Basics of the American tax system

Forrest Davis, E.A.

Davis Tax Services, LLP

Taypayers are confused

• The current political environment has confused many taxpayers

• Taxes: What is fair?

Quick history

• Income was 1st taxed for the Civil War, but the Supreme Court rejected it

• 16th Amendment created current income tax in 1913

• Enrolled Agents were instituted in 1884

Goals of the income tax

• Raise money to pay for government services

• Provide economic incentives for public policy

Economic incentives

• Mortgage interest: encourage home ownership

• Deduction for donations: encourage giving to charity

• Capital gains: encourage investing in businesses

• Salary deferral: encourage saving for retirement

• Depreciation: encourage businesses to buy equipment to be more productive

Progressive tax

• Higher income citizens should pay more tax

• Poorest citizens should be exempt• 6 tax brackets from 10% to 35%• Highest bracket is for income over

$388,350

Taxpayers today

• 46% of American households pay no income tax

• 1/4th of households still would pay no tax if all tax breaks were cut

• About half have no tax because of tax breaks

• Top 1% of filers pay 31% of total taxes

Earned Income Tax Credit

• 26 million filers receive Earned Income Credit (2009)

• "Negative income tax" for low-income workers

• Refundable -- get money from taxes instead of paying

• Many also get Child Tax Credit

How the US stacks up

• Americans pay less taxes than many other countries

Where does the money go?

• Mandatory spending 57%– Social Security 21%– Medicare 13%– Medicaid 7%– Other programs 17%

An alternative: Flat tax

• Premise: Everyone should contribute• Everyone should be equal

– Opposite of current progressive approach• Would eliminate nearly all tax breaks

– No incentives for public policy

An alternative: National Sales Tax• Often tied to eliminating income tax• Common in Europe• Sales tax hits lower income citizens

harder• Economic ups & downs affect sales tax

revenues

An alternative: Tax businesses more

• Premise: businesses generate the money for everybody

• Higher taxes could make companies move out of US

• Higher taxes might force some companies out of business

What's the answer?

• Congress doesn't know• No easy answers• Lots of different views

Davis Tax Services, LLP

• C. Forrest Davis, EA• Tax Planning, Preparation &

Representation• www.davis-tax.com• 4402 E. Brott St.• Tucson, AZ 85712