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Unformatted text preview: H Chapter One H AN OVERVIEW OF FEDERAL TAXATION SOLUTIONS TO PROBLEM MATERIALS DISCUSSION QUESTIONS 1-1 A tax base is the amount upon which a tax is levied. The tax base for the Federal income tax is called ‘‘taxable income’’ and is the taxpayer’s total income less exclusions, deductions, and exemptions that might be available to the taxpayer. (See Exhibits 1-3, 1-4, and 1-5 and pp. 1-11 through 1-17.) The tax base for the Federal estate tax is called ‘‘total taxable transfers’’ and is computed as follows: Gross Estate, less the sum of According to the technical definition, a regressive tax rate structure is one where the rate decreases (increases) as the base increases (decreases). In contrast, in a proportional tax rate structure, the rate is a constant percentage of the base. In the technical sense, both sales taxes and social security taxes are proportional taxes because the rate is always the same regardless of the size of the base. This is because the tax rates are defined in terms of the base on which they are levied. Relative to the taxpayer’s ability to pay, however, proportional taxes are regressive. For example, as the taxpayer’s ability to pay grows or his income rises, the taxpayer’s total sales taxes becomes a smaller percentage of income. Because the rate becomes smaller as the criterion for paying increases, the tax is regressive. (See p. 1-7.) 1-4 A deduction is a reduction in the gross (total) amount that must be included in the taxable base. A tax credit is a dollar for dollar offset against a tax liability. (See Examples 3 and 12 and pp. 1-6 through 1-11.) The value of a deduction is a function of the taxpayer’s marginal tax rate. For example, if a deduction equals $1,000 for a taxpayer in the 28 percent bracket, the value of that deduction would be $1,000 28% or $280. The $280 is the amount of tax that would be saved by using the $1,000 deduction. The value of a credit, on the other hand, is the full value of the amount of the credit (e.g., a $1,000 credit will save the taxpayer $1,000). (See Examples 9 and 12 and pp. 1-9 and 1-11.) Accordingly, if the taxpayer is faced with a choice between a deduction and a credit, he must use his marginal tax bracket to determine the relative worth of the two amounts. If, for example, the taxpayer is choosing between a $1,000 deduction or a credit of 20 percent of the $1,000 expenditure, and assuming he is in the 28 percent bracket, he would go through the following analysis: Value of the credit: 20% $1,000 ¼ $200 Value of the deduction: 28% (marginal tax rate) $1,000 ¼ $280 In this case, the taxpayer would choose the $280 deduction over the $200 credit. 1-5 Significant differences between computing a corporation’s taxable income and computing an individual’s taxable income include the following: Only individual taxpayers have deductions ‘‘for’’ adjusted gross income. Corporations simply compute gross income and then reduce it with allowable deductions to compute taxable income.compute gross income and then reduce it with allowable deductions to compute taxable income....
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- Spring '08
- Progressive Tax, Taxation in the United States