds that increasing income tax rates or

eliminating deductions for wealthier Americans will generate greater

revenue for the U.S. Treasury, history shows otherwise.

The Dow Jones Industrial Average dropped by about half, from 119 in

November 1919 to 64 in August 1921. Double digit unemployment

ensued. The federal government made it clear it would not intervene

except to raise interest rates, cut taxes and reduce the size of the

government. The economy recovered so quickly that the stock market

crash of of 1919 is largely forgotten.

During the 1920's Presidents Warren Harding and Calvin Coolidge cut the

top marginal income tax rates from 77% to 25% only to see federal

revenues rise dramatically as the economy grew increasingly stronger.


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The rich, who at that time were earning more than $50,000 per year, went

from paying 44% of total income tax revenues to paying 78.4%.

On December 14, 1962 the 35th President of the United States, John F.

Kennedy delivered a speech to the Economic Club of New York in which

he stated: It is increasingly clear that...an economy hampered by

restrictive tax rates will never produce enough revenues to balance our

budget just as it will never produce enough jobs or enough profits... In

short, it is a paradoxical truth that tax rates are too high today and tax

revenues are too low and the soundest way to raise the revenues in the

long run is to cut the rates now. After Presidents Kennedy and Lyndon

Johnson slashed the capital gains tax and cut the top marginal tax rate

from 91% to 70% federal tax revenues rose from $91 billion in 1960 to

$153 billion in 1968. During those years the rich saw their total share ofrevenues increase by 57% while the poor's share increased by just 11%.

During President Ronald Reagan's term in office (1981-1989) he cut taxes

but doubled revenue, and decreased unemployment from 7% to 5.4%

and inflation from 13.5% to 4.1%. In the Reagan years, the top 1% of

earners paid 57.2% of taxes, up from 48%.

The table below shows how much money the federal government

collects each year in taxes:


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Total Individual Individual

%

Increase

Income Tax

Collections

%

Increase

Tax % of

Total

1960 $91,774,803,000 $44,945,711,000 48.97%

1970 $195,722,096,000 113% $103,651,585,000 131% 52.96%

1980 $519,375,273,000 165% $287,547,782,000 177% 55.36%

1990 $1,056,365,652,000 103% $540,228,408,000 88% 51.14%

2000 $2,096,916,925,000 99% $1,137,077,702,000 110% 54.23%

2001 $2,128,831,182,000 2% $1,178,209,880,000 4% 55.35%

2002 $2,016,627,269,000 -5% $1,037,733,908,000 -12% 51.46%

2003 $1,952,928,045,000 -3% $987,208,878,000 -5% 50.55%

2004 $2,018,502,103,000 3% $990,248,760,000 0% 49.06%

2005 $2,268,895,122,000 12% $1,107,500,994,000 12% 48.81%

2006 $2,518,680,230,000 11% $1,236,259,371,000 12% 49.08%

2007 $2,691,537,557,000 7% $1,366,241,437,000 11% 50.76%

2008 $2,745,035,410,000 2% $1,425,990,183,000 4% 51.95%

2009 $2,345,337,177,000 -15% $1,190,382,757,000 -17% 50.76%

2010 $2,345,055,978,000 0% $1,175,989,528,000 -1% 50.15%

2011 $2,414,952,112,000 3% $1,346,182,227,000 14% 55.74%

2012 $2,524,320,134,000 5% $2,172,233,368,000 61% 86.05%

2013 $2,855,059,420,000 13% $2,462,201,645,000 13% 86.24%

Table: Internal Revenue Gross Collections

Year

Total Tax

Collections

MedicareIn 1965 Congress enacted the Medicare program which provides for the

medical needs of persons aged 65 or older. Social Security Amendments

created the Medicaid program which provides medical assistance for

people with low incomes and resources. The expansions of Social

Security and the creation of Medicare and Medicaid required additional

tax revenues. In 1972 benefits were indexed for the cost of living. In

1949 the FICA payroll tax rate was 2%. The expansions in 1965 led to

further rate increases, with the combined payroll tax rate climbing to

15.3 % by 1990. The maximum Social Security tax burden rose from $60

in 1949 to $7,849 by 1990.

The Economic Recovery Tax Act of 1981In the late 1960s and through the 1970s there was persistent and rising

inflation, ultimately reaching 13.3% in 1979. During this time, the income tax

was not indexed for inflation. Despite repeated tax cuts, the tax burden of


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the citizens rose. The Economic Recovery Tax Act of 1981, which enjoyed

strong bi-partisan support in Congress, was passed on August 4, 1981 and

was signed into law by President Ronald Regan on August 13, 1981. It was

the largest tax cut in U.S. history. It amended the Internal Revenue Code of1954 to encourage economic growth through reductions in individual

income tax rates, first year expensing of depreciable property, incentives for

small businesses, and incentives for savings. The Accelerated Cost Recovery

System was implemented for depreciation. The Act reduced the income tax

rates by approximately 25% over three years with the top rate falling from

70% to 50% and the bottom rate falling to 11%. The rates were indexed for

inflation, although indexing was delayed until 1985, and a 10% Investment

Tax Credit was implemented to spur capital formation. The tax cuts resulted

in deficits in the federal budget in the 1980s and early 1990s, but also

created an economic expansion.

The Tax Reform Act of 1984 tries to plug loopholes and ensure that all

taxpayers pay a fair share of the tax burden. It also reforms taxation of

international income, and tries to improve the administration and efficiency

of the tax system.

The Tax Reform Act of 1986The Congress passed the Tax Reform Act of 1986 on October 22, 1986.

President Reagan signed the most significant piece of tax legislation in 30

years. It contained 300 provisions and took three years to implement. The

Act codified the federal tax laws for the third time since the Revenue Act of

1918. It simplified the income tax code, broadened the tax base and

eliminated many tax shelters and other preferences. The top tax rate was

lowered from 50% to 28%, the lowest it had been since 1916, while the

bottom rate was raised from 11% to 15% - the only time in history that the

top rate was reduced and the bottom rate increased concurrently. 15% and

28% became the only two income tax brackets. The capital gains tax rate

was the same as for ordinary income. Interest on consumer loans and state

and local sales tax were no longer deductible. Income averaging, whichreduced taxes for those only recently making a much higher income than

before, was eliminated. The Act increased the personal exemption and the

standard deduction. Deductions for passive activities were limited to

remove the tax benefits of many tax shelters, especially for real estate

investments. Also in 1986, limited electronic filing began.


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Flowchart: Number of Days Worked

T a x Q u o t e

"Government is saying to the average citizen every January 1: 'For the nextfive months youll be working for us, for goals we shall determine. Is that

clear? After May 5 you may look after your own needs and ambitions, but

report back to us next January. Now move along.'

If nearly half of what you make is spent by someone else, that means that

half your work time is spent working for someone else. Call me a radical,

but I think that comes dangerously close to being a form of indentured

servitude."

Richard "Dick" Armey (1940 - ) House Majority Leader (1995-2003)


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The Internal Revenue Service

Restructuring and Reform Act of 1998The Internal Revenue Service Restructuring and Reform Act of 1998 resulted

from hearings held by the Congress in 1996 and 1997. It prompted the

most comprehensive reorganization and modernization of IRS in nearly half

a century. The Act, which expanded taxpayer rights and called for

reorganizing the agency into four operating divisions aligned according to

taxpayer needs, included numerous amendments to the Internal Revenue

Code of 1986. It provides that individuals who fail to provide their taxpayer

identification numbers are not allowed to take the earned income credit for

the year in which the failure occurs and that individuals are allowed to

deduct interest expense paid on certain student loans. The Taxpayer Bill of

Rights III was enacted on July 22, 1998 as title III of the Act. It established aTaxpayer Advocate Service as an independent voice inside the IRS.

During the 1990s the top income tax rate rose again, standing at 39.6% by

the end of the decade. In 2000 the IRS ended its geographic based structure

and implemented the four major operating divisions required by the

Restructuring and Reform Act of 1998: Wage and Investment, Small

Business/Self-Employed, Large and Mid-Size Business, and Tax Exempt and

Government Entities.

The Economic Growth and Tax ReliefReconciliation Act of 2001The top income tax rate was cut to 35% and the bottom rate was cut to

10% by the Economic Growth and Tax Relief Reconciliation Act of 2001

(EGTRRA). EGTRRA made significant changes in several areas of the Internal

Revenue Code, including income tax rates, estate and gift tax exclusions,

and qualified and retirement plan rules for Individual retirement accounts,

401(k) plans, 403(b), and pension plans. Many of the tax reductions in

EGTRRA were designed to be phased in over a period of up to 9 years.

One of the most notable characteristics of EGTRRA is that its provisions are

designed to sunset, or revert to the provisions that were in effect before it

was passed. EGTRRA will sunset on January 1, 2011 unless further legislation

is enacted to make its changes permanent.


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EGTRRA brought to prominence a lesser known provision of the Internal

Revenue Code, the Alternative Minimum Tax (AMT). It is an alternate system

of calculating a taxpayer's liability that removes many so called "tax

preference items". The applicable AMT rates were not adjusted in step withthe lowered rates of EGTRRA and the 2003 act, causing many more people

to face higher taxes because of the AMT than had originally been planned.

The AMT was originally designed as a way of making sure that wealthy

taxpayers could not take advantage of "too many" tax incentives and reduce

their tax obligation by too much. When it was introduced in 1969 it was

intended to target 155 high-income households that had been eligible for

so many tax benefits that they owed little or no income tax. In 1970, 20,000

taxpayers owed AMT. In 2006, 3.5 million taxpayers owed AMT, because of a

temporarily higher exemption, which expires at the end of the year. In 2007,

unless Congress acts, 23.4 million taxpayers will owe AMT. If the 2001-2006tax cuts expire as scheduled at the end of 2010, 39 million taxpayers, more

than one-third of all taxpayers, will be hit with the AMT in 2017. If the tax

cuts are extended, that number jumps to 53 million taxpayers, about half of

all taxpayers.

EGTRRA changed the rate of tax on dividend income starting in 2003 to

5% for those in the 0% or 15% brackets, falling to 0% in 2008. It was

lowered to 15% for all other brackets. The capital gains tax on qualified

gains of property or stock held for five years was reduced from 10% to

8%.


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The table below shows the current federal income tax brackets:

2001(1)

Rebate 15.0% 27.5% 30.5% 35.5% 39.1%

2002 10.0% 15.0% 27.0% 30.0% 35.0% 38.6%2003-12 10.0% 15.0% 25.0% 28.0% 33.0% 35.0%

2013+ 10.0% 15.0% 25.0% 28.0% 33.0% 35.0% 39.6%(2)

Table: Individual Income Tax Brackets

(1)In 2001 a new 10% tax bracket was introduced and tax rates were lowered. The

planned tax rates through 2010 were passed as part of the Tax and Economic

Recovery Acts in 2001 and 2003. They were extended in late 2010 through 2012.

They were extended again in January 2013, with a 39.6% rate for high income

earners.

(2)Taxpayers in this bracket may also be subject to Affordable Care Act surtax of

0.9%.

The Jobs and Growth Tax Relief

Reconciliation Act of 2003The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), was

passed by Congress on May 23, 2003 and signed by President Bush on May

28, 2003. The act increased the exemption amount for the individual

Alternative Minimum Tax, lowered taxes on dividends and capital gains,accelerated the tax rate cuts that had been enacted in 2001, and temporarily

reduced the tax rate on capital gains and dividends to 15%. Many of the

slow phase-ins enacted in 2001 were accelerated by the Act of 2003, which

removed the waiting periods for many of EGTRRA's changes.

Two tax bills signed in 2005 and 2006 extended through 2010 the favorable

rates on capital gains and dividends, raised the exemption levels for the

Alternative Minimum Tax, and enacted new tax incentives designed to

persuade individuals to save more for retirement.

The Patient Protection and Affordable Care

Act of 2010The Patient Protection and Affordable Care Act ("The Act") fundamentally

alters the health care system for individuals and employers. All individuals

not covered by Medicaid or Medicare must obtain health care coverage or


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pay a tax penalty. Employer-provided coverage will generally satisfy the

coverage requirement. Lower-income individuals and some middle-class

families will receive a credit or voucher to help them pay for their health

insurance. Employers electing not to offer qualifying coverage are subject toan additional tax. Exceptions are made for small businesses.

The key provisions of The Act, as amended by the House Reconciliation Act

(see below), include:

Tax Penalty: All individuals not covered by Medicaid or Medicare must

obtain health care coverage or pay a tax penalty which increases from the

greater of $95 or 1% of income in 2014 to the greater of $695 or 2.5% of

income in 2016 and thereafter, indexed for inflation.

Adult Children Coverage: The Act extends the employer-provided healthcoverage gross income exclusion to coverage for adult children under age

27 as of the end of the tax year.

Employers:The Act does not require employers to provide health insurance

coverage. However, large employers (businesses with 50 or more "full-

time employees", which are defined as employees working 30 or more

hours per week) that do not provide minimum essential coverage are liable

for an additional tax.

Additional Medicare Payroll Tax:The Act broadens the Medicare tax base forhigher income taxpayers by:

1. Imposing an additional of 0.9 percent tax on earned income in excess of

$200,000 for individuals and $250,000 for families; and

2. Imposing an unearned income Medicare contribution tax of 3.8 percent

on investment income for individuals with Adjusted Gross Income (AGI)

above $200,000 and joint filers with AGI above $250,000. Net investment

income includes interest, dividends, royalties, rents, gain from the

disposition of property, and income earned from a trade or business that isa passive activity.

Tax on High-Cost Insurance:The Act imposes a 40% non-refundable excise

tax on group insurers if annual premium payments exceed an inflation

adjusted $10,200 for individual coverage and $27,500 for family coverage

beginning in 2018.


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Market Sector Fees:The Act imposes annual nondeductible fees on various

health-related industries, such as medical device manufacturers and

importers, health insurance providers and others.

Medical Expense Deduction: The Act raises the threshold for the itemized

medical expense deduction from 7.5% of AGI to 10% of AGI for regular

income tax purposes effective for 2013. However, individuals age 65 and

older (and their spouses) are temporarily exempt from the increase until

2017.

Medicare Part D: The Act eliminates the deduction for the subsidy for

employers that maintain prescription drug coverage for retirees who are

eligible for Medicare Part D.

Tax-Exempt Hospitals: The Act requires Code Sec. 501(c)(3) hospitals toconduct periodic community health needs assessments and adopt written

financial assistance policies. Individuals who qualify for financial assistance

are billed at the same rates as insured individuals.

Health Insurance Executive Pay: The Act modifies Code Sec. 162(m) as it

applies to compensation paid by health insurance providers to high-level

executives. If at least 25 percent of the insurers premium income does not

meet minimum essential coverage requirements under the Act, no Code

Sec. 162(m) deduction is allowed if compensation exceeds $500,000.

Indoor Tanning Tax: The Act imposed a tax of 10% on qualified indoor

tanning services effective July 1, 2010.

For complete details on The Patient Protection and Affordable Care Act see

the CCH Tax Briefings available for download at the Lesson 1 Homework

section.

The Health Care and Education

Reconciliation Act of 2010The Health Care and Education Reconciliation Act of 2010 ("The

Reconciliation Act"), signed by President Obama on March 30, 2010,

completed a massive overhaul of the nations health insurance and health

delivery systems. The Reconciliation Act amends the Patient Protection and

Affordable Care Act of 2010, which President Obama signed on March 23rd.


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Combined, the two new laws include more than $400 billion in revenue

raisers and new taxes on employers and individuals.

For complete details on The Health Care and Education Reconciliation Act

see the CCH Tax Briefings available for download at the Lesson 1

Homework section.

The American Taxpayer Relief Act of 2012The American Taxpayer Relief Act makes permanent for 2013 and thereafter

the Bush tax cuts, except for married taxpayers filing jointly (MFJ) with

taxable income above $450,000, taxpayers filing as Head of Household

(HOH) with taxable income above $425,000, and taxpayers filing Single (S)

with taxable income above $400,000. Income above the aforementioned

levels is now taxed at 39.6%.

The key provisions of the American Taxpayer Relief Act include:

a 20% capital gains and dividend tax rate for the aforementioned

taxpayers

a permanent fix for the Alternative Minimum Tax, by increasing the

exemption amounts and adjusting them annually for inflation

a revival of the "Pease Limitation" which limits itemized deductions

for taxpayers with income above $300,000 (MFJ), $275,000 (HOH),

$250,000 (S), and $150,000 (MFS)

a revival of the Personal Exemption phase-out for taxpayers with

income above $300,000 (MFJ), $275,000 (HOH), $250,000 (S), and

$150,000 (MFS)

a maximum federal estate tax rate of 40% with a $5,000,000

"portable" (between spouses) exclusion, which is adjusted annually

for inflation, and

a revival of many "tax extenders".

For complete details on The American Taxpayer Relief Act of 2012 see the

CCH Tax Briefings available for download at the Lesson 1 Homework

section.


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The Modern Income TaxThe United States imposes an income tax on individuals, corporations,

trusts, and certain estates. This tax is imposed on income, such as wages,

and realization of a gains on the disposition of property. An individual's taxbracket depends upon their income and their filing status. There are five (5)

filing statuses: single, married filing jointly, married filing separately, head of

household and qualifying widow or widower.

Tax rates can be progressive, regressive, or flat. With a progressive tax the

rate of tax increases as the amount of taxable income increases. The U.S.

income tax is a progressive tax. There are seven tax brackets for ordinary

income ranging from 10% to 39.6%.

An individual pays tax at a given bracket only for each dollar within thatbracket's range. The individual's marginal tax rate, the percentage of tax on

the last dollar earned, has no effect on any underlying income taxed at a

lower bracket. This ensures that every rise in a person's pre-tax salary results

in an increase of their after-tax salary.

Income tax systems often have deductions available that lessen the income

tax liability by reducing taxable income. Claiming deductions may reduce an

individual's tax liability by a rate equal to the marginal tax rate of their

particular tax bracket. If an individual is able to increase the amount of their

tax deductions by $1,000 and the individual's marginal tax rate is 25%, thetax deductions will reduce the individuals tax liability by $250 ($1,000 x

25%). Please note that if part of the individuals $1,000 of income that was

offset by $1,000 of tax deductions was taxed in a lower tax bracket then the

reduction in tax liability would be less than $250.

Short-term capital gains are taxed at the ordinary income tax rates. Long-

term capital gains have lower tax rates, with special tax rates in some

circumstances.


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T a x T ipWho must file a tax return?

Generally, if the taxpayers income is less than his personal exemptionand standard deduction, he doesn't need to file a tax return unless he is

entitled to refund of federal tax withheld from his paycheck or if he

qualifies for the Earned Income Tax Credit, Additional Child Tax Credit, or

Adoption Credit. However there are exceptions that well explain in

Lesson 5.

S I D E B A R

How much is a fair share?

We hear it all the time. Politicians speak about the Tax Code and

make statements such as Everyone has to pay their fair share.

Sounds good, right?

But did you ever wonder exactly how many dollars are in a fair

share?

Its impossible to tell because what is completely fair under one

political ideology is completely unfair under another political

ideology. There is simply no way to determine exactly how much a

fair share is.


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The table below shows how much money the Federal Government

collects from each type of tax:

Type of Tax

Gross Collections in Fiscal

2013

(1)

Percentage of 2013

TotalBusiness Income Tax $311,993,954 11.15%

Individual Income Tax $2,462,201,645 86.05%

Unemployment Ins. Tax $7,895,992 0.28%

Railroad Retirement Tax $5,510,733 0.19%

Estate / Trust Income Tax $24,696,073 0.86%

Estate Tax $14,051,771 0.49%

Gift Tax $5,778,377 0.08%

Excise Tax $61,033,674 2.23%

Grand Total $2,855,059,420 100.00%

Table: Internal Revenue Collections By Type

(1)Dollar amounts are in thousands of dollars and rounded.

S I D E B A RDo the rich pay taxes?

In a nutshell, yes. While a small percentage of the rich pay no income

taxes in any given year for various different reasons, the rich as agroup pay the greatest share of income taxes - more than any other

group. Consider the following facts:

According to the IRS, taxpayers with adjusted gross incomes

greater than $388,905were in the top 1% of all US households

in terms of income in 2011.

The top 1% of taxpayers contributed 35.1%of all income taxes

collected by the U.S government. The top 50% of taxpayers

contributed 97.1% of all income taxes collected. The bottom50% of taxpayers contributed 2.89% of all income taxes

collected.

In 2011the top 1% paid an average effective tax rate of 23.5%

on their income far more than any other group, and more

than seven and a half times the average effective rate of the

bottom 50%, who paid 3.13%percent on average.


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The wealthy's share of income taxes paid has increased

dramatically since 1986. However, so has their income.

(Sources: Internal Revenue Service,TaxFoundation.org)

What are the different types of taxes?

Income Tax

The federal government taxes income as its main source of revenue. Forty-

three (43) states and a few counties and cities also levy income tax. Seven

states - Alaska, Florida, Nevada, South Dakota, Texas, Washington and

Wyoming - collect no income tax. Two others, New Hampshire and

Tennessee, only collect tax on dividend and interest income, not wages.Income can be taxed at a flat rate - or on a graduated scale, with the people

who earn the most money paying a greater percentage of income tax.

Advantage:Graduated income taxes are a progressive tax, which means the

taxpayers with lower incomes pay less in income tax than those with higher

incomes.

Disadvantage:Truly fair and equitable income taxes are difficult to assess.

Sales Tax

Sales tax is levied on the purchase of such things as furniture, clothing and

movie tickets. The federal government does not have a sales tax, but states,

counties, and cities often rely heavily on sales tax. The tax rate and the types

of goods subject to these taxes vary from place to place.

Advantage: Sales tax is collected by the merchant, making it easy for

governments to track.

Disadvantage: Sales taxes are regressive, meaning that they impact most

heavily on those with the least ability to pay. Both poor and wealthy people

pay the same tax for the same item, although that sum represents a higher

percentage of the poor person's income than it does of the wealthy

person's income.


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Use Tax

Similar to sales tax, these taxes are levied for services such as telephone,

electric and other utilities, and for leases and rentals. They are also levied on

"users" of goods purchased "sales tax free" in another state.

Advantage: Use taxes are collected by the vendor, making it easier for

governments to track.

Disadvantage: Use taxes are regressive, meaning that they impact most

heavily on those with the least ability to pay.

Excise Tax

Excise tax, sometimes called "luxury tax," is used by both the state and

federal governments. Some examples of items subject to excise tax are

heavy tires, fishing equipment, airplane tickets, gasoline, beer and liquor,

firearms, and cigarettes.

Advantage: These taxes can sometimes be used to discourage the use of

items such as cigarettes and alcohol, or to reduce demand for items that

may be scarce.

Disadvantage: Excise taxes are regressive, meaning that they impact most

heavily on those with the least ability to pay.

Real Estate TaxFederal and state governments do not tax real estate. Real estate tax is most

local government's main source of revenue. Most localities tax private

homes, land, and business property based on the property's value (ad

valorem). When real estate is mortgaged, real estate taxes are ordinarily

collected and escrowed monthly by the mortgage lender along with the

mortgages principal and interest payment. The escrowed real estate tax is

then remitted to the taxing authority once a year.

Advantage: This is a progressive tax, which means people with lower

property values pay less in real estate taxes than the wealthy who usually

own property of higher value.

Disadvantage:If re-assessments are not made by the Property Tax Assessor

annually, owners of new homes pay more than those who own older homes

that have appreciated in value over the years.


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Personal Property Tax

Some local governments also assess tax on personal property such as boats,

cars, airplanes, appliances, and furniture.

Advantage:This is a progressive tax. The poor usually pay less in property

tax than the wealthy, because they own less property and property of lower

value, than the wealthy.

Tolls and Permits

These are use fees for such public services as highways, parking lots and

public parks.

Advantage:Tools and permits place the burden of paying the tax only on

the people who use the services. Revenue from tolls is often used to build

and maintain highways and bridges and only people who drive on those

highways and bridges pay the tax.

Disadvantage: Tolls and permits are considered regressive, meaning that

they impact most heavily on those with the least ability to pay.

Estate, Gift and Inheritance Taxes

Estate tax is imposed on the entire estate of the individual. Inheritance tax is

imposed on the transfer of property after the owner's death. Under the

inheritance tax system, the beneficiary of the property must pay the tax. A

gift tax is levied on large gifts from one individual to another, usually parent

to child. The federal government has an estate tax and a gift tax. Many

states have some type of inheritance tax.

Advantage: Estate, inheritance or gift taxes are progressive since they are

levied only on those whose wealth has increased.

Disadvantage:Death taxes sometimes require the sale of some or all of the

property to pay the taxes.

TariffsTariffs are taxes that governments levy on imports and exports. The tariff is

usually paid by the person or vendor doing the importing and passed on to

the consumer.

Advantage: Tariffs make foreign goods more expensive, thus making

American made items more attractive.


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Disadvantage:Tariffs are regressive, meaning that they impact most heavily

on those with the least ability to pay.

Value Added Tax (VAT)

Value Added Tax is similar to a sales tax. However it is a tax on the

estimated market value added to a product or material at each stage of its

manufacture, production or distribution. As with a sales tax, a VAT is

ultimately passed on to the consumer. The consumer is often unaware

exactly how much VAT is built into the price they pay for a product.

Conversely, the consumer can see the amount of sales tax charged on their

sales receipt. VAT allows countries to collect tax from foreign consumers

when they purchase exported products. Of 192 countries, only 62 have an

income tax, yet 132 have a VAT.

VAT is becoming increasingly attractive since there are few other revenue

raising options. Politically however, VAT poses some major obstacles.

Conservatives perceive a VAT as a hidden tax which can be raised without

the knowledge of the consumer. Liberals see a VAT as a highly regressive

tax which hits low and middle income taxpayers more severely.

Advantage: VAT is collected by the business, making it easy for

governments to track and collect.

Disadvantage:VAT is regressive, meaning that it impacts most heavily on

those with the least ability to pay.

IMPORTANT REMINDERS

Take the Quiz- Taking each lesson's quiz promptly after lessoncompletion will help you solidify you're understanding of the

most important lesson content, and will also help you pass the

Final Exam.

Do the Homework - While completing the homework is notmandatory, we strongly recommend that you complete each

lesson's homework assignment. It will expand your knowledge

and understanding of the topics covered in this course.


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Glossary

10-Year Averaging- a special computation method to determine the tax on a qualified lump-sum

distribution for taxpayers born before 1936.

Accelerated Cost Recovery System (ACRS)- the system of depreciation mainly used for propertyplaced in service after 1980 and before 1987. The Modified Accelerated Cost Recovery System

(MACRS) replaced ACRS for assets placed into service after 1986.

Accelerated Depreciationmethod(s) of depreciation that yield larger tax deductions in the earlier

years of the life of an asset and smaller deductions at the end.

Accountable Plan- a plan for reimbursing employees for expenses such as meals, travel, and

transportation incurred for business purposes on behalf of the employer. Reimbursements are not

taxable and expenses are not deductible to the employee.

Accounting Method- a method under which income and expenses are determined for t

Federal Taxation

Documents

Transcript of Federal Taxation