CCH Federal Taxation Basic Principles Chapter 1 Introduction to Federal Taxation and Understanding the Federal Tax Law ©2004, CCH INCORPORATED 4025 W. Peterson Ave. Chicago, IL

CCH Federal Taxation Basic Principles2 of 15 Federal Taxes Income taxes  Corporations, individuals, fiduciaries Employment taxes  Old age, survivors, disability, and hospital insurance (federal insurance contributions, self-employment insurance contributions), unemployment insurance, railroad retirement Estate and gift taxes  Estate, gift, and generation-skipping transfers Excise and custom taxes  Alcohol, tobacco, gasoline, other Chapter 1, Exhibit 1

CCH Federal Taxation Basic Principles3 of 15 Other Taxes State and local taxes Value-added tax (VAT) Flat tax Chapter 1, Exhibit 2

CCH Federal Taxation Basic Principles4 of 15 Tax Revenue Statistics Chapter 1, Exhibit 3a Source% Total Revenue Avg. Rev. per Return Overall Audit Probability Tax Revenue ($’s in billions # Returns (#’s in millions) Individual Income Tax 51.46%$ 7, %$1, Corporate Income Tax 10.48%$37, %$ Excise and Customs Taxes 2.59%$57, %$ Estate and Gift Tax 1.35%$67, %$ Employment 34.12%$23, %$ Partnerships N/A 0.26%N/A2.2 Other (mostly Declarations of Estimated Tax) Totals 100.0%$2, Source: Compiled from Internal Revenue Service Data Books for 2002.

CCH Federal Taxation Basic Principles5 of 15  The General Accounting Office has reported that U.S. taxpayer compliance is the highest in the world, approximately 83 to 85 percent.  Nevertheless, the IRS has acknowledged that the problem of tax evasion is a serious one. Each percentage point of noncompliance costs the government approximately $7 billion in lost revenue.  The IRS has decreased its audit coverage of individual returns since the mid-1990s. The increase is largely attributable to expanded applications of technology and upgraded IRS information systems. Chapter 1, Exhibit 3b Tax Revenue Statistics

CCH Federal Taxation Basic Principles6 of 15 Tax Avoidance v. Tax Evasion Tax avoidance—Saving tax dollars through specific actions to avoid the tax liability prior to the time it would have occurred according to the law. Tax evasion—The taxpayer does not report income even though the taxpayer already has a tax liability and all actions are definitely complete. Chapter 1, Exhibit 4a

CCH Federal Taxation Basic Principles7 of 15 Tax Avoidance v. Tax Evasion What frequently distinguishes avoidance from evasion is the intent of the taxpayer. Some identifying “badges” of fraud are:  Understatement of income  Claiming of fictitious or improper deductions  Accounting irregularities  Allocation of income  Acts and conduct of the taxpayer Chapter 1, Exhibit 4b

CCH Federal Taxation Basic Principles8 of 15 Audit Probabilities for Individuals Chapter 1, Exhibit 5 National AverageYear 1.08 % % % % % % 0.49 % % %

CCH Federal Taxation Basic Principles9 of 15 Sampling of TCMP Audit Probabilities Taxpayer ClassificationProbability Self-employed taxpayers with Schedule C gross receipts over $25,000.1 in 112 Small C corporations with assets under $10 million.1 in 68 Lawyers, accountants, engineers, and architects:  Schedule C gross receipts of $150,000 to $1 million  Partnerships, 10 or few partners, receipts over $100,000  S corporations, assets under $200,000 1 in 51 1 in in 239 Doctors, dentists, and other medical providers:  Schedule C gross receipts of $150,000 to $1 million  Partnerships, 10 or few partners, receipts over $100,000  S corporations, assets under $200,000 1 in 79 1 in 76 1 in 212 Taxpayers who do not itemize or file supporting schedules1 in 6,616 Source: “When to Say No,” Laura Saunders and Janet Masters, Forbes, Oct. 9, 1995, p. 94. Chapter 1, Exhibit 6

CCH Federal Taxation Basic Principles10 of 15 Statute of Limitations for IRS Assessments Time LimitsNature of IRS Claim 3 Years Omission of  25% income (nonfraudulent). Excess deductions (nonfraudulent). 6 Years Omission of > 25% income (nonfraudulent). Unlimited Fraudulent return or failure to file. The SOL “clock” starts “ticking” on the filing due date or the actual filing date, whichever is later. Chapter 1, Exhibit 7

CCH Federal Taxation Basic Principles11 of 15 Statute of Limitation for Taxpayer Refunds 1. 3 years from the date the return was filed or 2. 2 years from the date the tax was paid. Taxpayers may file for refunds by the later of (Returns filed early are deemed to have been filed on the filing due date.) Chapter 1, Exhibit 8

CCH Federal Taxation Basic Principles12 of 15 Brief History of Federal Income Tax Income Tax Law of 1894  2% on gains, profits, and income over $4,000  declared unconstitutional in Pollack case Corporation Excise Tax of 1909  1% excise tax on corporations with net income over $5,000 Sixteenth Amendment and the Revenue Act of 1913  Amendment allowed Congress to enact direct tax  Act imposed tax on net income of individuals and corporations  Act repealed the Corporation Excise Tax of 1909 Chapter 1, Exhibit 9

CCH Federal Taxation Basic Principles13 of 15 Tax Legislative Process 1. Tax bill is screened by House Ways and Means Committee 2. Consideration by the House of Representatives 3. Referred to Senate Finance Committee 4. Consideration by the Senate  Bill may be sent to Joint Conference Committee if the House and Senate differ. Bill would then be sent back to House and Senate for consideration. 5. Approval or veto by the President 6. Incorporation into the Code (if approved by President or if veto is overridden) Chapter 1, Exhibit 10

CCH Federal Taxation Basic Principles14 of 15 Objectives of the Tax Law Economic—to stimulate or control the economy Social—to encourage behavior (e.g., deduction for charitable contributions) or discourage behavior (e.g., illegal kickbacks are not deductible) Political—to benefit one’s own constituents or to discourage certain activities Chapter 1, Exhibit 11