CHAPTER 3 Tax Law INTRODUCTION GENERAL PRINCIPLES THE ABILITY TO TAX TAX ASSESSMENTS, RATES, AND SCHEDULES

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1 CHAPTER 3 Tax Law INTRODUCTION If any business wishes to operate, it must have revenue. Taxes are the source of government revenue. In order for government to operate on a day-to-day basis and provide services to the general population, it must have revenue. It must collect taxes. Terminology explaining how these taxes are established and collected is set out in this chapter. Also discussed is terminology used to describe taxes based on what they tax or how they are determined. The terms and principles of tax avoidance are presented along with the consequences of violations of tax law. GENERAL PRINCIPLES THE ABILITY TO TAX Taxing power the power of government to levy and collect taxes is given to the federal government by the U.S. Constitution, Article I, Section 8, Clause 1. (See Appendix 1, the U.S. Constitution.) Generally, a tax is a charge by the government on the income of an individual, a corporation, or trust, or on the value of an estate or gift. The purpose in assessing the tax is to generate revenue to be used by the government for the needs of the public. Taxation is the process of taxing an individual or corporation or imposing a tax. Double taxation is the taxing of the same item or piece of property twice to the same purpose, or taxing it as the property of one person and then as the property of another. Double taxation occurs when the income of a corporation is taxed as corporate income and then again as shareholder income if it is distributed as dividends. TAX ASSESSMENTS, RATES, AND SCHEDULES In order to know how much to levy, tax assessment must take place. Tax assessment is the value given to the property, real and personal, that is being taxed. Tax assessment is used to determine how much an individual will have to pay in taxes because he or she owns the property. For example, a home has a particular monetary value, so its owner must pay a particular amount of tax. A consumer pays a certain amount for an automobile; she, too, will pay a corresponding amount of tax on the vehicle. The amount of tax is determined by multiplying the assessed value of the property by the tax rate, the amount of tax imposed on personal or corporation property. The tax assessment is performed by a tax assessor, a government official assigned this duty. The tax assessor will assess the property and determine its market value. This is the value to which the tax rate is applied. A tax rate schedule is used to determine the tax on a given level of taxable income. Tax tables, which are the same as schedules, are tables established by the taxing authority for 1

2 2 CHAPTER 3 the computation of taxes. For example, Astrid earns between $10,000 and $30,000; the tax table states her tax rate is 10% of her income. Persons whose income is $30,001 to $50,000 pay 15% of their income. See Exhibit 3-1 for the IRS income tax rates. EXHIBIT 3-1 FEDERAL PERSONAL INCOME TAX RATES FILING STATUS AND TAXABLE INCOME LEVEL Married Filing Jointly or Qualifying Married Filing Single Filers Widow/Widower Separately Head of Household Tax Rate Up to Up to $7,000 $14,000 Up to $7,000 Up to $10,000 10% $7,001 $28,400 $14,001 $56,800 $7,001 $28,400 $10,001 $38,050 15% $28,401 $68,800 $56,801 $114,650 $28,401 $57,325 $38,051 $98,250 25% $68,801 $143,500 $114,651 $174,700 $57,326 $87,350 $98,251 $159,100 28% $143,501 $311,950 $174,701 $311,950 $87,351 $155,975 $159,101 $311,950 33% $311,951 $311,951 $155,976 $311,951 35% or more or more or more or more A tax levy is an order for payment of taxes. Once the value of an item of property is established and the tax rate is applied, or an amount of income is determined and the tax rate schedule is applied, an owner or earner may receive a tax levy setting out how much he or she owes in taxes. A tax bracket is the specified interval of income that a specific tax rate is applied to. For example, if a wage earner s income is between $10,000 and $11,000, he or she pays 5% in income tax; he or she is in the 5% bracket. A person who makes $11,001 to $12,000 pays 7% in taxes and is in the 7% bracket. WHEN SOMETHING CAN BE TAXED When something is taxable, it is subject to taxation, liable to be assessed for a share in tax. If it is not taxable, then taxes cannot be assessed against it. A taxable estate is the gross estate of a deceased person reduced by deductions allowed by the Internal Revenue Service (IRS) Code. See Exhibit 3-2. EXHIBIT 3-2 FEDERAL ESTATE TAX Definition of gross estate (a) General The value of the gross estate of the decedent shall be determined by including to the extent provided for in this part, the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated. (c)(3) In the case of estates of The exclusion decedents dying during: limitation is: 1998 $100, $200, $300, $400, or thereafter $500,000. Source: United States Code For example, a gross estate all of a decedent s property owned at the time of his death has a value of $100,000, but the maximum amount of deductions is $500,000, so no taxes are owed on the estate. The estate is allowed to deduct property with a value up to $500,000 from the part of the estate that is subject to the tax. Because the value of the estate is less than $500,000, no taxes are due.

3 TAX LAW 3 Another example of something that can be taxed is a taxable gift. A taxable gift is subject to the unified transfer tax. If a person gives another person a gift, the person who receives the gift may have to pay taxes based on the value of the gift. TAX BASE AND TAXPAYERS A tax base is the total assessed value of all the property in a given area and determines the rate at which an individual property is assessed. For example, if all the property in a given area is worth $1.5 million, the $1.5 million is the tax base. A tax base is based on a tax roll, an official record maintained by cities and towns listing the names of taxpayers and assessed properties. The tax roll and tax base may reflect the amount collected for local taxes, those imposed by municipalities local property taxes, city income taxes, and sales taxes. A taxpayer is a person who is subject to a tax on income regardless of whether he or she pays the tax or not. For example, Ginger has not paid income tax on her income because her deductions are so great she does not owe income tax. She always gets a full refund of the taxes taken out of her gross earnings. She is a taxpayer, but never really pays taxes on her income. Taxable income is gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual s or entity s income. For example, Blanche made $42,354, but is allowed to reduce the amount that is subject to tax by the amount of interest she paid on her mortgage. Blanche paid $7,000 in mortgage interest; thus, her taxable income is reduced to $35,354. A taxpayer s tax liability is the amount of taxes he or she owes after properly figuring his or her gross income and deductions using the appropriate tax rate and subtracting any tax credits. For example, Bobby earns $62,000 a year. He deducts the amount of mortgage insurance he paid ($6,000); he gave $2,000 to charity; and he is allowed deductions for himself, his wife, and his two children in the amount of $6,000. His taxable income is $48,000; he is in the 10% tax bracket, so his tax liability is $4,800. TYPES OF TAXES FLAT TAXES AND GRADUATED TAXES Taxes can be classified according to how the tax rate is applied to what is being taxed. A flat tax rate is tax imposed at the same rate on all levels of income. If a flat tax rate is in effect, no matter how much money an individual earns, the tax rate is 10%. Everyone pays the same rate, regardless of how much or how little he or she earns. A graduated tax is a rate that increases as the amount of the income or value of the property increases. For example, real property that has a value of $20,000 may be taxed at a 5% rate. Property that is worth more than $20,000 may be taxed at a 7% rate. A person making between $10,000 and $20,000 a year pays taxes at one rate. PROGRESSIVE, REGRESSIVE, AND PROPORTIONAL TAXES A progressive tax is one that increases as income increases: the more a person makes, the higher his or her tax rate. A regressive tax is a tax system in which higher income groups pay a smaller percentage of their income to taxes than do lower income groups. For example, someone who earns less than $40,000 may pay 10% in income tax, while a person who

4 4 CHAPTER 3 makes over $40,000 pays only 8% in income tax. The person who makes $40,000 is paying $4,000 in taxes; the person who makes $41,000 will pay $3,280 in taxes. Proportional taxation is a system of taxation in which the rate of taxation is uniform no matter how much income a person has. See Exhibit 3-3 for a summary of these types of taxes. EXHIBIT 3-3 TYPES OF TAXES Flat Tax The tax rate is imposed at the same rate on all levels of income. Graduated Tax The tax rate increases as the amount of the income or value of the property increases. Progressive Tax A tax that increases as the income of the person increases. The more a person makes, the higher his or her tax rate. Regressive Tax A tax system in which higher income groups pay a smaller percentage of their income to taxes than do lower income groups. Proportional Taxation A system of taxation in which the rate of taxation is uniform no matter how much income a person has. TAX AVOIDANCE TAX AVOIDANCE, EVASION, AND FRAUD Because no one likes to pay taxes, and because they may be upset by the amount of their tax liability, people use several methods legal and illegal to avoid paying taxes. Tax avoidance is the minimization of one s tax liability by taking advantage of legally available tax planning opportunities. Bobby, in the earlier example, was engaging in tax avoidance. Tax evasion is illegally paying less in taxes than the law permits. It may be reporting less income actually earned or deducting nonexistent expenses. For example, Rodney earns $32,000 in salary, and on the side he earns another $10,000. He does not report the extra $10,000, and he also claims business expenses that he did not incur. This can also be tax fraud, a criminal offense of willfully attempting to evade or defeat the payment of taxes due and owing. There must be a specific intent to avoid paying the tax negligence is not enough for a criminal conviction. See Exhibit 3-4 for examples of activities that can be tax fraud. EXHIBIT 3-4 EXAMPLES OF TAX FRAUD Deliberately underreporting or omitting income Overstating the amount of deductions Keeping two sets of books Making false entries in books and records Claiming personal expenses as business expenses Claiming false deductions Hiding or transferring assets or income TAX SHELTERS, LOOPHOLES, AND EXEMPTIONS A person may attempt tax avoidance by putting income into a tax shelter, a device used to reduce or defer payment of taxes. Some common types of shelters are limited partner-

5 TAX LAW 5 ship interests or real estate investments that allow deductions. Their use has been limited by reforms in the income tax code. A taxpayer may use a tax loophole, a provision in the tax code that allows a taxpayer to legally avoid or reduce his or her income tax. A tax shelter used to be such a loophole, but changes in the law effectively closed the loophole. See Exhibit 3-5 for an example of a disallowed tax shelter. EXHIBIT 3-5 AN EXAMPLE OF A DISALLOWED TAX SHELTER Notice ; IRB 1 (25 Jun 2002) Partnership Straddle Tax Shelters Part III Administrative, Procedural, and Miscellaneous [1] The Internal Revenue Service and the Treasury Department have become aware of a type of transaction, described below, that is being used by taxpayers for the purpose of generating deductions. This notice alerts taxpayers and their representatives that the tax benefits purportedly generated by these transactions are not allowable for federal income tax purposes. This notice also alerts taxpayers, their representatives, and promoters of these transactions of certain responsibilities that may arise from participating in these transactions. FACTS [2] This transaction involves partnerships manipulated through a series of steps carried out in the following order. No 754 election is in effect at any relevant time. Step 1: Corporation acquires a majority interest in an upper tier partnership (UTP) at fair market value. Step 2: UTP acquires a majority interest in a lower tier partnership (LTP) at fair market value. Step 3: LTP enters into straddles on foreign currencies and may acquire other assets. Step 4: LTP terminates the gain leg of a foreign currency straddle. LTP allocates a pro rata share of the gain to UTP, which in turn allocates a pro rata share of the gain to Corporation. This gain increases the basis of each partnership interest. Step 5: Corporation sells its interest in UTP to Taxpayer at fair market value. This results in a loss to Corporation sufficient to offset the gain that was allocated to Corporation. Step 6: Taxpayer purchases UTP s interest in LTP at fair market value. UTP realizes a loss on this sale, but the loss is disallowed under 707(b)(1)(A) because Taxpayer owns more than 50% of UTP. Step 7: LTP engages in a transaction that is intended to increase Taxpayer s basis in the LTP interest. For example, LTP may incur a liability that Taxpayer guarantees. LTP then terminates the loss leg of the foreign currency straddle and allocates a pro rata share of the loss to Taxpayer. Step 8: Taxpayer sells the interest in LTP at its fair market value and realizes gain (for example, from the relief of liability). Taxpayer then claims that this gain is offset under 267(d) by the amount of the loss that was disallowed to UTP under 707(b)(1)(A). Source: Internal Revenue Service A taxpayer may invest in tax exempt investments, those on which no taxes are levied because they have a tax exemption, or immunity from the payment of taxes. Tax exempt status also applies to property used for educational, religious, or charitable purposes. Income shifting is another attempt to reduce tax liability by transferring money to one or more family members. Tax reform also limited this loophole by creation of the kiddie tax, which is imposed on the unearned income of children under the age of 14 that exceeds a minimal amount. The income is taxed at the parent s income tax rate. For example, Henry and Shirley want to reduce the amount of their tax liability. They are in a 22% tax bracket. They transfer money to their son William, who is twelve. They plan on giving just enough to be taxed at a 5% rate. But if Henry and Shirley give too much money, William will not be taxed at a 5% rate, but will be taxed at a 22% rate. If a taxpayer is fortunate enough, his or her income is earned in a tax haven, a country that imposes little or no tax on the profits from the transactions carried on in that country.

6 6 CHAPTER 3 NONPAYMENT OF TAXES TAX AUDITS If someone is too liberal with his or her tax avoidance, he or she may face a tax audit, an examination of books, vouchers, and records conducted by agents of the IRS. The taxpayer may also find himself or herself in tax court, the court that tries cases and makes decisions regarding the existence of deficiencies or overpayment of taxes payable to the U.S. government. For example, if someone engaged in tax evasion and he or she were charged, the case would be heard in U.S. Tax Court, where the amount of the deficiency would be determined. TAXPAYER S BILL OF RIGHTS Taxpayers do have certain rights when dealing with the IRS. These rights are listed in the taxpayer s bill of rights and include the following. 1. The right to receive an explanation of the examination and collection process. 2. The right to representation. 3. The right to make audio recordings of meetings with the IRS. 4. The right to rely on the IRS s written advice. 5. The right to file an application for relief with the IRS ombudsman. 6. The right to receive written notice of a tax levy the order to pay taxes thirty days prior to enforcement. TAX REBATES, DEFICIENCIES, WARRANTIES, AND LIENS If a taxpayer pays more than he or she is supposed to, he or she will receive a tax rebate, the amount of money returned by the taxing authority after the taxes due are paid. If a taxpayer underpays his or her taxes, or does not pay them at all, the IRS may perform a tax deficiency assessment. This is the process used by the IRS to audit a taxpayer s return and determine whether the gross income has been understated or deductions have been overstated. If there is a tax deficiency, the taxpayer will receive a tax levy. If the taxpayer still refuses to pay state or federal taxes, he and his property may be subject to a tax warranty, the process used for the collection of unpaid taxes under which property can be seized and sold. As part of this process, the government may place a tax lien on the property. A tax lien is created by statute and binds the taxpayer s property for the taxes due. If the federal government places the lien on the property, it is a federal tax lien. If the lien is not satisfied, then the property is subject to tax foreclosure, the seizure and sale of the property by the government for nonpayment of taxes. The tax sale is the actual sale of the property. The person who purchases the property at the tax sale is given a tax certificate, which entitles the holder to own the property purchased if it is not redeemed within the period allowed by law. Tax redemption occurs when the taxpayer reclaims the property that was sold for nonpayment of taxes. In order to redeem the property, the taxpayer must pay any delinquent taxes as well as interest, costs, and penalties. If the property is not redeemed, then the buyer of the property at the tax sale receives a tax deed, the proof of ownership that is given to the purchaser by the government after the finalization of the sale. The person who bought the property is said to have tax title, the title held because of purchase at a tax sale. See the flow chart in Exhibit 3-6.

7 TAX LAW 7 EXHIBIT 3-6 TAX DISPUTE FLOW CHART Taxpayer has a deduction disallowed. The IRS performs a tax audit and determines that the taxpayer owes back taxes. The taxpayer disputes owing the money. Dispute is heard internally within the IRS. Taxpayer loses. Taxpayer takes the case to the United States Tax Court. The court rules in favor of the IRS and determines the amount of taxes owed by the taxpayer. Taxpayer still does not pay the taxes due. The IRS issues a tax lien on the property of the taxpayer. Taxpayer does not pay off the lien, so the IRS forecloses on the property. The property is sold at a tax sale. The person who purchases the property receives a tax certificate, which gives the purchaser the right to own the property if the property is not redeemed by the taxpayer. Taxpayer pays the delinquent taxes, interest, and penalties, and then reclaims the property. If the taxpayer does not pay within the time frame, then the purchaser receives a tax deed. For example, Roberta refuses to pay any income tax to the federal government to protest the wasting of tax dollars. A tax lien is placed on her property, and she still refuses to pay. She receives notice that failure to pay will result in her property being sold, and she still refuses to pay. The property is sold and Clifford purchases it. He will take possession subject to Roberta s right of redemption. If she does not redeem the property in the specified time, it becomes his property free and clear of any claim Roberta had. INCOME TAX Some taxes apply to business, other taxes apply to individuals, and some types of taxes apply to companies and individuals. Income tax a tax on income, wages, and salary is a tax applied to individuals and corporations. For individuals, income tax is also a withholding tax, a tax that is collected by deducting it from the wages of employees. THE TAX RETURN When determining what income tax is owed, a taxpayer will prepare a tax return, the form on which an individual or corporation reports income, deductions, and exemptions and calculates tax liability. IRS Forms 1040 EZ, 1040 A, and 1040 are examples of tax returns. An amended return is a tax return filed after the original return, generally containing a correction of an error. A joint return is filed jointly by both spouses, even if they only have one income. A separate return is filed by only one spouse and covers only his or her income.

8 8 CHAPTER 3 DEDUCTIONS AND CREDITS A tax deduction is a subtraction from gross income to arrive at taxable income. A deduction reduces taxable income and results in a percentage reduction of the amount of tax owed. A tax credit is an amount subtracted from the taxpayer s tax liability to arrive at the final tax bill. It is a dollar-for-dollar reduction of the taxes owed. For example, Bettina makes $30,000 and has a tax deduction of $3,000. The deduction reduces her taxable income by $3,000 to $27,000, so the tax rate applies only to the $27,000. She also has a tax credit of $1000. The amount of the tax Bettina owes $2,700 will be reduced by the $1000 tax credit, for the final amount owed of $1,700. Depreciation, which is a decline in the value of property because of age, wear and tear, and obsolescence and which is usually measured by a set formula, is also a tax deduction. INDIVIDUAL TAXES CAPITAL GAINS AND GIFTS Individuals also have to pay taxes other than income tax. One of these is a capital gains tax, which is a tax on the profit made from the sale of capital assets. Capital gains are taxed at the same rate as income tax. For example, a taxpayer sells stock in Microsoft and makes a $12,000 profit. This profit is a capital gain and is subject to the capital gains tax. Gift tax is assessed on the transfer of assets without adequate consideration. The federal gift tax is imposed on the donor, but some states impose the tax on the receiver of the gift. For example, a taxpayer gives his nephew stock worth $100,000. This would be taxed as a gift because the ownership of the stock transferred with no consideration being paid. PROPERTY TAXES Government can be authorized to tax personal property and real property. Both taxes are based on the value of the property. Personal property tax is imposed against personal property, usually by cities and towns. Real estate or property taxes are based on the value of the real property. SALES, USE, AND CONSUMPTION TAXES Sales tax is levied by states on the sale of goods and is based on their value. For example, if Elaine buys a car for $10,000 and her state has a 6% sales tax, the amount of tax she will have to pay is 6% of the cost of the car, or $600. A consumption tax is imposed on sales of consumable goods and services: the more one consumes the good or service, the more tax one will have to pay. A use tax is imposed by a state on the use of certain goods that are not subject to sales tax. Such a tax is designed to discourage people from going out of state and purchasing goods that are not subject to sales tax where they are purchased. For example, State A has sales tax on cars. State B does not. Carol, who lives on the border of the two states, crosses into State B and purchases a new car. Upon her return, her home state, State A, may impose a use tax on the car she bought.

9 TAX LAW 9 STAMP, LUXURY, AND ESTATE TAXES A stamp tax is collected through the sale of stamps that must be affixed to certain documents. For example, when a house is purchased, stamps will be placed on the deed. Those stamps are purchased at the time of transfer of title. A luxury tax is imposed on the purchase of items that are not considered essential items, such as jewelry, yachts, or luxury automobiles. An estate tax is imposed on the right to transfer property at death. It is a debt of the estate that is usually paid from the estate itself. An inheritance tax is not a tax on the property that is being inherited; rather, it is a tax on the right to inherit the property. See Exhibit 3-7 for a summary of these taxes. EXHIBIT 3-7 SUMMARY OF INDIVIDUAL TAXES Capital Gains Tax A tax on the profit that is made from the sale of capital assets. Capital gains are taxed at the same rate as income tax. Gift Tax A tax on the transfer of assets without adequate consideration. The federal gift tax is imposed on the donor, but some states impose the tax on the receiver of the gift. Personal Property Tax A tax imposed against personal property, usually by cities and towns. Real Estate or Property Tax Tax that is based on the value of real property. Sales Tax A tax levied by states on the sale of goods and based on their value. Consumption Tax A tax imposed on sales of consumable goods and services. The more one consumes the good or service, the more tax one will have to pay. Use Tax A tax that is imposed by a state on the use of certain goods that are not subject to sales tax. It is designed to discourage people from going out of state and purchasing goods that are not subject to sales tax where they are purchased. Stamp Tax A tax that is collected through the sale of stamps that must be affixed to certain documents. Luxury Tax A tax imposed on the purchase of items that are not essential items. Estate Tax A tax imposed on the right to transfer property at death. It is a debt of the estate that is usually paid from the estate itself. Inheritance Tax A tax on the right to inherit property. CORPORATE OR BUSINESS TAXES ACCUMULATED EARNINGS AND EXCESS PROFIT TAXES Some taxes are assessed against only businesses or corporations. They are not levied against individual taxpayers. Accumulated earnings tax is a corporate income tax imposed in addition to regular corporate tax. Accumulated earnings tax is imposed on a corporation that has accumulated earnings beyond the reasonable needs of the business. This tax can be avoided by distributing the surplus via dividends. For example, a business needs $1,000,000 to operate for a year, but has earnings of $2,500,000. $1,500,000 could be subject to an accumulated earnings tax unless it was distributed to stockholders as dividends. Excess profits tax is levied on profits that are beyond the normal profits of a business and are usually imposed in times of national crisis like war to prevent profiteering. A gross receipt tax is based on total sales rather than net profits. A surtax is an additional tax imposed on income exceeding a specific amount.

10 10 CHAPTER 3 EXCISE, FRANCHISE, AND ACCUMULATED EARNINGS TAXES An excise tax is imposed on the performance of an act, the engaging in an occupation, or the enjoyment of a privilege. A franchise tax is an annual tax on the privilege of doing business in a state. It is not a tax on the income of the business. An undistributed profits tax or an accumulated earnings tax is imposed on the accumulated surplus of a corporation when the surplus reaches a certain level. The intent is to encourage a corporation to distribute any surplus as dividends to the holders of stock. The dividends will then be taxed to the shareholders as income. SUMMARY There are many different types of taxes government levies in order to generate income. Taxation takes place at the local, county, state, and federal levels. Taxes can apply to income, to personal property, to real property, to business transactions, to sales, to profits in excess of needs, to property that is used, or for the privilege of being in business. All taxes are designed to do one thing: generate income so government can provide the services the public wants.

11 CHAPTER 3 REVIEW KEY WORDS AND PHRASES accumulated earnings tax capital gains tax consumption tax depreciation double taxation estate tax excise tax federal tax lien flat tax franchise tax gift tax graduated tax gross receipt tax income shifting income tax luxury tax marginal tax rate progressive tax property tax proportional taxation real estate tax regressive tax sales tax surtax tax tax assessment tax audit tax avoidance tax base tax bracket tax credit tax deduction tax deficiency assessment tax evasion tax exempt tax foreclosure tax fraud tax haven tax levy tax lien tax loophole tax rate tax rebate tax sale tax shelter taxable taxable estate taxable gift taxable income taxing power taxpayer s bill of rights use tax withholding tax REVIEW QUESTIONS SHORT ANSWER 1. What is capital gains tax? 2. What is a stamp tax? 3. What does being taxable mean? 4. What is a taxable gift? 5. What is a tax deduction? 6. What is a tax credit? 7. What is a franchise tax? 8. What is a graduated tax? 9. What is an amended return? 10. What is a consumption tax? 11. What is income shifting? 12. What is tax avoidance? 13. What is a tax deed? 14. What is a progressive tax? 15. What is proportional taxation? 16. What is tax evasion? 17. What is a tax haven? 11

12 12 CHAPTER What is a tax sale? 19. What is the taxpayer s bill of rights? 20. What is a tax shelter? 21. What is a tax loophole? 22. What is a use tax? 23. What is a tax warranty? 24. What is a tax roll? 25. What is a tax levy? FILL IN THE BLANK 1. The list of tax payers in an area is known as the. 2. is illegally avoiding paying taxes. 3. is taking advantage of legal methods of avoiding paying taxes. 4. A tax on nonessential items is known as a. 5. The is a tax imposed on certain legal documents. 6. A tax on the privilege of doing business in a state is called a. 7. A is a tax that increases as the income of the person increases. The more a person makes, the higher his or her tax rate is. 8. An attempt to reduce tax liability by transferring money to one or more family members is. 9. A is a tax system in which higher income groups pay a smaller percentage of their income to taxes than do lower income groups. 10. Gross income reduced by adjustments and allowable deductions is known as. FACT SITUATIONS 1. What has Butch committed if he deliberately omits listing income he earned while filling out his income tax return? 2. What might happen if Rodney forgets to pay the property taxes due on his ranch? What can he do to remedy this? 3. Henri purchases two delivery vans to use in his antique business. How can he take the cost of these vehicles off of his income tax over time? 4. In order to limit people crossing the border to purchase goods from another state where there is no sales tax, what sort of tax might the first state impose on goods brought in from the other state? 5. Phillip becomes a top tennis player. He changes his citizenship to a state where there is no state income tax imposed. What is the state known as? 6. Ivan discovers that he improperly reported his income on his most recent tax return. What will he file to correct this problem? 7. When calculating her taxes due, Patsy subtracts her deductions and the tax credit to which she is entitled. The remaining amount is what she pays income tax on. What is this amount known as?

13 TAX LAW A corporation s earnings are several hundreds of thousands of dollars over any amount needed to meet its expenses and pay a reasonable dividend to its stockholders. What sort of tax might be imposed on these earnings? 9. John Mark did not pay taxes due on his property. The property is seized and sold. John Mark wants the property back. What does he have to do to get the property back? What is this process called? 10. If John Mark does not pay the back taxes on his property, what will the owner of the property receive?