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General Taxes

Four general types of business taxes.

1. Income Tax

2. SelfEmployment Tax

3. Employment Taxes

4. Excise Tax

q Income Tax

You must pay the tax as you earn or receive income1

during the

year. An employee usually has income tax withheld from his or

her pay. If you do no pay your tax through withholding, or do

not pay enough tax that way, you might have to pay estimated

tax.

q Employment Taxes

When you have employees, you as the employer have certain

employment tax responsibilities that you must pay and forms

you must file. Employment taxes include the following:

Social security and Medicare taxes

Federal income tax withholding

Federal unemployment (FUTA) tax

q Self Employment Taxes

Selfemployment tax (SE tax) is a social security and Medicare

tax primarily for individuals who work for themselves.

q Excise Taxes

Excise taxes generally are taxes levied on you if your business

does any of the following:

Manufacture or sell certain products.

Operate certain kinds of businesses.

Use various kinds of equipment, facilities, or products.

Receive payment for certain services.

Business Taxes:

q Payroll Tax

Whereas an income tax is levied on all sources of income, a

payroll taxapplies only to wages and salaries. Employers

automatically withhold payroll taxes from employees wages

and forward them to the government. Payroll taxes fund:

Social insurance programs

Programs that benefit the poor, elderly, unemployed, and

disabled.

1Income includes wages, salaries, and other earnings from

ones occupation; interest earned by savings accounts and

certain types of bonds; rents (earnings from rented properties);

royalties earned on sales of patented or copyrighted items,

such as inventions and books; and dividends from stock.

Income also includes capital gains, which are profits from the

sale of stock, real estate, or other investments whose value has

increased over time.

q A consumption tax

A consumption tax is a tax levied on sales of goods or services

The most important kinds of consumption taxes are general

sales taxes, excise taxes, valueadded taxes, and tariffs.

q A general sales tax

General sales tax imposes the same tax rate on a wide variety

of goods and, in some cases, services.

In US, states and local governments impose a general sales ta

There is no national general sales tax. State sales taxes range

from 3 to 7 percent, and local sales taxes range from a fractio

of 1 percent to 7 perce

q Excise Taxes

Federal, state, and local governments levy excise taxes, which

are sales taxes on specific goods or services. Excise taxes are

also called selective sales taxes. (e.g. Tobacco, Alcohol)

q Value Added Tax

VAT is just a general sales tax that is collected at multiple

stages. Favored in Europe

Seller pays the government a percentage of the value added tgoods or services at each stage of production. The value adde

at each stage of production is the difference between the

sellers costs for materials and the selling price.

qTariffs

Tariffs, also called duties or customs duties, are taxes levied o

imported or exported goods.

q Property tax

Property taxes is a tax on an individuals wealth2, notably rea

estate3.

q Estate tax

An estate tax is a tax on the deceased persons estate, which

includes everything the person owned at the time of death

money, real estate, stock, bonds, proceeds from insurance

policies, and material possessions

q Inheritance tax

An inheritance tax also taxes the value of the deceased

persons estate, but after the estate passes to heirs.

2Wealth is the value of all of the persons assets, both financi

(such as stocks and bonds) and real (such as houses, cars, and

artwork3

In practice, property taxes are usually more limited. In the

United States, state and local governments generally levy

property taxes on buildingssuch as homes, office buildings,

and factoriesand on land.

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u FOUR BASIC TASKS FOR TAX COMPUTATION:1. Compute adjusted gross income ones income from all

taxable sources minus certain expenses incurred in earning

that income.

2. Convert adjusted gross income to taxable income

income subject to tax subtract various amounts called

exemptions and deductions4.

3. Calculates the amount of tax due by consulting a tax table

or rate schedule, which shows the exact amount of tax due

for most levels of taxable income.

4. Subtract taxes paid during the year and any allowable tax

credits to arrive at final tax liability.

SCorp Taxes FAQs

Generally, the corporation must make estimated tax

payments for the following taxes if the total of these taxes

is more than an amount specified by law:

1. Tax on certain capital gains,2. Tax on builtin gains,

3. Excess net passive income tax, and

4. Investment credit recapture tax.

Because income from an S corporation is taxed at only one

level rather than two, your total tax bill will likely be less.

Business may have an operating loss the first year. With an

SCorp, you generally can pass that loss through to your

personal income tax return, using it to offset income

Shareholders pay income tax on their share of the SCorp

profits regardless of whether they actually received the

money or not. If the SCorp suffered a loss, shareholders

can claim their share of that loss.

You can deduct losses on your personal return only to the

extent of the money you put into the corporation (to buy

stock) and any money you personally loaned to the SCorp.

Interest you incur to buy SCorp stock is potentially

deductible as an investment interest expense

FICAThe FICA tax need only be paid on employee wages and not on

distributive shares.

Because FICA tax is avoided on distributive shares, the IRS and equivalentstate revenue agencies may recategorize distributions paid to shareholder

employees as wages if shareholderemployees are not paid a reasonable wage

for their position within the company.

4Other deductions are allowed to encourage certain kinds of

behavior. For example, some governments permit deductions

of charitable contributions as an incentive for individuals to

give money to worthy causes.

DistributionsActual distributions of profits, as opposed to distributive

shares, typically have no effect on shareholder tax liability.

In other words, a shareholder's pro rata share, or distributive share, of the

corporation's profit is what gets taxednot the money paid out to the

shareholder. However, a distribution to a shareholder that is in excess of the

shareholder's basis in his or her stock is taxed to the shareholder as capital

gain.

Taxation of S Corporation Distributive ShareWhile an S corporation is not taxed on its profits, the owners

an S corporation are taxed on their proportional shares of the

corporation's profits.

Example: Widgets Inc, an SCorp, makes 10,000,000 in net income and isowned 51% by Bob and 49% by John. On Bob's personal tax return, he will

report 5,100,000 in income and pay taxes on this income. John will report

4,900,000 of income on his personal 1040 return and pay taxes on this incom

If for some reason, Bob (as the majority owner) decides not to distribute the

money, both Bob and John will still owe taxes on their distributive shares, eve

though neither received any cash distribution. (Typically, S corporations use

shareholder agreements that stipulate at least enough distribution must be

made for shareholders to pay the taxes on their distributive shares.) They wi

also be required to pay their FICA tax, currently 15.3 percent, on any salary

paid, following the rules of the FICA Tax. Keeping it simple, we'll assume they

both pay themselves 94,200. Their FICA Tax liability will be 14,412 each. The

distribution of the additional profits from the SCorp will be done FICA Tax

Free. Their total tax savings will be approximately 603,000, or 6.15% of their

income minus their salaries.

California state taxesScorps pay a franchise tax of 1.5% of Net Income in the state

of California.

THE STUDY OF TAXES

To understand the effect of any tax, determine who bear

the burden of the tax

When the government levies a tax on a good/service, it

distorts consumer behaviorpeople buy less.

A Taxinduced change in behavior is called an excess

burden

A good tax system should be efficient, wasting as little

money and resources as possible. Measures of efficiency

1. Administration costs,

2. Compliance costs3. Excess burden.

Principles of Fairness in Taxes:

Abilitytopay principle holds that peoples taxes

should be based upon their ability to pay, usually as

measured by income or wealth

Benefits principle of taxation states that only the

beneficiaries of a particular government program

should have to pay for it.