Designing Tax Systems: An Equitable, Convenient, and Economical

School: Ohio Northern University - Course: LAW 1280 - Subject: Accounting

Chapter 1DESIGNING TAX SYSTEMS I. Designing Tax Systems A.Designing Tax Systems 1.A good tax ought to be equitable, convenient, certain and economical 2.Tax = Tax Base x Rate B.Major Taxes: 1.Income Taxes:Federal and most states 2.Property Taxes:Taxes based on the value of property are common sources of revenue for local governments 3.Sales Taxes:Vary widely - common source of state and local revenue 4.Employment Taxes:May be paid by employer, employee or both 5.Excise Taxes:Taxes on certain goods or services 6.Wealth Transfer Taxes:Gift and estate taxation II. Tax Rate Terminology A.Marginal Tax Rate 1.% at which next $1 of tax base will be taxed B.Average Tax Rate: 1.Tax ÷ Tax Base 2.Example: Tax ($22,250)÷Taxable Income ($100,000) = Average Tax Rate (22.25%) C.Effective Tax Rate 1.Tax÷Economic Base 2.Example:Tax ($22,250)÷Taxable Income ($100,000) + Income Not Taxed ($100,000) $22,250÷$200,000 = 11.125% D.Proportional 1.Tax rate remains the same as the tax base increases 2.Example:Sales tax of 8%Sales of $1,000 taxed at 8% Sales of $10,000 taxed at 8% 1-1

E.Progressive 1.Tax Rate increases as the tax base increases 2.Example:Income TaxIncome of $1,000 taxed at 10% Income of $400,000 taxed at 35% F.Regressive 1.Tax rate decreases as the tax base increases 2.Example:OASDI tax6.2% of first $113,700 of wages 0% of wages in excess of $113,700 III. Wealth Transfer Taxes - The Gift Tax A.The gift tax is based on the value of property given to a donee each year.Property includes real, personal, tangible and intangible property. B.An annual exclusion of up to $14,000 to each donee is available for 2013.The annual exclusion is indexed for inflation. C.Gift splitting may be elected by married donors. The impact of gift splitting enables both the husband and wife to claim up to the maximum allowable annual exclusion. *(Refer to Problem 1-26) D.Advantages of gifts - appreciation and income of gifted property are transferred to the donee. E.Calculation of the tax:A separate gift tax rate schedule is applicable for 2010.In 2011 and subsequent years the tax rate schedule is the same schedule used for estate tax.While the gift tax is computed annually, it is based on the cumulative amount of taxable gifts made over an individual's life F.Unified Credit(now renamed the "Applicable Credit Amount") 1.This credit is an offset to the gift tax liability.Congress has recently changed the gift and estate tax rules. 2.The credit for 2013 is $2,045,800 and is available to each donor. 3.The unified credit exemption amount is $5,250,000 for 2013. Actual payment of gift tax is not required until total taxable cumulative aggregate value of gifts exceeds $5,250,000.