SUMMARY OF CHAPTER - Chapter 1 Introduction to Federal Taxation and ...

© 2022 CCH Incorporated and its affiliates. All rights reserved. Chapter 1 Chapter 1 Introduction to Federal Taxation and Understanding the Federal Tax Law

SUMMARY OF CHAPTER

This chapter presents information on the magnitude of federal taxes collected and on taxpayer obligations. Also, the history of U.S. federal taxation is briefly summarized followed by a review of the federal legislative process.Fundamental Aspects of Federal Taxation ¶1101 Sources of Revenue Types of federal taxes include (1) income taxes on corporations, individuals, and fiduciaries, (2) employment taxes, (3) estate and gift taxes, and (4) excise and customs taxes. Also, revenues are generated from state and local taxes. Consideration is given to the attractiveness of alternative systems—the value-added tax and flat tax.¶1121 Tax Collection and Penalties Taxes are big business and figures are given to demonstrate just how vast and complex the federal revenue collection system has become. In 1989, the civil tax penalty provisions were extensively revamped to create a fairer, less complex and more effective penalty system. Changes were made in the (1) document and information return penalties, (2) accuracy-related penalties, (3) preparer, promoter, and protester penalties, and (4) penalties for failure to file or pay.¶1131 Taxpayer Obligations A clear understanding of tax avoidance versus tax evasion is necessary to achieve good tax planning. Tax avoidance is legal and a legitimate pursuit of a business entity. Tax evasion requires the presence of a tax liability. There is a legal obligation to disclose a tax liability based on completed transactions and the refusal to report the tax liability is illegal.¶1151 Brief History of the Federal Income Tax The adoption of the Sixteenth Amendment to the Constitution enabled Congress to levy "taxes on income, from whatever source derived." A brief chronological history of changes affecting the tax law from 1913 to the present is presented.•16th Amendment (2/15/1913). Congress empowered itself to tax income.•Revenue Act of 1913. Imposed income tax on individuals, corporations and other entities, effective 3/1/1913.•Internal Revenue Codes of 1939, 1954 and 1986. Recodified the numerical referencing format of legislative tax law after significant tax law revisions had occurred.Solutions Manual Complete Chapter 1-24 1 / 4

• CCH Federal Taxation—Comprehensive Topics

© 2022 CCH Incorporated and its affiliates. All rights reserved. Chapter 1 ¶1161 Federal Tax Legislative Process Steps in the enactment of a revenue bill are (1) origination in the House of Representatives Ways and Means Committee, (2) passage by the House, (3) passage by the Senate, (4) resolution of differences in House and Senate versions by the Joint Conference Committee, composed of members of both legislative bodies, (5) approval of the final version by both the House and the Senate, (6) approval or veto by the President, and (7) incorporation into the Internal Revenue Code.Both the Senate and the House must vote affirmatively by a two-thirds majority to override a veto.¶1165 Tax Reform The Tax Cuts and Jobs Act was the most significant tax legislation since the Tax Reform Act of

• Major features of the act are discussed below.

Underlying Rationale of the Federal Income Tax ¶1171 Objectives of the Tax Law The federal income tax system is comprised of a complicated and continually evolving blend of legislative provisions, administrative pronouncements, and judicial decisions. The primary purpose of the tax law is obviously to raise revenue, but social, political, and economic objectives are also important. These various objectives, which frequently work at cross-purposes with the revenue-raising objective of the law, must be examined and understood to appreciate the rationale underlying the immense multipurpose body of law known as the federal income tax.¶1175 Economic Factors Numerous provisions of the tax law have been employed to help stimulate the economy, to encourage capital investment, or to direct resources to selected business activities. Examples include the following: MACRS depreciation; the optional expensing election in lieu of depreciation; percentage depletion; special farming elections to expense rather than to capitalize expenses for soil and water conservation, land clearing, and fertilizers; the S corporation provisions; the Section 1244 stock loss provision; and the tax rate structure for regular corporations.¶1181 Social Factors Numerous tax provisions can best be explained in light of their underlying social objectives.Examples include the following: the tax-free status accorded to employees on premiums paid by an employer on group-term insurance, accident and health plans, and medical benefit plans; and the tax-deferred status accorded to employees' current income under deferred compensation plans.¶1185 Political Factors Since the tax law is created by Congress, and Congress consists of several hundred elected officials, political factors play a major role in the development of tax legislation. Additionally, special interest groups and influential constituents have a definite impact on the legislative process.For example, depletion under the percentage depletion method is limited to 50% of "taxable net 2 / 4

• Instructor’s Manual

© 2022 CCH Incorporated and its affiliates. All rights reserved. Chapter 1 income before depletion" for all natural resource properties except oil and gas properties. For oil and gas properties, the limit is 100% of taxable net income before depletion.¶1187 Tax Policy and Reform Measures Reform of the tax statutes has been a trend through the years. The tax policy implications of the 1986 revision will be under examination for some time to come. In an effort to further the concept of neutrality in the tax law, the Revenue Reconciliation Act of 1990 made major changes in the way high-income individuals compute their taxable income. Also, for 1991 the tax rate schedules were changed to incorporate a third tax bracket: 31 percent. The Revenue Reconciliation Act of 1993 extended the tax rates to also include a 36 percent bracket and a 39.6 bracket. The Taxpayer Relief Act of 1997 made major modifications to capital gains. The holding period of capital assets to qualify as long term was extended from more than 12 months to more than 18 months. Also, the long-term capital gains tax rate for many items decreased from 28 percent to 20 percent.The IRS Restructuring and Reform Act of 1998 changed the holding period for long term classification from more than 18 months to more than 12 months. The year 2000 saw the passage of three important tax bills that contain many provisions impacting taxpayers. The Community Renewal Tax Relief Act of 2000 was contained in the Consolidated Appropriations Act, 2001. This Act renewed provisions designed to enhance investment in low- and moderate-income, rural and urban communities. The Act also extended for two years medical savings accounts (MSAs). Also included was a provision expanding innocent spouse relief. The Installment Tax Correction Act of 2000 reinstated the availability of the installment method of accounting for accrual basis taxpayers.The year 2001 brought another tax bill, the Economic Growth and Tax Relief Reconciliation Act of

• The major provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001

are: reduction in the individual income tax rates; increased 401(k) and IRA contributions; tax relief for financing higher education, including graduate education; estate and gift tax relief; and a reduction in the marriage penalty.The highlights of the Jobs and Growth Tax Relief Reconciliation Act of 2003 are the rate reductions for individuals, the marriage penalty was reduced, the child tax credit was increased, the maximum tax rate for most long-term capital gains was reduced, the tax rate on dividend income was reduced, additional first-year depreciation was increased, the alternative minimum tax exemption was increased, the accumulated earnings tax rate was reduced, and the tax on undistributed personal holding company income was reduced. The Working Families Tax Relief Act of 2004 extended many of the provisions which were set to expire in 2004. The Pension Protection Act of 2006 contains numerous provisions to strengthen current employer pension plans.Specific reference was given to defined benefit plans. The Emergency Economic Stabilization Act of 2008 provided $700 billion to stabilize the economy. The Act also extended numerous tax provisions that were set to expire at the end of 2008. Included in this list was the AMT (alternative minimum tax). The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the Bush-era tax cuts for two more years. This included the capital gains and dividend tax cuts. Further, it cut the payroll tax two percentage points for the year 2011 and put a patch on the alternative minimum tax for two years.

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• CCH Federal Taxation—Comprehensive Topics

© 2022 CCH Incorporated and its affiliates. All rights reserved. Chapter 1 The American Taxpayer Relief Act of 2012 allowed the US to avert the "fiscal cliff." The Act allowed the Bush-era tax cuts to sunset for single taxpayers with incomes over $418,400 and for couples with income over $470,700 for 2017. Many tax breaks that were to expire were extended.It permanently patched the alternative minimum tax and provides for a maximum estate tax of 40 percent with a $5 million indexed exclusion, $5.49 million for 2017.Other highlights of the Act include raising the tax on incomes over $418,400 (individuals) and $470,700 (filing jointly) to 39.6 percent in 2017, and the maximum capital gains tax to 20 percent, with a five-year extension on the American Opportunity Tax Credit and a two-year extension on certain business tax items.The Act also extended all marriage penalty relief provisions. However, the Act reinstated the phaseout of itemized deductions and revived the personal exemption phaseout.President Obama signed into law in December 2015 The Protecting Americans from Tax Hikes (PATH) Act of 2015. It did much more than just extend the 50-plus provisions that expired at the end of 2014. Some provisions were made permanent, others extended for five years (through 2019) and others extended for two years (through 2016). Among the more notable extensions for individuals are: the American Opportunity Tax Credit, deduction for certain expenses for elementary and secondary school teachers, increases in the earned income credit and transit benefits parity. For businesses the more notable extensions are: enhanced expensing under Section 179, and the research tax credit.The Tax Cuts and Jobs Act signed into law by President Trump on December 22, 2017 was a massive tax bill. The center piece of the bill is the lowering of the corporate tax rate from a high of 35 percent to a flat 21 percent. The cut in the corporate rate is a permanent change and does not sunset. The changes in tax rates, with respect to individuals, mostly take affect after December 31, 2017 and sunset at the end of 2025. Several of the major changes that affect individuals are: almost doubling of the standard deduction and the limiting of the state and local tax deduction and property tax deduction to $10,000. Also, although the alternative minimum tax remains, the phase- out of the AMT exemption has been dramatically raised and fewer individuals will be subject to the AMT.The Further Consolidated Appropriations Act, 2020 was signed into law on December 20,

• It renewed tax breaks known as “extenders” and the Setting Every Community Up for

Retirement Enhancement Act of 2019 (the SECURE Act) which makes major changes to 401(k) plans, IRAs, and creates a new multiple employer plan. The American Rescue Plan Act of 2021 funded vaccination and testing for COVID-19. It also excluded up to $10,200 of unemployment benefits from gross income subject to limitations. Further, it allows for the exclusion from gross income for discharge of indebtedness of student loan amounts after 2020 and before 2026 under certain conditions. The Infrastructure Investment Jobs Act contains several tax provisions. It requires information reporting for digital assets like cryptocurrency and the retroactive termination to October 1, 2021 of the employee retention credit.As of press time no legislation has been enacted to extend the expiring tax provisions. From the list presented in the textbook it can be seen that the extenders fall into three groups: those affecting individuals, those affecting businesses, and those related to energy.

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