Finance Tax Time

Did you know the federal income tax celebrated its 92nd birthday on October 3rd?

In February of 1913 the 16th Amendment was ratified by the required two-thirds of the states. The amendment gave Congress the power to “lay and collect tax on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration.” On October 3, 1913, Congress passed the Revenue Act of 1913, which created the first permanent federal income tax.

Congress has made two previous attempts at instituting a federal income tax. The first, in 1861, was an emergency measure to fund the Civil War, and was repealed in 1872. In 1894, in response to complaints that an excessive reliance on tariffs as a source of revenue caused the price of imported goods to rise, Congress again passed an income tax law, which the Supreme Court ruled unconstititional in 1895.

In celebration of this special occasion, here are some facts about the very first Form 1040:

* The tax applied to salaries and wages, interest, dividends, rents, royalties, pensions and annuities, income from estates, trusts, sole proprietorships and partnerships, and gains from the sale of most types of property.

* The salaries and wages of state and local government employees were exempt from income tax.

* Interest from federal, as well as state and local, government bonds were exempt from income tax.

* Deductions were allowed for “personal” interest, federal excise taxes, taxes paid to state and local governments, casualty and theft losses, bad debts, business expenses, and depreciation of property used in business.

* There was an exemption of $3,000.00 for single persons and $4,000.00 for married couples.

* A “normal” tax of 1% was applied to the first $20,000.00 of taxable income. Dividends were exempt from this “normal” tax. An additional or “super” tax of from 1% to 6% was applied to income, including dividends, in excess of $20,000.00.

* The return was due “on or before the first day of March”.

* There was only one page of instructions!

* In the first year of the income tax only 1 out of every 271 American citizens were taxed and $28 Million in revenue was raised.

Over the years the federal income tax has evolved into the complicated “mess” that it is today, with 54,000 pages of code. According to former Treasury Secretary Paul O’neill, “Our tax code is so complicated; we’ve made it nearly impossible for even the Internal Revenue Service to understand.” Here are some of the landmarks of this evolution:

* A personal exemption allowance for dependents and a deduction for charitable contributions were added in 1917.

* Capital gains were singled out for preferential treatment in 1922, although profits on the sale of certain types of property received special tax treatment as early as 1918.

* A deduction for medical expenses was introduced in 1942.

* The Standard Deduction was added in 1944 as an alternative to requiring taxpayers to itemize qualified expenses.

* An Income Averaging method of tax compution was initiated in 1964, to be taken away by the Tax Reform Act of 1986.

* A “minimum” tax on specified “tax preference” items first appeared in 1970, and was replaced by the dreaded Alternative Minimum Tax (AMT) in 1979.

* An Individual Retirement Account for taxpayers not covered by an employer pension plan was introduced in 1974.

* The refundable Earned Income Credit for low wage earners with dependent children was created in 1975.

* Unemployment compensation was made partially taxable in 1979, and was eventually made fully taxable. I remember saying at the time, “The next thing you know they will be taxing Social Security!”

* Social Security and Railroad Retirement benefits became partially taxable in 1984.

By the way, if you think taxes are too high today, from the end of World War II through the early 1960s the top tax rate was more than 90%!

More details on the history of the federal income tax appears on the TAX HISTORY Page at www.robertdflach.net.

Robert D. Flach is a tax professional with 34 tax seasons of experience preparing 1040s for individuals in all walks of life. He writes THE WANDERING TAX PRO weblog (rdftaxpro.tripod.com/weblog), the NJ TAX PRACTICE BLOG (rdftaxpro.tripod.com/newjerseytaxpractitionernetwork), and the tax planning and preparation website http://www.robertdflach.net, which has a wealth of tax advice and information. He also writes and publishes THE FLACH REPORT, a quarterly tax newsletter.

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Instead of giving cash to charity at year-end you can donate stock or mutual fund shares that you have held for more than one year and which have increased in value, and save some money in the process.

You are able to claim a deduction as a charitable contribution on Schedule A for the full market price of the stock or mutual fund on the date you make the contribution. You do not have to report the increase in value as a capital gain on Schedule D.

Art Center pledged $5,000.00 to his church building fund. He also has 100 shares of Online Profits, Inc. which he purchased in 1998 for $2,000.00 and is now worth $5,000.00. He decides to give the stock to the church to satisfy his pledge. Art can deduct $5,000.00 on his Schedule A. He does not have to pay tax on the $3,000.00 appreciation in value of the stock.

If Art were to sell the Online Profits, Inc. stock and give $5,000.00 cash to the church he would have to report the sale of the stock on Schedule D and pay $450.00 in federal tax, as well as state income tax, on the gain. Plus, the $3,000.00 gain would increase his Adjusted Gross Income, which could reduce or altogether wipe out a multitude of deductions and credits that are affected by AGI.

As an added bonus, by donating the stock rather than selling it Art will save the broker’s commission and other expenses of sale.

You must be sure that any investment you donate to charity is long-term property - an investment you have held for more than one year. If you donate stock that you held for one year or less your tax deduction is limited to the cost basis, which in the above example would be $2,000.00.

Also, do not donate an investment that has gone down in value. It is better to sell the stock, claim the loss on Schedule D, and donate the cash to charity.

Robert D Flach is a tax professional with 34 tax seasons of experience preparing 1040s for individuals in all walks of life. He writes THE WANDERING TAX PRO weblog (http://rdftaxpro.tripod.com/weblog), the NJ TAX PRACTICE BLOG (http://rdftaxpro.tripod.com/newjerseytaxpractitionernetwork), and the website http://www.robertdflach.net, with a wealth of tax advice and information. He also writes and publishes THE FLACH REPORT, a quarterly tax newsletter. The above article is taken from a posting to THE WANDERING TAX PRO.

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The tax imposed by the U.S. government on the taxable incomes of individuals, corporations, trusts and estates is known as federal income tax. Personal income taxes are payable on the total income of the individual (after some permissible deductions). Corporate income taxes are payable on the gross profit, the difference between the total receipts and total direct and indirect expenses.

Federal income tax was imposed for the first time by the U.S. government in 1861 to finance the Civil War. A tax of 3 percent was levied on incomes above $600, which rose to 5 percent for incomes above $10,000. These rates were raised in 1864. A new income tax act was enacted in the late 1800s. After the Civil War, income tax was rescinded in 1872.

In the present scenario, the revenues of the federal government mainly accrue from personal and corporate income taxes. Earlier, tariffs on imported goods constituted a large chunk of the government?s revenues, but, at present tariffs represent only a minor portion of federal revenues. Other non-tax fees are also levied, which recompense agencies for services or fill specific trust funds.

Several specific taxes, in addition to the general income tax, are also collected by the federal government. For example, the social support programs such as social security and Medicare are funded by taxes on personal earned income. Estate taxes are also levied on inheritances.

It is income tax that forms the bulk of the taxes collected by the U.S. government. Personal income tax rates range from 0 to 35 percent, depending upon the individual’s total income.

Income tax is called a progressive tax because its levy is based on the total income of individuals: the higher the income, the more the tax. Corporate tax rates also range from 0 to 35%. A corporation pays taxes on its profits and may choose to distribute its profits after tax as dividend to its shareholders. Despite the fact that the money paid as dividend has been taxed at the corporate level, it is taxed again in the hands of the shareholder at the personal level. This is known as double taxation. The tax paid on the dividends by an individual is called dividend tax.

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