1 eggc4214 systems engineering & economy lecture 9 income taxing systems

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  • EGGC4214 Systems Engineering & Economy

    Lecture 9Income Taxing Systems

  • Income TaxesThe goal of this chapter is to give an overview of the income taxes. There is so much detail on taxes, you could spend the rest of your working life on the subject and still not know everything about taxes. Indeed, this is exactly what many tax accountants do.

    No realistic economic analysis can ignore taxes.Tax laws change regularly. For example, Table 12-1, 2003 Tax Rates for individuals, does not apply for 2002.Sources of information on taxes include:1. Governmental rates and categories of taxes2. Good PC software for doing individual taxesBoth individuals and corporations pay taxes. We will consider basic tax information in each area.

  • Income TaxesBasic purpose of taxes: to pay for government services. For your information, some governments charge more taxes than others many of them also provide more services than others.

    Helpful Viewpoint for Understanding Taxes: Think of the government as your partner in every business activity.

    Related Point of View:Think of taxes as one more disbursement(like operating costs, maintenance, labor and materials, etc.)

  • Taxable Income of IndividualsWhat is the difference between a taxidermist and a tax collector? The taxidermist takes only your skin. Mark Twain

    Adjusted gross income = Gross income AdjustmentsTaxable income = Adjusted gross income - Personal exemption(s) - Itemized deductions or Standard deduction

    The tax any individual pays depends on the individuals gross income.Gross income is the sum of:wages, salary, etc.interest incomedividends (e.g., from stocks, mutual funds)capital gains (e.g., from stocks, mutual funds)unemployment compensationother income.

    Adjusted gross income (AGI) is the difference between gross income and allowable deductions such as retirement plan contributions, or social security income.

  • Taxable Income of IndividualsIf it weren't for those eleven saving clauses under the head of "Deductions" I should be beggared every year. Mark Twain

    From adjusted gross income, individuals may deduct:Personal Exemptions: One exemption ($3,050 for 2003 in US) is provided for each person who depends on the gross income for his or her living.

    Itemized Deductions, including:Excessive medical and dental expenses (exceeding 7.5% of adjusted gross income); State and local income tax; property and personal property tax;Home mortgage interest; Charitable contributions; Casualty and theft losses; Miscellaneous deductions (exceeding 2% of adjusted gross income).

    Standard Deduction. Each taxpayer may either itemize his or her deductions, or else take a standard deduction as follows:Single taxpayers: $4,750 (for year 2003 in US)Married taxpayers filling a joint return: $9,500 (for year 2000 in US)

  • Taxable Income of IndividualsTaxable income = Gross income- All expenditures but capital expenditures- Depreciation and depletion charges

    Note: Except for land, business capital expenditures are charged to accounting records period by period through depreciation or depletion charges.

  • Classification of Business ExpendituresThere are three distinct types of business expenditures:1. for depreciable assets (e.g., buildings);2. for non-depreciable assets (e.g., land, minerals);3. all other business expenditures (e.g., labor, materials).

    Expenditures for depreciable assets. This is the subject of the last chapter.

    Expenditures for non-depreciable assets. Non-depreciable assets include: land (land has no finite life); properties not used either in a trade, business, or for the production of income (e.g., home, automobile). Assets subject to depletion.Since firms usually acquire assets for use in the business, their only non-depreciable assets normally are land and assets subject to depletion.

    All other business expenditures. This is probably the largest category. It includes all the ordinary and necessary expenditures of operating a business, including the following:1. labor costs; 2. materials;3. all direct and indirect costs;4. facilities and productive equipment with a useful life of one year or less.These are all routine expenditures.

  • Taxable Income of IndividualsRecall there are three distinct types of business expenditures:1) for depreciable assets; 2) for non-depreciable assets;

    3) all other business expenditures.

    Entering capital expenditures into the accounting records of the firm is called capitalizing them.

    Entering all other business expenditures into the accounting records is called expensing them.

    Capital ExpendituresExpense Expenditures

  • Taxable Income: ExampleExample: A firm has the following results (in millions of dollars) for a three-year period.

    For SL depreciation and no salvage value, the annual depreciation charge is (P-S)/N = (60-0)/3 = $20 million;taxable income = 200 140 20 = $40 million for each of the three years.

    - Do you think the cash results (0,60,60) or the taxable income (40,40,40) is a better indication of the annual performance of the firm?

    Year 1Year 2Year 3Gross income from sales $200$200$200Purchase of special tooling (useful life: 3 years) -$60All other expenditures -$140-$140-$140Cash results for the year $0$60$60

  • Individual Tax Rates2003 US Tax Rates If you are not married

    Tax BracketsTaxOverBut not overBase TaxPlusOn Income Over$0$ 6,000$0.0010.0%$06,00028,400600.0015.0%6,00028,40068,8003,960.0027.0%28,40068,800143,50014,868.0030.0%68,800143,500311,95037,278.0035.0%143,500Over 311,95096,235.5038.6%311,950

  • Individual Tax Rates

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