The Tax System in the United States. Indiviual and Corporate Income Tax and State Taxes in Wisconsin

Table of Contents:

1 Introduction and Basis tax model ... 5
1.1 History of U.S. Taxation ... 5
1.1.1 Early Periods ... 5
1.1.2 Revenue Acts ... 5
1.1.3 Federal Budget receipts -2008 ... 5
1.1.4 Criteria for Evaluating a Tax Structure ... 5
1.2 The Tax Structure ... 5
1.3 Major Types of Taxes ... 6
1.3.1 Property Taxes ... 6
1.3.2 General Sales Taxes ... 6
1.4 The Federal Tax Law ... 6

2 The Tax Law and Sources ... 6
2.1 Statutory Sources of the Tax Law ... 6
2.2 Administrative Sources of the Tax Law ... 7
2.3 Judicial Sources in the Tax Law ... 7
2.3.1 Trail Courts ... 7
2.3.2 Appellate Courts ... 7

3 Individual Income Tax ... 8
3.1 Tax Determination with the Tax Formula ... 8
3.1.1 Tax Formula ... 8
3.1.2 Components of the Tax Formula ... 8
3.1.3 Personal Exemptions ... 9
3.1.4 Dependency Exemptions ... 9
3.2 Gross Income ... 9
3.2.1 Definition ... 9
3.2.2 Year of Inclusion ... 10
3.2.3 Income Sources ... 10
3.3 Exclusions from the Income ... 10
3.3.1 Items specifically excluded from Gross Income ... 10
3.3.2 Gifts and Inheritances ... 11
3.3.3 Life Insurance Proceeds ... 11
3.3.4 Foreign Earned Income ... 11
3.3.5 Interests on Certain State and Local Government Obligations ... 11
3.4 Deductions and Losses ... 11
3.4.1 Classification of Deductible Expenses ... 11
3.4.2 Deductions for Adjusted Gross Income ... 12
3.4.3 Business and Hobby Losses ... 12
3.5 Depreciation, Cost Recovery, Amortization, and Depletion ... 12
3.5.1 Concepts Relating to Depreciation - Nature of Property ... 13
3.5.2 Modified Accelerated Cost Recovery System (MACRS) ... 13
3.5.3 Amortization ... 13
3.6 Alternative Minimum Tax ... 14
3.6.1 Individual Alternative Minimum Taxable Income (AMTI) ... 14
3.6.2 AMT Formula for Alternative Minimum Taxable Income (AMTI) ... 14
3.6.3 AMT Adjustment ... 14
3.6.4 Tax Preferences ... 14
3.6.5 Other Components ... 15
3.7 Tax Credits ... 15
3.7.1 Refundable and Nonrefundable Credits ... 15
3.7.2 General Business Credit ... 15
3.7.3 Other Tax Credits ... 16
3.8 Property Transactions ... 17
3.8.1 Determination of Gain or Loss ... 17

4 Corporations and Partnerships ... 18
4.1 Income Tax Considerations ... 18
4.1.1 Individuals and Corporations Compared ... 18
4.1.2 Deductions Available to Corporations ... 19
4.1.3 Determination of Corporate Tax Liability ... 19
4.2 Operating the Corporation ... 20
4.2.1 Dividend Distributions ... 20
4.3 Liquidating the Corporation ... 20
4.3.1 General Rule of § 331 ... 20
4.3.2 Exception to the General Rule ... 20
4.4 Partnerships ... 20
4.4.1 Nature of Partnership Taxation ... 20
4.4.2 Partnership Formation ... 21
4.4.3 Partnership Operation ... 21

5 Non Federal Taxes ... 21
5.1 State Taxes in Wisconsin ... 21
5.1.1 Income Tax ... 21

6 Summary ... ... 21

7 Bibliography ... ... 22

1 Introduction and Basis tax model

1.1 History of U.S. Taxation

1.1.1 Early Periods

The English colonists in the Massachusetts Bay Colony enacted the first income tax in 1634, but the federal government did not adapt this form of taxation until 1861. Eleven states and the Federal Union raised income tax to finance the civil war. After the civil war, there was no need for income tax and the federal government to repeal the tax. All operations could be financed by customs duties. In 1894, a new federal income tax on individuals was enacted. The federal corporate income tax was enacted by the Congress in 1909. The U.S. Supreme Court had approved all these laws.^[1] The German Einkommensteuergesetz was enacted in 1934, the Körperschaftssteuergesetz was enacted in 1920, and the Gewerbesteuergesetz in 1936.

1.1.2 Revenue Acts

With the Revenue Act from 1913, the first form 1040 was due on March 1, 1914. The structure was very similar. They already had deductions and personal exemptions. The rates ranged from 2 percent to 6 percent. The 6 percent rate applied for income in excess of $ 500,000. Nowadays the highest rate is 35 percent and applies on taxable income above $357,700.

1.1.3 Federal Budget receipts -2008

[Figures and tables are omitted from this preview.]
In total, the summary of receipts, outlays, and surpluses or deficits are 2,662,474 millions dollars, which equals 18.3 percent of the GDP.^[2]

1.1.4 Criteria for Evaluating a Tax Structure

Adam Smith identified the following canons of taxation to consider how evaluating tax structures.^[3]

- Equality
- Convenience
- Certainty
- Economy

1.2 The Tax Structure

The tax base is the amount on which the taxpayer has to pay tax. For federal income purpose, it is the taxable income. The tax rates apply on the taxable income.

The U.S. tax distinguishes between proportional rates, when the rate stays constant, and progressive rates, when a higher rate applies by increasing the base. Sales taxes are examples of proportional taxes. We find progressive taxes on federal income tax, federal gift and estate taxes and the most of state income tax rates.

1.3 Major Types of Taxes

- Property Taxes
- Transaction Taxes
- Death Taxes
- Gift Taxes
- Income Taxes
- Employment Taxes
- Other U.S. Taxes

1.3.1 Property Taxes

Most taxes in the U.S. are ad valorem taxes, like the property tax. Property taxes are based on the value of the asset and are generally on realty or personalty (Explained further in Chapter 3.5.1.). Property taxes are exclusive jurisdiction of states and their local political subdivisions. However, they are deductible for federal income tax purposes.

1.3.2 General Sales Taxes

Sales taxes are currently jurisdiction of states and localities. So there is no federal sales tax in general. States that impose sales taxes also charge a use tax on items bought in other states but used in their jurisdiction. So if the taxpayer transfers goods from one into another state, one technically has to pay the use tax. There are several states without sales or use taxes. These are Alaska, Delaware, Montana, New Hampshire, and Oregon.

1.4 The Federal Tax Law

The tax law in the United States has three major sources: Statutory provisions, administrative pronouncements, and court decisions. The major objective of the tax law is to raise revenue. In addition to this economic factor, social, equity and political factors also play significant roles.

2 The Tax Law and Sources

The U.S. tax law comes from all branches of the government, which are legislative, executive, and judicial. Thus, the major sources are the Internal Revenue Codes, Treasury Department regulations and also court decisions.

2.1 Statutory Sources of the Tax Law

Under the statutory sources, the mean sources are the Internal Revenue Codes. The law was based on individual codes until the first code was published in 1939. The advantage of this new Code is it was more logical and consequent. After the Code from 1939, Code of 1954 and 1986 were published. Each Code applies to all cases that take place after the last Code was published.

2.2 Administrative Sources of the Tax Law

The administrative part of the tax law can be classified into three parts, which are Treasury Department Regulations, Revenue Rulings and Revenue Procedures, and various other administrative pronouncements. These sources are all issued either by U.S. Treasury Department or the Internal Revenue Service (IRS). Furthermore, they can issue three types of Regulations. Proposed Regulations, theses may be change until they are finalized. Interested parties, like taxpayers are allowed to comment the correctness of the new regulations. Moreover, they can issue Finalized Regulations which force and effect of law. In some cases the Treasury Department release Temporary Regulations when immediate guidance is important. They expire automatically after three years.^[4]

2.3 Judicial Sources in the Tax Law

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2.3.1 Trail Courts

In case of a dispute, the case will be taken to federal courts. First step is taking the case to any of the Courts of Original Jurisdiction, also known as Trail Courts. The taxpayer may choose between one of the four trail courts, which are Federal District Court, the U.S. Court of Federal Claims, the U.S. Tax Court, or the Small Cases Division of the U.S. Court. The Small Cases Division only takes case up to the amount of 50,000 USD and the procedure is more informal.

2.3.2 Appellate Courts

The losing party can appeal a trail court decision to a Circuit Court of Appeals. A particular Court of Appeals does not have to follow the decision of other Court of Appeals. However, all Courts have to follow the decisions of the U.S. Supreme Court. Also, fundamentals of the law can be changed through period of time and a new understanding of law and justice.

3 Individual Income Tax

3.1 Tax Determination with the Tax Formula

3.1.1 Tax Formula

[Figures and tables are omitted from this preview.]

3.1.2 Components of the Tax Formula

3.1.2.1 Income -Broadly Conceived

The income broadly conceived includes all the taxpayer’s income, both taxable and nontaxable income.

3.1.2.2 Exclusions

The Exclusions are the first step, which reduces the taxable income.

3.1.2.3 Gross Income

The Internal Revenue Code defines gross income broadly as "except as otherwise provided ... , all income from whatever source derived"^[5]. However, the gross income does not include unrealized gains.

3.1.2.4 Adjusted Gross Income (AGI)

AGI is an important subtotal for the computation of the taxable income. It serves as the basis for computing percentage limitations on certain itemized deductions such as medical expenses, charitable contributions, and certain casualty losses. For example, medical expenses are only deductible up to 7.5% of AGI. This limitation might be described as a 7.5% "floor" under the medical expense deduction.

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[1] Pollcock vs. Farmers’ Loan and Trust Co., AFTR 2602, 15S.Ct. 912 (USSC, 1895) Flint v. Stone Tracy Co., 3 AFTR 2834, 31 S.Ct. 342 (USSC, 1911)

[2] Budget of the U.S. Government for Fiscal Year 2008, Office of Management and Budget (Washington, D.C.: U.S. Government Printing Office, 2007), Page 25-27

[3] The Wealth of Nations, Book V, Chapter II, Part II (Dutton, New York: 1910)

[4] §7805(e)

[5] §61(a)