Chapter 1:
Approaching the Study of Taxation:
What Is Taxation?
● primary purpose of taxation: to raise revenue for govt operations
● used as a tool to influence the behavior of individuals & businesses
○ to providedirect benefitsto taxpayers (ex/help payfor health insurance) and
indirect benefits(in the form of exclusions, deductions,and credits that reduce a
taxpayer’s tax liability)
○ Ex/
■ tax credit (reduces a taxpayer’s tax bill) may be designed to encourage
people to purchase a fuel-efficient car
■ tobacco excise tax may discourage individuals from smoking by increasing
the cost of tobacco products
Taxation in Our Lives: KIDD
● Direct Tax:paid to the government by the person whopays the tax
○ ex/ personal income tax (Form 1040-to fed); Property Tax (to local govt); Sales tax
(seller has to collect and remit to govt)
● Indirect Tax:
○ ex/ Embedded sales tax: :
■ Gasoline: buyer has to pay for some of the income taxes & the gasoline
excise taxes owed by the oil company
■ renter indirectly pays property taxes assessed on the landlord
● Ultimately, all taxes are paid by individuals
○ ex/ corporate income tax: paid directly by corp but is rlly paid indirectly by
individuals in their capacity as customers, investors (owners), or employees
○ taxes are passed along to individuals through higher prices, lower dividends,
and/or lower wages
Relevance of Taxation to Accounting and Finance Professionals:
● U.S. corporate income tax rate is 21 % but can rise up by 5% bc of state income taxes
○ means a company might have to devote up to 26% of net income to income tax
● Necessary Types of Tax:
○ Compliance:make sure business file all tax returnsand makes all tax payments
on time
○ Planning:Help a business apply favorable tax rules,such as income deferral and
tax credits, to minimize tax liability (and maximize owner wealth)
○ Financial reporting: Financial statements & Footnotes(reports various tax
details including the company’s effective tax rate)
○ Environmental, Social, and Governance (ESG) reporting:to address various
business sustainability and responsibility matters and to report environmental,
social, and governance activities and impact
■ Standard framework w/ tax metrics: Global Reporting Initiative (GRI)
Standards or ones generated by the World Economic Forum
■ Tax professionals assist businesses in identifying relevant and possibly
required ESG reporting and help verify that the information is accurate
and clearly explained
○ Controversy:interaction a taxpayer may have witha tax agency (ex/ IRS)
■ Tax Represenation services: to represent a taxpayer to the tax agency to
assist w/ an audit or to provide answers to questions given by tax agency
○ C ash Management:Businesses must be sure they have the funds ready when the
taxes are due and have procedures to track due dates
○ Data Analysis:need skills in data analysis & visualizationto identify samples for
both internal & external audits, find ways to
identify the products and services subject to
sales tax in different states, and extract tax
data to help inform other business functions
such as where to locate a new sales office
○ Tax advocacy:the improvement & evolution
of tax laws
■ Done by taxpayers, practitioners,
organizations: American Institute of
CPAs (AICPA), industry associations,
and various policy organizations
Ultimately, much of taxation istransaction-based.
●
How a transaction is structured (e.g., as a sale or a
lease) has varying tax consequences that must be
considered.
Brief History of U.S. Taxation
A
Early Periods:
● Early Income Tax was used for Civil War (adopted by the Fed in 1861)
○ When war ended, income tax was not needed anymore & Fed was financed
through tariffs
● New Fed Income Tax on individuals 1894: was questioned for consitutionality through
casePollock v. Farmers’ Loan and Trust Co
○ Supreme Court concludes taxes on the income of real and personal property
were the legal equivalent of a tax on the property involved and, therefore,
required apportionment based on the population of the United States
● Fed Corporate Income Tax (1909):declared constitutionalbc seen as tax on the right to
do business in the corporate form (franchise tax)
○ Corp is an entity created under law, therefore law can tax it’s creation & operation
● Ratification of 16th Amendment allowed for Federal individual and corporate income
taxes, thus neutralizing effect of Pollock decision
● Revenue Act of 1913: birth of Form 1040
○ allowed various deductions and personal exemptions of $3,000 for a single
individual and $4,000 for married taxpayers
■ Mostly applied to wealthy individuals
■ rates from 1-6%; 6% applicable to taxable income in excess of $500k
● Internal Revenue Code of 1986: Current collection of codified laws (arranged in
systematic manner); Includes revenue codes of 1939 & 1954 & previous revenue laws
○ Used as the current law w/ changes made every year
Tax Trends:
● Tax Revenue Sources ->
○ Borrowing to cover the deficit is
missing from chart (has represented
b/w 17-48% of total govt revenues)
○ Income Tax collections from indiv &
corps = 61% of total recipes