Tax Brackets
What is the formula for calculating the effective/average tax rate?
Total Tax / Total Income
What is the tax deadline for the following (assume both are calendar year taxpayers):
C Corps
Individuals
April 15 (15th day of the fourth month following the close of the tax year)
Case facts: The marginal tax rate is 32%. The effective tax rate is 18%. The taxpayer has a tax-deductible expense of $17,000, and a nondeductible expense of $5,000.
What is the impact on taxable income from each of the expenses above? How much would the tax savings be for each?
Deductible expense: Reduces taxable income by $17K. Tax savings would be $17K * 32% = $5,440.
Non-deductible expense: No effect on taxable income. Tax savings would be 0.
Sample question #3: Which of the following is a primary source of tax law?
a. Internal Revenue Code
Note: other primary sources include:
U.S. Constitution & Tax Treaties
Legislative History (e.g. Joint Committee Reports)
Court Cases (those appealable to your circuit court of appeals or the federal circuit)
Treasury Regulations
Revenue Rulings & Revenue Procedures
IRS Announcements & Notices
What is the difference between permanent and temporary book to tax differences and give one example of each?
Permanent differences arise when an item of income or expense is recorded for book purposes but never recognized for tax purposes. Examples: life insurance proceeds, municipal bond interest, Fines, 50% Meals
Temporary differences arise from timing differences between GAAP and tax. The cumulative amount of the income or deduction is the same, but recognition occurs in different periods for GAAP compared to tax. Ex. Prepaid rental income, Accrued bonus/vacation, Depreciation, Bad Debt Expense, Warranty Expense, unearned revenue, etc.
What is the name of the tax rate that is most appropriate to use when making tax planning decisions? Where is this rate found?
Marginal tax rate, found in the tax brackets by using the taxpayer's taxable income (Last bracket utilized for the taxpayer's taxable income amount)
If a taxpayer with an unextended due date of April 15th requests an automatic extension of time to file, when is their tax return due?
Extended due date for the return is October 15 (6 months from original due date).
Case facts: The marginal tax rate is 32%. The effective tax rate is 18%. The taxpayer has a tax-deductible expense of $17,000, and a nondeductible expense of $5,000.
What is the after tax-cost of each expense?
Deductible expense: After-tax cost would be $17K - (32%*$17,000) = $11,560
Non-deductible expense: After-tax cost would be $5,000, since there is no deduction to generate tax savings.
Sample Question #1: How much tax will a $50 deduction save a taxpayer who is in the 30% tax bracket?
$50 * 30% = $15 tax savings
Carl is a dentist and owns a dental practice and is a cash basis, calendar year taxpayer. Carl performed dental services in December 2024 and the patients paid for those services with checks at the time of service. Carl did not deposit the checks into his business bank account until Jan 5th. When is the income taxable to Carl?
Carl has constructive receipt of the money when the patients gave him the checks. Thus, the amount is taxable to Carl in 2024. The fact that he chose not to deposit them into the bank (i.e. cash the checks) until Jan is irrelevant.
Galileo (single) has taxable income of $50,000 using the 2024 tax brackets below, what is his income tax?
Income Tax Rate
$0 - $11,600 10%
$11,601 - $47,150 12%
$47,151 - $100,525 22%
$100,526 – $191,950 24%
$191,951 - $243,725 32%
$243,726 - $609,350 35%
$609,351 and up 37%
11,600 - 0 = 11,600 * 10% = 1,160
47,150 - 11,600 = 35,550 * 12% = 4,266
50,000 - 47,150 = 2,850 * 22% = 627
Total Tax = 6,053
If an individual filed a tax return extension, by what date is the corresponding tax payment due (assume a calendar year taxpayer)?
April 15th. The extension is for filing purposes only, it does not extend the time to pay!
Note: The filing extension is 6 months, so the tax return filing would be due on Oct. 15
Sample Question #4: T Corporation generated a $100,000 net operating loss during the 2022 tax year. T has no NOL carryforwards from any earlier year. If T expects to have taxable income before NOL deduction of $60,000 in 2023, what would T’s 2023 taxable income be after taking the NOL deduction?
2023: NOL Max: 60K * 80% = 48K. Have enough NOL carryforward to use the max NOL deduction
Taxable income = $60k - $48k = $12k
Carry forward NOL of $52K
What are the 3 rules listed in class for the current law's treatment of NOLs?
1. Carry forward NOLs and do not expire
2. NOLs can offset up to 80% of taxable income each year
3. Carryback NOLs not permitted
Under the accrual method, what are the 2 rules for recognizing income for tax purposes?
What are some exceptions? What types of income do not qualify for exceptions?
Under the accrual method, income is recognized for tax purposes when:
1. All events have occurred to fix the taxpayer’s right to receive the income, and
2. The amount can be determined with reasonable accuracy
Exceptions: Prepayments for services, Prepayment for sales of inventory
Not Exceptions: Prepaid Rent, Insurance premiums, warranty contracts
Agamemnon has taxable income of $100,000 and pays tax of $20,000. Menelaus has taxable income of $50,000 and pays tax of $10,000. This tax rate structure is: Regressive, Progressive, or Proportionate
Proportionate
True or false: if an individual taxpayer does not have taxes withheld on their income (e.g., they have business income from their own business), they must make estimated payments during the year to avoid underpayment penalty and interest.
True
What is the NPV of the following series of cash flows, using a 6% discount rate?
(6,000)/ 1.060 =(6,000)
(1,000)/ 1.061 = (943)
8,000/ 1.063 = 6,717
Total NPV = ($226)
Sample question #2: On October 6, 2022 Firm C (a cash basis, calendar-year taxpayer) paid $90,000 rent for the period January 1, 2023 to December 31, 2023. How much of this rent payment can Firm C deduct in 2022?
$90,000. For a cash basis taxpayer, a prepaid expense is only deductible if the benefit lasts 12 months or less, and does not extend beyond the end of the next tax year (12-month rule).
What are the rules for a cash basis taxpayer hoping to deduct prepaid rent expense in the year paid?
12-month rule: Cash basis taxpayers may fully deduct prepaid expense if it meets two requirements:
1.Benefit lasts 12 months or less, and
2.Does not extend beyond the end of the following tax year
Note: If prepaid expense doesn’t meet both tests, it must be capitalized. Expensed following the accrual method, over each period the expense is incurred.
Cupcake Co. has a 32% marginal tax rate and a 17% average tax rate. If Cupcake incurs a non-deductible expense of $5,000, how much tax would this save Cupcake?
Zero, it is a non-deductible expense.
Note: If it was a deductible expense use the Marginal rate * Deductible expense = Tax savings
Sharon filed her 2023 tax return on March 30, 2024. She reported $100,000 of salary income, but forgot to report $3,000 of dividend income. What is the last date the IRS can assess additional tax on Sharon's 2023 tax return (i.e., when does the statute of limitations close)?
April 15, 2027. This is three years from the later of the actual filing date or statutory due date. Although Sharon omitted some income on her return, it is less than 25% of the gross income reported on the return, so the statute of limitations does not extend to 6 years.
Sample Question #5: Mabel is considering taking on a consulting project which will take one year. She and her client have agreed on a fee of $40,000, with $30,000 of the fee payable now and $10,000 payable on completion of the project (i.e., next year). Mabel expects to be in the 22 percent tax bracket this year and the 12 percent tax bracket next year. Calculate the NPV of Mabel’s after-tax income from this project, assuming that the income is fully taxable and assuming a discount rate of 6 percent.
Year 0: $30,000 * (1-0.22) = 23,400 after-tax income. PV = $23,400
Year 1: $10,000 * (1-0.12) = 8,800 after-tax income. PV = 8,800/1.06 = $8,302
NPV of project = 23,400 + 8302 = $31,702
What is the general statute of limitations for the IRS to audit a taxpayer's tax return filing? What are the 2 exceptions under which it can be longer?
3 years from the later of the actual filing date or unextended statutory due date
Exception 1: If taxpayer omitted gross income exceeding 25% of gross income reported on the return, then 6 years
Exception 2: No limit if return is fraudulent
As an accrual basis taxpayer, what are the tax rules for accrued expenses and expense recognition (i.e. the all events test)? Provide an example.
3 requirements:
1. The expense is fixed;
2. The expense can be determined with reasonable accuracy; and
3. Economic performance has occurred (when service, property, or use of property is provided)