Essentials of Taxation: Individuals and Business Entities PDF

Instructor's Guide: Nellen/Cuccia/Persellin/Young, SWFT 2023 Volume 4: Essentials of Taxation: Individuals and Business Entities. 9780357720103; Chapter 1: Introduction to Taxation c. Taxes at Death i. The transfer of property upon the death of the owner may be a taxable event. 1. If the tax is imp...

Instructor's Guide: Nellen/Cuccia/Persellin/Young, SWFT 2023 Volume 4: Essentials of Taxation: Individuals and Business Entities. 9780357720103; Chapter 1: Introduction to Taxation c. Taxes at Death i. The transfer of property upon the death of the owner may be a taxable event. 1. If the tax is imposed on the transferor at death, it is called an estate tax. 2. If the law taxes the recipient of the property, it is termed an inheritance tax. ii. As is typical of other types of transaction taxes, the value of the property transferred provides the base for determining the amount of the tax at death. iii. The Federal government imposes an estate tax. Only a few state governments levy their own additional inheritance taxes, estate taxes, or both. iv. The Federal Estate Tax. The Federal estate tax was intended to prevent large concentrations of wealth from being kept within a family for many generations. Whether this objective has been accomplished is debatable, because estate taxes can be substantially reduced (or deferred for decades) through careful tax planning activities. 1. Determination of the estate tax base begins with the gross estate, which includes property the decedent owned at the time of death. 2. Deductions from the gross estate in arriving at the taxable estate include funeral and administration expenses, certain taxes, debts of the decedent, and transfers to charitable organizations. 3. A marital deduction is available for amounts passing to a surviving spouse (a widow or widower). 4. Once the taxable estate has been determined and certain taxable gifts have been added to it, one must determine a tentative tax liability. T�e tentative liability is reduced by a variety of credits to arrive at the amount due. 5. In 2022, $12,060,000 of a U.S. decedent's estate effectively is excluded from the estate tax, with a maximum 40% tax rate on any excess. Spouses can share a $24,120,000 estate tax exclusion. v. State Taxes at Death. State taxes on transfers at death may include an inheritance tax, an estate tax, or both. The taxes will differ according to whether the tax is imposed on the heirs or on the estate. Some states completely exempt from taxation amounts that pass to a surviving spouse. d. Gift Tax i. The Federal gift tax is an excise tax levied on the right to transfer property. The tax is imposed on transfers made during the owner's life rather than at death. ii. The Federal gift tax is intended to complement the estate tax. The gift tax base is the sum of all taxable gifts made during one's lifetime. .&,, - J. . � 9 •- .... < -, ,t, • l 1 ,,fit.�• -�.�-I � ._, ..... • •• I ' • ' • - C(••-.,• � .,; -- . ·� - �-�� �� . - --� -- . - Instructor's Guide: Nellen/Cuccia/Persellin/Young, SWFT 2023 Volume 4: Essentials of Taxation: Individuals and Business Entities, 9780357720103; Chapter 1: Introduction to Taxation iii. The Federal gift tax and the Federal estate tax are unified. The transfer of assets by a decedent at death effectively is treated as a final gift under the tax law. iv. Annual taxable gifts are determined by reducing the fair market value of gifts given by an annual exclusion of $16,000 per donee; this amount does not use up any of the lifetime exclusion. A married couple can elect gift splitting, which enables them to transfer twice the annual exclusion ($32,000) per donee per year, before eroding the lifetime exclusion amount. v. Taxable gifts are reduced by deductions for gifts to charity and to one's spouse (the marital deduction). vi. Gifts for medical and educational purposes may be exempt from the gift tax. e. Property Taxes i. A property tax can be a tax on the ownership of property or a tax on wealth depending on the base used. Most property taxes in the United States are taxes on wealth; they use value as a base. ii. Value-based property taxes are known as ad valorem taxes. iii. Taxes on Realty. Property taxes on real property, or realty, are used exclusively by states and their local political subdivisions such as cities, counties, and school districts. 1. Realty is land and anything permanently attached to land, and personalty encompasses all assets that are not realty. 2. The following are some of the characteristics of ad valorem taxes on realty: (a) States may have a homestead exemption, which makes some portion of the value of a personal residence exempt from tax. (b) Lower taxes may apply to a residence owned by a taxpayer age 65 or older. (c) Some jurisdictions extend immunity from tax for a specified period of time (a tax holiday) to new or relocated businesses. (d) Some states provide for lower valuations on property dedicated to agricultural use or other special uses (e.g., wildlife sanctuaries). iv. Taxes on Personalty. Personal property, or personalty, encompasses all assets that are not realty. Both realty and personalty can be either business use or personal use property. 1. Personalty also can be classified as tangible property or intangible property. 2. The following generalizations may be made concerning the property taxes on personalty: (a) Generally, for individuals, vehicles are the only non-realty personal use assets subject to property tax. The value of a vehicle typically is established by a schedule based on the vehicle's age and make/model. Usually, any vehicle property tax is assessed and collected along with vehicle license or registration fees. (b) Generally, businesses are assessed property taxes on equipment and other tangible property, although many states do not tax inventory. (c) Some jurisdictions impose an ad valorem property tax on intangibles, like stocks and bonds. f. Other U.S. Taxes i. Federal Customs Duties. Customs duties or tariffs can be characterized as a tax on the right to move goods across national borders. 1. These levies served as the mainstay of the Federal revenue system until slightly after the turn of the nineteenth century. Tariffs and excise taxes alone paid off the national debt in 1835 and enabled the U.S. Treasury to pay a surplus of $28 million to the states. 2. In recent years, tariffs have acted more as an instrument for carrying out protectionist policies and to generate revenue. 3. History shows that tariffs often lead to retaliatory action on the part of the nation or nations affected. ii. Miscellaneous State and Local Taxes. 1. A franchise tax is a tax on the privilege of doing business in a state or local jurisdiction. Typically, the tax is imposed by states on corporations, but the tax base varies from state to state. 2. Occupational taxes are applicable to various trades or businesses, such as a liquor store license, a taxicab or shared-ride permit, or a fee to practice a profession such as law, medicine, or accounting. Most of these are not significant revenue producers and fall more into the category of licenses than taxes. iii. Severance Taxes. Severance taxes are based on the extraction of natural resources (e.g., oil, gas, iron ore, and coal). They are an important source of revenue for many states. g. Income Taxes i. Income taxes are levied by the Federal government, most states, and some local governments. Most jurisdictions attempt to ensure the collection of income taxes by requiring certain pay-as-you-go procedures. ii. The Structure of the Federal Income Tax. (1.4, PPT Slides 48-54) Although some variations exist, the basic Federal income tax formula is similar for all taxable entities. This formula is shown in Exhibit 1.1 in the text. 1. The income tax is based on the doctrine known as legislative grace: all income is subject to tax, and no deductions are allowed unless specifically provided for in the law. 2. All entities are allowed to deduct business expenses from gross income, but a number of limitations and exceptions are applied. 3. Individual rates range from 10% to 37%. Estates and trusts are also subject to income taxation, with rates ranging from 10% to 37%. 4. Partnerships, qualifying small business corporations, and some limited liability companies are not taxable entities but must file information returns. 5. For individuals, deductions are separated into two categories­ deductions for adjusted gross income (AGI) and deductions from AGI. An overview of the individual income tax formula is,provided in Exhibit 1.2 in the text. iii. State Income Taxes. Most states impose a traditional income tax on individuals. New Hampshire taxes only certain dividend and interest income. Most states also impose either a corporate income tax or a franchise tax based in part on corporate income. iv. Local Income Taxes. The imposition of income taxes by local jurisdictions, though not uncommon, is more the exception than the rule. v. Concept Summary 1.1 in the text provides an overview of the major taxes existing in the United States and specifies which political jurisdiction imposes them. IV. Income Taxation of Business Entities (1.5, PPT Slides 55-63) a. Proprietorships i. The simplest form of business entity is a proprietorship. ii. Because a proprietorship is owned by an individual, the individual has great flexibility in structuring the entity's transactions in a way that will minimize his or her marginal income tax rate. iii. The owner of the proprietorship reports the income and deductions of the business on a Schedule C and the net profit (or loss) of the proprietorship on his or her Form 1040. b. CCorporations i. Corporations that are separate taxable entities are referred to as C corporations because they are governed by SubchapterC of the Internal RevenueCode. (SeeChapters 12 and 13 inthe text.) ii. AC corporation files its own tax return (Form 1120) and is subject to the Federal income tax. iii. The shareholders then pay income tax on the dividends they receive whenthe corporation distributes its profits. c. Partnerships i. A partnership is not a separate taxable entity. ii. The partnership files a tax return (Form 1065) on which it summarizes the financial results of the business. Each partner then reports his or her share of the net income or loss and other special items that were reported on the partnership return. (See Chapter 14 in the text.) d. S Corporations i. Corporations that meet certain requirements and pay no Federal income tax at the corporate level are referred to as S corporations, because they are governed by Subchapter S of the Code. (See Chapter 15 in the text.) ii. An S corporation is treated like a C corporation for all nontax purposes as both are entities formed under a particular state's corporate law. Regarding tax factors, however, an S corporation is more like a partnership. e. Limited Liability Companies and Limited Liability Partnerships i. Limited liability companies (LLCs) and limited liability partnerships (LLPs) offer limited liability and some (but not all) of the other nontax features of corporations. ii. Both forms usually are treated as partnerships for tax purposes. iii. The S corporation, limited liability company, and partnership forms of f. organization, which are referred to as flow-through entities, avoid the double taxation problem associated with the C corporation. Dealings between Individuals and Their Business Entities i. The following are some of the major interactions between owners and business entities: 1. Owners put assets into a business when they create a business entity (e.g., a proprietorship, partnership, or corporation). 2. Owners take assets out of the business during its existence in the form of salary, dividends, withdrawals, redemptions of stock, etc. 3. Through their entities, owner-employees setup retirement plans for themselves, including IRAs and qualified retirement and pension plans. 4. Owners dispose of all or part of a business entity. ii. The following are a few of the many tax issues that arise: 1. How the tax law applies at.both the owner level and the entity level (i.e., the multiple taxation problem) and what effective tax rate is assessed on such income. 2. How to move assets into the business with the least adverse tax consequences. 3. How to pull assets and accumulated profits out of the business with the least adverse tax consequences. 4. How to dispose of the business entity with the least adverse tax consequences.