A COMPARATIVE INTERPRITATION BETWEEN US AND ARMENIA
The U.S. tax system is set up on both a federal and state level. There are several types of taxes: income, sales, capital gains, etc. Federal and state taxes are completely separate and each has its own authority to charge taxes. The federal government doesn’t have the right to interfere with state taxation. Each state has its own tax system that is separate from the other states. Within the state there may be several jurisdictions that also charge taxes. For example, counties or towns may charge their own school taxes that are in addition to state taxes. The U.S. tax system is quite complex.
Income tax is probably one of the most well known forms of taxation. If any of you earn income in the U.S. you will see the deductions on your paycheck. Every person who earns income in the U.S. is supposed to pay income tax on both the federal and state level. Federal taxes include social security and FICA. Each state also has its own form of income tax that employers also withhold from your paycheck.
Generally, the Armenian tax system is fairly coherent and easy to follow. However, ongoing concerns about low tax collection rates, affect the tax administration’s approach to implementing the law and the nature of the government’s tax reform initiatives.
Consequently, compliant tax payers may need to invest significant time dealing with the administrative challenges in the system.
Still in Armenia is actively tax administration reform initiatives, having following goals:
• Increase the number and volume of electronic services provided by the tax authorities and expand electronic reporting system for voluntary payment (assessment) of taxes.
• Inform business community about the developments of tax administration.
• Make structural reforms and improvements in higher and local tax bodies.
• Improve tax legislation based on the best international practice.
• Improve the quality of human resources in tax authorities.
• Combat against tax deceptions and tax evasion.
• Enhance trust and transparency and improve collaboration.
Although Income tax system in US is complicated, comparing with Armenia, nevertheless its more flexible and having positive points, taking into consideration for future Armenian income taxation development. First of all, the US experience for tax deduction process is very bendy and giving more opportunities for taxpayers in process of their successfully tax planning. Secondly, the tax credits offsetting system in US from our viewpoint, also effective tool for additional activating motivation functions of taxes. Consequently, the exploration of US tax credits framework will be constructive for development income tax system in Armenia.
The main objective of presented manual is comparative interpretation of individual income tax system between US and Armenia, for the purpose of exchange a constructive experience in framework tax administration and calculation.
Dear reader,
The “The library of Accountant” book series is taking consideration comparative interpretation of US –Armenia personal incomes taxation having objectives to underline peculiarities of taxation administration and methodology of both countries. Our expectations is to give more awareness about personal tax accounting systems of various countries comparative framework, which will beneficial for foreign investor’s and employees.
Doctor of Economics Juguryan G. Armen
PhD of Economics Khachatryan K. Nonna
The publishing recommendation is given by scientific counsel of the Yerevan Northern University
Juguryan G. Armen, Khachatryan K. Nonna
Personal Income Tax Accounting/ Juguryan G. Armen, Khachatryan K. Nonna, Yerevan.- Edit Print Publishing House, 2014, - 100 pages.
Is presented personal income tax accounting comparative interpretation between US and Armenia. The guidebook is predes-tina¬ted to the businessmen’s and investors, making commer¬cial activity in Armenia or US, and also to persons, having individual tax returns obligation to the taxation bodies.
ISBN 978-9939-52-872-4
© Edit Print, 2014
CONTENTS
Introduction 4
Chapter I Income Taxation Framework 6
1.1 Income Tax Designation 6
1.2 Income Tax Calculation Road Map 9
1.3 Gross Income 15
Chapter II Income Tax Calculation 19
2.1Adjustments’ to Gross Income 19
2.2 Deductions 27
2.3 Taxable Income 35
2.4 Income Tax Brackets and Rates 37
2.5 State Income Tax 43
2.6 Tax Credits 45
2.7 Self Employment Taxation 54
Chapter III Income Tax Accounting 60
3.1 Accounting Periods and Methods 60
3.2 Tax Accounting Under GAAP and IRS 72
3.3 Accounting of Payroll Liabilities 85
3.4 Withholding of Tax 89
Appendix 1. Income Tax Annually Statement in RA 95
Appendix 2. U.S. Individual Income Tax Return
Form 1040 97
Chapter I
Income Taxation Framework
1.1 Income Tax Designation
Personal Income Tax in USA
The major sources of federal tax revenue are individual income taxes, Social Security and other payroll taxes, corporate income taxes, excise taxes, and estate and gift taxes. In FY2014, individual income taxes accounted for 46% of total federal revenue. Social Security taxes accounted for 35%. Corporate income taxes accounted for 10% while excise taxes accounted for 3%. Estate and gift, customs, and miscellaneous taxes accounted for the remaining 6% of total revenue. Over time, the corporate income tax has become much less important as a revenue source while Social Security taxes have provided a larger share of total revenues.
The individual income tax is the major source of federal revenues, followed closely by Social Security and other payroll taxes. As a revenue source, the corporate income tax is a distant third. Estate and gift and excise taxes play only minor roles as revenue sources in US.
The individual income tax is based on earnings individuals accrue from a variety of sources. Included in the individual income tax base are wages, salaries, tips, taxable interest and dividend income, business and farm income, realized net capital gains, income from rents, royalties, trusts, estates, partnerships, taxable pension and annuity income, and alimony received.
The tax base is reduced by adjustments to income, some interest paid on student loans and higher education expenses, contributions to health savings accounts, and alimony payments made by the taxpayer. This step of the process produces adjusted gross income (AGI), which is the basic measure of income under the federal income tax. Deductions from the income tax base that result in an individual’s AGI are also known deductions. These deductions are available to all taxpayers, whether the taxpayer chooses to take the standard deduction or itemize deductions.
The tax base is further reduced by either the standard deduction or individuals’ itemized deductions. Itemized deductions are allowed for home mortgage interest payments, state and local income taxes, state and local property taxes, charitable contributions, medical expenses in excess of 10% of AGI, and for a variety of other items. For taxable years 2004 through 2013, at the election of the taxpayer, state and local sales taxes can be deducted as an alternative to state and local income taxes.
The tax base is reduced further by subtracting personal and dependent exemptions. Exemptions are a fixed amount to be subtracted from AGI. Exemptions are allowed for the taxpayer, the taxpayer’s spouse, and each dependent. For taxpayers with high levels of AGI, the personal and dependent exemptions are phased out.
The tax liability depends on the filing status of the taxpayer. There are four main filing categories:
• married filing jointly,
• married filing separately,
• head of household,
• single individual.
The income tax system is designed to be progressive, with marginal tax rates increasing as income increases. At a particular marginal tax rate, all individuals, regardless of their level of earnings, pay the same tax rate on their first dollar of taxable income. Once a taxpayer’s income surpasses a threshold level placing them in a higher marginal tax bracket, the higher marginal tax rate is only applied on income that exceeds that threshold value. Currently, the individual income tax system has seven marginal income tax rates: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%
These marginal income tax rates are applied against taxable income to arrive at a taxpayer’s gross income tax liability.
After a taxpayer’s tax liability has been calculated, tax credits are subtracted from gross tax liability to arrive at a final tax liability. Major tax credits include the earned income tax credit, the child tax credit, education tax credits, and the credit for child and dependent care expenses.
Not all income is subject to the marginal income tax rates noted above. Long-term capital gains— that is, gain on the sale of assets held more than 12 months—and qualified dividend income are taxed at lower tax rates. Net investment income is also subject to an additional tax for taxpayers above certain income thresholds.
Personal Income Tax in Armenia
In conformity with the new RA law “On Income Tax”, which has entered into force since January 01, 2013, the income tax and the compulsory social security payments have been replaced with a new unified tax.
In the Republic of Armenia both resident and non-resident physical persons are entitled to pay income tax. An individual shall be considered a resident if during any twelve month period starting or ending in a tax year (from January 1 to December 31 inclusive) he/she has been residing in the Republic of Armenia for a total duration of 183 days or more, or whose centre of vital interests is in the Republic of Armenia.
The income tax is a direct tax paid to the State budget of the Republic of Armenia by taxpayers (in cases as prescribed by law through the tax agent – an organization or individual entrepreneur or notary) in the manner, at the amounts and within the timeframe as envisaged by this Law. According to Armenian tax legislation, income taxpayers are natural persons, including individual entrepreneurs and notaries who are residents of the Republic of Armenia (hereinafter referred to as residents) and natural persons, including individual entrepreneurs and notaries who are non-residents of the Republic of Armenia (hereinafter referred to as non-residents) shall be deemed as income taxpayers (hereinafter taxpayers). In the meaning of law a resident is considered to be the natural person who has resided in the Republic of Armenia for a total of 183 or more days during the course of the tax year at any stage of the 12-month period which starts and ends during the fiscal year (from January 1 through December 31) or who has the center of vital interests located in the Republic
Employers are required to calculate income tax on a monthly basis from their employees’ salaries and transfer these amounts to the state budget, no later than the 20th day of the month following the month of calculation.
The employer must prepare and submit to the tax authorities a monthly report on the income paid to employees (individuals) and income taxes withheld and remitted. The monthly report should be submitted no later than by 20th of the second month. Taxpayers (namely who were engaged in business activities) have to file an Annual Income Calculation of business income and expenses by 15 April in the following year.
1.2 Income Tax Calculation Road Map
Income tax calculation is taking several steps, which is requiring simple road mapping process. A process map is the output of the mapping technique. This is diagram or flow chart that includes blocks and arrows, which depict the process from beginning to end. Each block represents an action within process. Income tax calculation road map in taxation practice in US is presented in figure 1.1. According to Armenian tax legislation this process is looks like more uncomplicated (see figure 1.2).
Individual Income tax calculation framework in USA
Gross income includes all income earned or received from whatever source. This includes salaries and wages, tips, pensions, fees earned for services, price of goods sold, other business income, gains on sale of other property, rents received, interest and dividends received, alimony received, proceeds from selling crops, and many other types of income. Some income, however, is exempt from income tax. This includes interest on municipal bonds.
Adjustments: (usually reductions) to gross income of individuals are made for alimony paid, contributions to many types of retirement or health savings plans, certain student loan interest, half of self-employment tax, and a few other items. The cost of goods sold in a business is a direct reduction of gross income.
Business deductions: Taxable income of all taxpayers is reduced by tax deductions for expenses related to their business. These include salaries, rent, and other business expenses paid or accrued, as well as allowances for depreciation. The deduction of expenses may result in a loss. Generally, such loss can reduce other taxable income, subject to some limits.
Gross income
Adjustments Pay Roll
(AGI) Liabilities (FICA)
Deductions
Standard deduction
or
Personal exemptions
Itemized deductions
Federal Taxable State Taxable
Income Income
Income Tax Brackets and Rates
Gross Tax Liability
Tax credits
Income Tax Liabilities Payments During Calendar year
Tax returns
Figure 1.1 Individual Income Tax Calculation Road Map in US
Gross income
Adjustments
Taxable Income
Income Tax Brackets and Rates
Income Tax Liabilities Payments During Calendar year
Figure 1.2 Individual Income Tax Calculation Road Map in
Armenia
Personal deductions: Individuals are allowed several non business deductions. A flat amount per person is allowed as a deduction for personal exemptions. Taxpayers are allowed one such deduction for themselves and one for each person they support.
Standard deduction: In addition, individuals get a deduction from taxable income for certain personal expenses. Alternatively, the individual may claim a standard deduction. For 2014, the standard deduction is $6, 200 for single individuals, $12,400 for a married couple, and $9,100 for a head of household.
Itemized deductions: Those who choose to claim actual itemized deductions may deduct the following, subject to many conditions and limitations:
• Medical expenses in excess of 7.5% of adjusted gross income,
• State, local, and foreign taxes,
• Home mortgage interest,
• Contributions to charities,
• Losses on nonbusiness property due to casualty, and
• Deductions for expenses incurred in the production of income in excess of 2% of adjusted gross income.
Capital gains: and qualified dividends may be taxed as part of taxable income. However, the tax is limited to a lower tax rate. Capital gains include gains on selling stocks and bonds, real estate, and other capital assets. The gain is the excess of the proceeds over the adjusted basis (cost less depreciation deductions allowed) of the property. This limit on tax also applies to dividends from U.S. corporations and many foreign corporations. There are limits on how much net capital loss may reduce other taxable income.
Total U.S. Tax Revenue as a % of GDP and Income Tax Revenue as a % of GDP, 1945-2011, from Office of Management and Budget Historicals
Tax credits: All taxpayers are allowed a tax credit for foreign taxes and for a percentage of certain types of business expenses. Individuals are also allowed credits related to education expenses, retirement savings, child care expenses, and a credit for each child. Each of the credits is subject to specific rules and limitations. Some credits are treated as refundable payments.
Alternative Minimum Tax: All taxpayers are also subject to the Alternative Minimum Tax if their income exceeds certain exclusion amounts. This tax applies only if it exceeds regular income tax, and is reduced by some credits.
Tax returns: Individuals must file income tax returns in each year their income exceeds the standard deduction plus one personal exemption, or if any tax is due. Other taxpayers must file income tax returns each year. These returns may be filed electronically. Generally, an individual's tax return covers the calendar year. Corporations may elect a different tax year. Most states and localities follow the federal tax year, and require separate returns.
Tax payment: Taxpayers must pay income tax due without waiting for an assessment. Many taxpayers are subject to withholding taxes when they receive income. To the extent withholding taxes do not cover all taxes due, all taxpayers must make estimated tax payments.
Tax penalties: Failing to make payments on time, or failing to file returns, can result in substantial penalties. Certain intentional failures may result in jail time.
Tax returns may be examined and adjusted by tax authorities. Taxpayers have rights to appeal any change to tax, and these rights vary by jurisdiction. Taxpayers may also go to court to contest tax changes. Tax authorities may not make changes after a certain period of time (generally 3 years).
Individual Income tax calculation framework in Armenia
In process of calculating incomes of taxpayers, the income tax shall be withheld (levied) by the tax agent. On a monthly basis, by the 20th day of the next month, tax agents must submit exclusively electronically to the tax office a summary income tax return in the defined format which shall contain the following:
1) personal data (first and last names, patronymic, residence (registration) address, social security card number) of the natural person receiving income from the given tax agent (except for those receiving only passive incomes), incomes calculated for these individuals, income tax withholdings, and for persons participating in the fully-funded pension system, also calculated and withheld fully-funded pension contributions, as well as other information identified in Article 7 of the Law “On Personified Record Keeping on Income Tax and Funded Contributions”;
2) Brief information from the given tax agent about passive income calculated by the tax agent exclusively for the natural persons gaining passive incomes and the income tax withheld from these incomes,
When determining the tax base of income tax on business activities, apart from incomes deducted, the gross income shall be deducted, based on the declaration on annual income filed by the natural person, by the amount of costs which are directly related to the incomes gained from business activities and execution of civil-legal contracts and are supported by appropriate documentation. 2. In particular, costs shall include: 1) material costs; 2) wages and salaries and payments made equal to wages and salaries; 3) voluntary funded pension contributions paid by the employer on behalf of its hired employee, at the maximum amount of 5% of the employees salary; 4) amortization allowances; 5) rentals; 6) insurance premiums; 7) taxes not subject to refund (offsetting), 8) interests on loans and other borrowings; 9) fees against guarantees, security, and other bank services; 10) promotional costs; 11) representational costs; 12) sponsorship costs; 13) judicial costs; 14) travel costs; 15) indemnification of caused damage; 16 fines, penalties and other material sanctions, save for those fines, penalties and other material sanctions which are payable to the State or community budgets, as well as those charged against contributions to the funded pension system; 17) costs of audit, legal, other consulting, information and management services; 18) costs of factoring, trust (power of attorney related) operations; 19) understated costs for the preceding three years as identified during the reporting year.
1.3 Gross Income
Gross income in United States tax law is receipts and gains from all sources. Gross income is the starting point for determining Federal and state income tax of individuals, corporations, estates and trusts, whether resident or nonresident. "Except as otherwise provided" by law, Gross income means "all income from whatever source," and is not limited to cash received. However, tax regulations expand on this and say "all income from whatever source derived, unless excluded by law." The amount of income recognized is generally the value received or which the taxpayer has a right to receive. Certain types of income are specifically excluded from gross income.
The time at which gross income becomes taxable is determined under Federal tax rules, which differ in some cases from financial accounting rules. Individuals, corporations, members of partnerships, estates, trusts, and their beneficiaries ("taxpayers") are subject to Income tax in the United States. The amount on which tax is computed, taxable income, equals gross income less allowable tax deductions.
The Internal Revenue Code states that "gross income means all income from whatever source derived," and gives specific examples. The examples are not all inclusive. The term "income" is not defined in the law or regulations. However, a very early Supreme Court case stated, "Income may be defined as the gain derived from capital, from labor, or from both combined, provided it is understood to include profit gained through a sale or conversion of capital assets." The Court also held that the amount of gross income on disposition of property is the proceeds less the capital value (cost basis) of the property.
Gross income is not limited to cash received. "It includes income realized in any form, whether money, property, or services."
Following are some of the things that are included in income:
• Wages, fees for services, tips, and similar income. It is well established that income from personal services must be included in the gross income of the person who performs the services. Mere assignment of the income does not shift the liability for the tax.
• Interest received, as well as imputed interest on below market and gift loans.
• Dividends, including capital gain distributions, from corporations.
• Gross profit from sale of inventory. The sales price, net of discounts, less cost of goods sold is included in income.
• Gains on disposition of other property. Gain is measured as the excess of proceeds over the taxpayer's adjusted basis in the property. Losses from property may be allowed as tax deductions.
• Rents and royalties from use of tangible or intangible property. The full amount of rent or royalty is included in income, and expenses incurred to produce this income may be allowed as tax deductions.
• Alimony and separate maintenance payments.
• Pensions, annuities, and income from life insurance or endowment contracts.
• State and local income tax refunds, to the extent previously deducted. Note that these are generally excluded from gross income for state and local income tax purposes.
Gifts and inheritances are not considered income to the recipient under U.S. law. However, gift or estate tax may be imposed on the donor or the estate of the decedent.
According to article 5 of Armenian Income Tax Law:
1. gross income shall constitute the aggregate of all incomes to be received by the taxpayer during the reporting period.
2. Income shall constitute property receivable by the taxpayer under employment or civil-legal agreements or on any other grounds, as well as incomes subject to receipt in kind (non-cash).
3. Incomes to be received in kind (non-cash) shall be considered in the gross income at liberal (market) prices in the manner established by the Government of the Republic of Armenia.
4. Incomes receivable by natural persons in foreign currency shall be recalculated in Armenian drams based on the average market exchange rate as announced by the Central Bank of Armenia as of the date when the right to these incomes is earned.
Chapter II
Income Tax Calculation
2.1 Adjustments’ to Gross Income
In the United States income tax system, adjusted gross income (AGI) is an individual's total gross income minus specific reductions.Taxable income is adjusted gross income minus allowances for personal exemptions and itemized deductions. For most individual tax purposes, AGI is more relevant than gross income.
Gross income is sales price of goods or property, minus cost of the property sold, plus other income. It includes wages, interest, dividends, business income, rental income, and all other types of income. Adjusted gross income is gross income less deductions from a business or rental activity and other specific items.
Several deductions (e.g. medical expenses and miscellaneous itemized deductions) are limited based on a percentage of AGI. Certain phase outs, including those of lower tax rates and itemized deductions, are based on levels of AGI. Many states base state income tax on AGI with certain deductions.
Exclusions from gross income
Gross income includes "all income from whatever source derived." The courts have consistently given very broad meaning to this phrase, interpreting it to include all income unless a specific exclusion applies. Certain types of income are specifically excluded from gross income. These may be referred to as exempt income, exclusions, or tax exemptions. Among the more common excluded items are the following:
• Tax exempt interest. For Federal income tax, interest on state and municipal bonds is excluded from gross income. Some states provide an exemption from state income tax for certain bond interest.
• Social Security benefits. The amount exempt has varied by year. The exemption is phased out for individuals with gross income above certain amounts.
• Gifts and inheritances. However, a "gift" from an employer to an employee is considered compensation, and is generally included in gross income.
• Life insurance proceeds.
• Compensation for personal physical injury or physical sickness, including:
o Amounts received under worker’s compensation acts for personal physical injuries or physical sickness,
o Amounts received as damages (other than punitive damages) in a suit or settlement for personal physical injuries or physical sickness,
o Amounts received through insurance for personal physical injuries or physical sickness, and
o Amounts received as a pension, annuity, or similar allowance for personal physical injuries or physical sickness resulting from active service in the armed forces.
• Scholarships. However, amounts in the nature of compensation, such as for teaching, are included in gross income.
• Certain employee benefits. Non-taxable benefits include group health insurance, group life insurance for policies up to $50,000, and certain fringe benefits, including those under a flexible spending or cafeteria plan.
• Certain elective deferrals of salary (contributions to "401(k)" plans).
• Meals and lodging provided to employees on employer premises for the convenience of the employer.
• Foreign earned income exclusion for U.S. citizens or residents for income earned outside the U.S. when the individual met qualifying tests.
• Income from discharge of indebtedness for insolvent taxpayers or in certain other cases.
• Contributions to capital received by a corporation.
• Gain up to $250,000 ($500,000 on a married joint tax return) on the sale of a personal residence.
There are numerous other specific exclusions. Restrictions and specific definitions apply. Some state rules provide for different inclusions and exclusions.
In order to levy an income tax, income must first be defined. As a benchmark, economists often turn to the Haig-Simons comprehensive income definitions. Here, taxable resources are defined as changes in a taxpayer’s ability to consume during the tax year. Another way to view the individual income tax base is as an approximation of the sum of all labor and capital income earned or received over the course of the year. Under this view, the tax base resembles national income as measured by economists. In addition to labor and capital income, many transfer payments are also subject to taxation.
There are a number of forms of what would broadly be defined as income that are excluded from taxable income in practice. For example, wage income of employees is taxed, although most contributions to employee pension and health insurance plans and certain other employee benefits are not included in wages subject to income tax. Employer contributions to Social Security are also excluded from wages. When pensions are received, they are included in income to the extent that they represent contributions originally excluded. If the taxpayer has the same tax rate when contributions are made and when pensions are received, this treatment is equivalent to eliminating tax on the earnings of pension plans. Some Social Security benefits are also subject to tax.
Passive capital income, in the form of capital gains, interest, and dividends on financial instruments, is also taxed. The tax base excludes capital gains that are unrealized, such that capital gains are only taxed on realization.
Unlike capital gains, assets earning interest are taxed on accrual. Taxes are paid on the interest earned in each tax year. Taxable interest income is added to a taxpayer’s AGI and taxed according to the taxpayer’s marginal tax rate. Interest that is earned on tax-exempt securities, such as those issued by state and local governments, is not subject to taxation. Like capital gains, dividends are taxed at a lower rate than other income. Qualified dividends are taxed at the same rate as capital gains.
A health savings account (HSA) is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan (HDHP).The funds contributed to an account are not subject to federal income tax at the time of deposit. Unlike a flexible spending account (FSA), funds roll over and accumulate year to year if not spent. HSAs are owned by the individual, which differentiates them from company-owned Health Reimbursement Arrangements (HRA) that are an alternate tax-deductible source of funds paired with either HDHPs or standard health plans. HSA funds may currently be used to pay for qualified medical expenses at any time without federal tax liability or penalty. However, beginning in early 2011 OTC (over the counter) medications cannot be paid with HSA dollars without a doctor's prescription. Withdrawals for non-medical expenses are treated very similarly to those in an individual retirement account (IRA) in that they may provide tax advantages if taken after retirement age, and they incur penalties if taken earlier. These accounts are a component of consumer-driven health care.
Proponents of HSAs believe that they are an important reform that will help reduce the growth of health care costs and increase the efficiency of the health care system. According to proponents, HSAs encourage saving for future health care expenses, allow the patient to receive needed care without a gatekeeper to determine what benefits are allowed and make consumers more responsible for their own health care choices through the required High-Deductible Health Plan.
Opponents of HSAs say they may worsen, rather than improve, the U.S. health system's problems because people may hold back the healthcare spending that would be covered by their Health Savings Accounts, or may spend it unnecessarily just because it has accumulated and to avoid the penalty taxes for withdrawing it, while people who have health problems that have predictable annual costs will avoid HSAs in order to have those costs paid by insurance. There is also debate about consumer satisfaction with these plans.
Various tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Tax exemption may also refer to a personal allowance or specific monetary exemption which may be claimed by an individual to reduce taxable income under some systems. Tax exempt status may provide a potential taxpayer complete relief from tax, tax at a reduced rate, or tax on only a portion of the items subject to tax. Examples include exemption of charitable organizations from property taxes and income taxes, exemptions provided to veterans, and exemptions under cross-border or multi-jurisdictional principles. Tax exemption generally refers to a statutory exception to a general rule rather than the mere absence of taxation in particular circumstances (i.e., an exclusion). Tax exemption also generally refers to removal from taxation of a particular item or class rather than a reduction of taxable items by way of deduction of other items (i.e., a deduction). Tax exemptions may theoretically be granted at any governmental level that imposes taxation, though in some broader systems restraints are imposed on such exemptions by lower tier governmental units.
According to Armenian Tax Legislation, adjustments to gross income are:
1) Benefits paid in conformity with the legislation of the Republic of Armenia, with the exception of benefit amounts defined by the Law of the Republic of Armenia “On Temporary Incapacity”;
2) All types of pensions paid in conformity with the legislation of the Republic of Armenia (including pensions paid for voluntary participation in the mandatory funded pension system), save for pensions duly paid under the voluntary fully-funded pension system;
3) Funded pension insurance contributions paid by the taxpayer in his/her name and/or paid by a third party (including the employer) on behalf of the taxpayer under a funded pension scheme as prescribed by the legislation of the Republic of Armenia, at the maximum of 5% amount of the taxpayers gross income;
4) Insurance fees, save for amounts (including pensions) duly receivable at the expense of amounts under the voluntary funded pension contributions paid by the taxpayer for himself/herself and/or paid by a third person (including the employer) on behalf of the taxpayer under a voluntary funded pension scheme in the manner prescribed by the legislation of the Republic of Armenia;
5) Funded pension contributions paid by the State on behalf of the taxpayer under a mandatory funded pension scheme in the manner prescribed by the legislation of the Republic of Armenia;
6) Incomes receivable before the legally prescribed date of pension entitlement against funded pension insurance contributions paid by the taxpayer for himself/herself and/or paid by a third party (including the State, employer) on behalf of the taxpayer under the funded pension scheme in the manner prescribed by the legislation of the Republic of Armenia;
7) Incomes related to the service in the military and persons with an equivalent status, rescue service servants;
8) Lump sum amounts paid to family members of deceased military servants and to those military servants who have become disabled in compliance with the legislation of the Republic of Armenia;
9) Awards, assistance in cash and aids provided under the social protection system in conformity with the legislation of the Republic of Armenia;
10) Alimonies (maintenance allowances) paid in conformity with the legislation of the Republic of Armenia;
11) Incomes receivable by natural persons against donor blood and breast milk and other types of donor ship;
12) Compensations paid under the norms defined by the legislation of the Republic of Armenia against the performance of works (delivery of services) under employment and civil-legal agreements (including compensations paid to diplomatic servants), other than payments of compensation against unused leave upon resigning;
13) Property and funds receivable from natural persons as a heritage and (or) donation (gift) in accordance with the legislation of the Republic of Armenia;
14) Cash and in-kind assistance to natural persons provided within their statutory activities by non-commercial organizations which are incorporated in the manner prescribed by the legislation of the Republic of Armenia and registered with the tax authorities;
15) Gratis property and funds provided to natural persons on the basis of decisions of the state and local self-government bodies of the Republic of Armenia, as well as by foreign governments and international inter-state (inter-governmental) organizations;
16) Value of food allowances, as well as amounts paid as a replacement for these allowances;
17) Proceeds receivable by natural persons, other than from tax agents, from the sale of their own property, with the exception of proceeds receivable from the sale of property as part of their business operations;
18) State scholarships paid by the State to students, post-graduates of higher educational institutions, students of secondary vocational and professional technical educational institutions, attendees of seminaries, as well as scholarships provided to them by the above educational institutions or organizations specified in sub-clauses 14 and 15 of this clause;
19) Amounts duly received as a compensation for incurred losses, save for compensation against lost income;
20) Amount of receivable loans and borrowings, save for loans or borrowings forgiven by the creditor or any other agreement reached with the creditor on non-repayment of these amounts (including, the moment of expiration of the statute of limitation as stipulated by law);
21) Lump-sum benefits provided in case of the death of the employee or his or her family member;
22) Prizes of sportsmen and coaches won at international contests and competitions as members of national team of the Republic of Armenia;
23) Cash and in-kind winnings of participants of lotteries conducted in the manner and under conditions established by the legislation of the Republic of Armenia;
24) Value of cash prizes won at contests and competitions at the maximum amount of 10000 AMD;
25) Amounts of compensation at 10 percent of the annual tuition fee paid for students of higher educational institutions studying on a paid basis within the limits set out by the Government of the Republic of Armenia;
26) Government awards (prizes);
27) Amounts redeemable from the Deposit Insurance Guarantee Fund in the manner prescribed by the Law of the Republic of Armenia “On Guaranteeing Compensation of Bank Deposits of Natural Persons”, except for the accrued payable interests on the deposit amounts;
28) Amounts redeemable against cash deposits placed with the ArSSR Republican Bank of the USSR Savings Bank before June 10, 1993;
29) Amounts paid to individuals against their owned real estate taken away from them for the State or community needs, as well as to the registered tenants of such real estate.
30) Prizes and bonuses provided as a result of lottery;
31) Income receivable from sale of hand-made carpets by taxpayers engaged in production of hand-made carpets;
32) Insurance premiums paid by employers for the health insurance of their hired employees at the maximum amount of AMD 10 000 per employee for each month of his/her receivable income.
2.2 Deductions
Individuals subtract from their adjusted gross income either the standard deduction or itemized deductions, along with an exemption for each family member. The standard deduction will increase by $100 from $6,100 to $6,200 for singles (Table 2.1). For married couples filing jointly, it will increase by $200 from $12,200 to $12,400.
Next year’s personal exemption will increase by $50 to $3,950.
Table 2.1 . 2014 Standard Deduction and Personal Exemption
Filing Status Deduction Amount
Single $6,200.00
Married Filing Jointly $12,400.00
Head of Household $9,100.00
Personal Exemption $3,950.00
Source: Internal Revenue Service
Personal exemptions
Many jurisdictions allow certain classes of taxpayers to reduce taxable income for certain inherently personal items. A common such deduction is a fixed allowance for the taxpayer and certain family members or other persons supported by the taxpayer. The U.S. allows such a deduction for “personal exemptions” for the taxpayer and certain members of the taxpayer's household. The UK grants a “personal allowance.” Both U.S. and UK allowances are phased out for individuals or married couples with income in excess of specified levels.
In addition, many jurisdictions allow reduction of taxable income for certain categories of expenses not incurred in connection with a business or investments. In the U.S. system, these (as well as certain business or investment expenses) are referred to as “itemized deductions” for individuals. The UK allows a few of these as personal reliefs. These include, for example, the following for U.S. residents (and UK residents as noted):
• Medical expenses (in excess of 7.5% of adjusted gross income)
• State and local income and property taxes
• Interest expense on certain home loans
• Gifts of money or property to qualifying charitable organizations, subject to certain maximum limitations,
• Losses on non-income-producing property due to casualty or theft,
• Contribution to certain retirement or health savings plans (U.S. and UK),
• Certain educational expenses.
Many systems provide that an individual may claim a tax deduction for personal payments that, upon payment, become taxable to another person, such as alimony. Such systems generally require, at a minimum, reporting of such amounts, and may require that withholding tax be applied to the payment.
An itemized deduction is an eligible expense that individual taxpayers in the United States can report on their federal income tax returns in order to decrease their taxable income.
Most taxpayers are allowed a choice between the itemized deductions and the standard deduction. After computing their adjusted gross income (AGI), taxpayers can itemize their deductions (from a list of allowable items) and subtract those itemized deductions (and any applicable personal exemption deductions) from their AGI amount to arrive at their taxable income amount. Alternatively, they can elect to subtract the standard deduction for their filing status (and any applicable personal exemption deduction) to arrive at their taxable income. In other words, the taxpayer may generally deduct the total itemized deduction amount, or the standard deduction amount, whichever is greater.
The choice between the standard deduction and itemizing involves a number of factors:
• Only a taxpayer eligible for standard deduction can choose it.
• U.S. citizens and resident aliens (for tax purposes) are eligible to take the standard deduction. Nonresident aliens are not eligible.
• If the taxpayer is filing as "married, filing separately", and his or her spouse itemizes, then the taxpayer cannot take the standard deduction. In other words, a taxpayer whose spouse itemizes deductions must either itemize as well, or claim "0" (zero) as the amount of the standard deduction.
• The taxpayer must have maintained the records required to substantiate the itemized deductions.
• If the amounts of the itemized deductions and the standard deduction do not differ much, the taxpayer may take the standard deduction to reduce the possibility of adjustment by the Internal Revenue Service (IRS). The amount of standard deduction cannot be changed upon audit unless the taxpayer's filing status changes.
• If the taxpayer is otherwise eligible to file a shorter tax form such as 1040EZ or 1040A, he would prefer not to prepare (or pay to prepare) the more complicated Form 1040 and the associated Schedule A for itemized deductions.
• The standard deduction is not allowed for calculating the Alternative Minimum Tax. If the taxpayer chooses to take the standard deduction for regular income tax, he or she cannot itemize deductions for the AMT. Thus, for a taxpayer who pays the AMT (i.e. their AMT is higher than regular tax), it may be better to itemize deductions, even if it is less than the standard deduction.
Deductions are reported in the tax year in which the eligible expenses were paid. For example, an annual membership fee for a professional association paid in December 2014 for year 2015 is deductible in year 2014.
The standard deduction, as defined under United States tax law, is a dollar amount that non-itemizers may subtract from their income and is based upon filing status. It is available to US citizens and resident aliens (for tax purposes) who are individuals, married persons, and heads of household and increases every year. Additional amounts are available for persons who are blind and/or are at least 65 years of age. The standard deduction is distinct from personal exemptions, which also are available to all taxpayers and dependents. As one may not take both itemized deductions and a standard deduction, taxpayers generally choose the deduction that results in the lesser amount of tax owed.
The standard deduction may be higher than the basic standard deduction if any of the following conditions are met:
• The taxpayer is 65 years of age or older;
• The taxpayer's spouse is 65 years of age or older
• The taxpayer is blind (generally defined as not having corrected vision of at least 20/200 or as having extreme "limitation in the fields of vision"); and/or
• The taxpayer's spouse is blind.
The applicable basic standard deduction amounts for tax years 2006-2014 are as follows:
Table 2.2. Changing Standard deduction amounts for tax years
Filing status
Year Single Married Filing Jointly Married Filing Separately Head of household Qualifying Surviving Spouse
2014 $6,200 $12,400 $6,200 $9,100 $12,400
2013 $6,100 $12,200 $6,100 $8,950 $12,200
2012 $5,950 $11,900 $5,950 $8,700 $11,900
2011 $5,800 $11,600 $5,800 $8,500 $11,600
2010 $5,700 $11,400 $5,700 $8,400 $11,400
2009 $5,700 $11,400 $5,700 $8,350 $11,400
2008 $5,450 $10,900 $5,450 $8,000 $10,900
2007 $5,350 $10,700 $5,350 $7,850 $10,700
2006 $5,150 $10,300 $5,150 $7,550 $10,300
Source: Internal Revenue Service
When calculating a U.S. taxpayer's federal income tax, the personal exemption is a tax deduction composed of amounts for the individual taxpayer, the taxpayer's spouse, and the taxpayer's child, as provided in Internal Revenue Code at 26 U.S.C. § 151. The personal exemption is deducted against the taxpayer's income to arrive at the taxable income - the amount against which the tax rates are applied to compute the total tax liability per 26 U.S.C. § 1.
Phase-out
PEP (personal exemption phase-out) and Pease are two provisions in the tax code that increase taxable income for high-income earners. PEP is the phase out of the personal exemption and Pease (named after former Senator Donald Pease) reduces the value of most itemized deductions once a taxpayer’s adjusted gross income reaches a certain point.
The income threshold for both PEP and Pease will be $254,200 for single filers and $305,050 for married filers (Tables 2.3 & 2.4). PEP will end at $376,700 for singles and $427,550 for couples filing jointly, meaning these taxpayers will no longer have a personal exemption.
Table 2.3. 2014 Pease Limitations on Itemized Deductions
Filing Status Income Threshold
Single $254,200.00
Married Filing Jointly $305,050.00
Head of Household $279,650.00
Source: Internal Revenue Service
Table 2 4. Personal Exemption Phase-out
Filing Status Phase out Begin Phase out Complete
Single $254,200.00 $376,700.00
Married Filing Jointly $305,050.00 $427,550.00
Head of Household $279,650.00 $402,150.00
Source: Internal Revenue Service
The tax deduction for personal tax exemptions begins phase out when AGI exceeds $305 050 for joint tax returns and $254 200 400 for single tax returns. Each tax exemption is reduced by 2% for each $2,500 by which one's AGI exceeds the threshold amount until the benefit of all tax exemptions is eliminated or reduced by one-third on one's tax return.
Dependents
Section 152 of the code contains nuanced requirements that must be met before a taxpayer can claim another as a dependent for personal exemption purposes. The general rule is that a personal exemption may be taken for a dependent that is either a qualifying child or a qualifying relative. § 152(a). However, there are several exceptions to this rule.
Taxpayers who are claimed as dependents of others cannot themselves claim personal exemptions for their qualifying dependents. § 152(b)(1). Married individuals who file joint returns cannot also be claimed as dependents of another taxpayer. § 152(b)(2). Citizens or nationals of other countries cannot be claimed as dependents unless they also reside in the U.S. or in contiguous countries. § 152(b)(3). However, taxpayers who are also U.S. citizens or nationals may claim as a dependent any child who shares the taxpayer’s abode and is a member of the taxpayer’s household.
Qualifying children as dependents
Qualifying children must first be “children” in the sense of § 152(f)(1). The term “children” includes adopted children, children placed for adoption, stepchildren, and foster children. Id. Qualifying children must have the same principal place of abode as the taxpayer for more than one-half of the year and must not have provided more than one-half of their own support. § 152(c)(1). They can include a taxpayer’s children, a taxpayer’s siblings, half-siblings, or step siblings, or the descendants of a taxpayer’s children, siblings, half-siblings, or step siblings. §§ 152(c)(2), (f)(4). They may not have reached the age of 19 by the close of the year, unless they are students, in which case they must not have reached the age of 24, or unless they are permanently and totally disabled. § 152(c)(3).
A child cannot qualify as a dependent on more than one tax return, so the code has a set of rules to prevent this from happening. § 152(c)(4). The code first attempts to break the tie by limiting eligible taxpayers to the child’s parents, followed by the contending non-parental taxpayer with the highest adjusted gross income. Id. If more than one parent attempts to claim the child and they do not file a joint return, the code first attempts to break the tie in favor of the parent with whom the child resided longest during the taxable year. Id. If that does not break the tie, the parent with the highest adjusted gross income wins the right to claim the child as a dependent.
Other qualifying relatives as dependents
A qualifying relative cannot be the qualifying child of any taxpayer. § 152(d)(1). The individual must have gross income less than the amount of the personal exemption. The taxpayer must have provided over one-half of the individual’s support.
The allowable relationships between the taxpayer and the qualifying relative are almost innumerable, but under no circumstances can the relationship be one that violates local law. §§ 152(d)(2), (f)(3). Included are children (in the broad sense of § 152(f)(1)), descendants of children, siblings, half-siblings, step-siblings, father, mother, ancestors of parents, stepparents, nieces, nephews, various in-laws, or any other non-spousal individual sharing the taxpayer’s abode and household. § 152(d)(2). Special rules dealing with multiple support agreements, handicapped dependents, and child support are detailed at § 152(d)(3)-(5).
2.3 Taxable Income
A tax is imposed on net taxable income in the United States by the federal, most state, and some local governments. Income tax is imposed on individuals, corporations, estates, and trusts. The definition of net taxable income for most sub-federal jurisdictions mostly follows the federal definition.
The rate of tax at the federal level is graduated; that is, the tax rates of higher amounts of income are higher than on lower amounts. Some states and localities impose an income tax at a graduated rate, and some at a flat rate on all taxable income. Federal tax rates in 2014 varied from 10% to 39,6%.
Taxable income is defined in a comprehensive manner in the Internal Revenue Code and regulations issued by the Department of Treasury and the Internal Revenue Service. Taxable income is gross income as adjusted minus tax deductions. Most states and localities follow this definition at least in part, though some make adjustments to determine income taxed in that jurisdiction. Taxable income for a company or business may not be the same as its book income.
Alternative Minimum Tax
AMT, is a parallel tax system. Every taxpayer is responsible for paying the higher of the regular tax or the minimum tax. The difference between the two tax calculations is calculated on IRS and using. If the minimum tax is higher, the difference between the two tax rates is added to your Form 1040 as an additional alternative minimum tax.
The alternative minimum tax began as a way to ensure that taxpayers pay at least a minimum amount of tax. The AMT has a completely different set of calculations than the regular tax. For the regular tax, you add up your total income, subtract out various deductions and personal exemptions, then calculate the tax. Against the regular tax you can claim various credits to reduce your tax even further. The AMT, however, does not allow the standard deduction, personal exemptions, or certain itemized deductions. Also some income which is not subject to the regular tax is added for AMT purposes. Your tax under AMT rules may be higher than your tax under regular tax rules.
When calculating the alternative minimum tax, various adjustments are made. Some income is added which is not subject to the regular tax. Some deductions are adjusted downwards or eliminated entirely. The following items may trigger an AMT liability:
• Itemized deductions for state and local taxes,
medical expenses, and miscellaneous expenses
• Mortgage interest on home equity debt
• Accelerated depreciation
• Exercising (but not selling) incentive stock
options
• Tax-exempt interest from private activity bonds
• Passive income or losses
• Net operating loss deduction
• Foreign tax credits
• Investment expenses
This list is not comprehensive, but reflects the typical adjustments I see that can trigger an AMT liability. Typically, the alternative minimum tax eliminates most or exactly all of the regular tax savings from the above-mentioned deductions.
• $52,800 for single and head of household filers,
• $82,100 for married people filing jointly and for qualifying widows or widowers, and
• $41,050 for married people filing separately.
Since its creation in the 1960s, the Alternative Minimum Tax (AMT) has not been adjusted for inflation. Thus, Congress was forced to “patch” the AMT by raising the exemption amount to prevent middle class taxpayers from being hit by the tax as a result of inflation.
On January 2, 2013 the American Taxpayer Relief Act of 2012 finally indexed the income thresholds to inflation, preventing the necessity for an annual patch. The AMT exemption amount for 2014 is $52,800 for singles and $82,100 for married couple filing jointly (Table 2.5).
Table 2.5. 2014 Alternative Minimum Tax
Filing Status Exemption Amount
Single $52,800.00
Married Filing Jointly $82,100.00
Married Filing Separately $41,050.00
Source: Internal Revenue Service
2.4 Income Tax Brackets and Rates
Every year, the IRS adjusts more than forty tax provisions for inflation. This is done to prevent what is called “bracket creep.” This is the phenomenon by which people are pushed into higher income tax brackets or have reduced value from credits or deductions due to inflation instead of any increase in real income.
The IRS uses the Consumer Price Index (CPI) to calculate the past year’s inflation and adjusts income thresholds, deduction amounts, and credit values accordingly.
In 2014, the income limits for all brackets and all filers will be adjusted for inflation and will be as follows (Table 2.6) The top marginal income tax rate of 39.6 percent will hit taxpayers with an adjusted gross income of $406,751 and higher for single filers and $457,601 and higher for married filers.
Table 2.6 . 2014 Taxable Income Brackets and Rates
Rate Single Filers Married Joint Filers Head of Household Filers
10% $0 to $9,075 $0 to $18,150 $0 to $12,950
15% $9,076 to $36,900 $18,151 to$73,800 $12,951 to $49,400
25% $36,901 to $89,350 $73,801 to $148,850 $49,401 to $127,550
28% $89,351 to $186,350 $148,851 to $226,850 $127,551 to $206,600
33% $186,351 to $405,100 $226,851 to $405,100 $206,601 to $405,100
35% $405,101 to 406,750 $405,101 to 457,600 $405,101 to $432,200
39.6% $406,751+ $457,601+ $432,201+
Source: Internal Revenue Service
Examples of a tax computation
Income tax for year 2014:
Assume, that you are living in Texas and don’t paying state tax. Your annual income is $75 000 and you need to calculate your federal income tax amount, in case that you are single and have not personal tax exemptions. Hence, the in this case the gross income is equal to adjusted gross income.
First of all, you need make standard $ 6 200 deduction from your income. That means, your taxable income will be 75 000 – 6 200 = $ 68 800. Putting taxable income in cones¬quent tax brackets, you are calculating federal income tax:
10% $0 to $9,075 9 075 x 0.1 = 907.5
15% $9,076 to $36,900 (36 900-9 076) x 0.15 = 4173.6
25% $36,901 to $89,350 (68 800 – 36 900) x 0.25 = 7 975,0
Total federal income tax without FICA 13 056.1
• Total income tax is 13 056.1 (13 056/75 000 x 100~17.5% effective tax)
Note that in addition to income tax, a wage earner would also have to pay Federal Insurance Contributions Act tax (FICA) (and an equal amount of FICA tax must be paid by the employer):
• $75,000 (adjusted gross income)
$75,000 × 6.2% = $4 650 (Social Security portion)
$75,000 × 1.45% = $1 087.5 (Medicare portion)
• Total FICA tax paid by employee = $5 737.5 (7.65% of income)
• Total federal tax of individual = $13 050.1+ $5 737.5 = $18 787.6 (~25.05% of income)
Total federal tax including employer's contribution:
• Total FICA tax contributed by employer = $5 737.5 (7.65% of income)
• Total federal tax of individual including employer's contribution = $13 050.1+ $5 737.5 + $5 737.5 = $24 525.1 (~32.71% of income)
Income tax for year 2013:
Single taxpayer from Texas, no children, under 65 and not blind, taking standard deduction;
• $40,000 (adjusted gross income) – $6,100 standard deduction – $3,900 personal exemption = $30,000 taxable income
$8,925 × 10% = $892.50 (taxation of the first income bracket)
$30,000 – $8,925 = $21,075.00 (amount in the second income bracket)
$21,075.00 × 15% = $3,161.25 (taxation of the amount in the second income bracket)
• Total income tax is $892.50 + $3,161.75 = $4,053.75 (~10.13% effective tax)
Note that in addition to income tax, a wage earner would also have to pay Federal Insurance Contributions Act tax (FICA) (and an equal amount of FICA tax must be paid by the employer):
• $40,000 (adjusted gross income)
$40,000 × 6.2% = $2,480 (Social Security portion)
$40,000 × 1.45% = $580 (Medicare portion)
• Total FICA tax paid by employee = $3,060 (7.65% of income)
• Total federal tax of individual = $4,053.75+ $3,060.00 = $7,113.75 (~17.78% of income)
Total federal tax including employer's contribution:
• Total FICA tax contributed by employer = $3,060 (7.65% of income)
• Total federal tax of individual including employer's contribution = $4,091.25 + $3,060.00 + $3,060.00 = $10,211.25 (~23.71% of income)
According to Armenian Tax Legislation, the income tax shall be calculated by the tax agent at the following rates, without any filers status brackets and personal conditions:
Monthly taxable income Tax amount
Up to AMD 120.000 24.4 percent of taxable income
Above AMD 120.000 up to 2 000 000 AMD AMD 29.280 plus 26 percent of the excess amount of AMD 120.000
Above AMD 2 000 000 AMD 351 3601 plus 36 percent of the excess amount of AMD 120.000
The income tax on non-taxed incomes shall be calculated by the tax agent at the following rates:
Size of annual taxable income Tax amount
Up to AMD 1.440.000 24.4 percent of taxable income
Above AMD 1.440.000 AMD 351.360 plus 26 percent of the excess amount of AMD 1.440.000
Until 2012 in Armenia Social Security tax was calculated and reported separately. Currently Social Security tax and Income tax in Armenia is combined and calculating by above presented merge rates.
Income tax for year 2014:
Assume, that Armenian “Taxi” LTD make a contract for monthly payment by following employees:
➢ taxi drivers (5 persons) – AMD 150 000
➢ technical assistants (2 person) – AMD 180 000
➢ supervisor (1 person) – AMD 260 000
➢ dispatchers (2 persons) AMD 100 000
The monthly income tax calculation for each employee category will be;
• dispatchers 100 000 x 24,4% x 2 persons = AMD 48 800
• technical assistants 29 280 +
+ (180 000 –120 000) x 26% x 2 persons = AMD 89 760
• supervisor 29 280 +
+ (260 000 – 120 000) x 26% x 1 persons = AMD 65 680
• taxi drivers 29 280 +
(150 000 – 120 000) x 26% x 5 persons = AMD185 400
389 640
Consequently, the total monthly income tax will be AMD 389 640, which should be withheld (levied) by the tax agent “Taxi” LTD and recognized as a tax liability to the state budget.
In US every year, the IRS adjusts more than forty tax provisions for inflation. This is done to prevent what is called “bracket creep.” This is the phenomenon by which people are pushed into higher income tax brackets or have reduced value from credits or deductions due to inflation instead of any increase in real income. In Armenia is non in practice applying the tax brackets annually adjustments, concerning to inflation, Changing in this field happening, when the tax law is updating.
If the natural person receives the accrued amount under a voluntary funded pension insurance scheme as one-off withdrawal in the manner established by the legislation of the Republic of Armenia, then the income tax shall be calculated at the above presented rate Income tax for receipt of pensions from the amount of voluntary funded pension insurance scheme paid by the taxpayer for himself/herself and/or by a third party. On behalf of the taxpayer under a voluntary funded pension insurance scheme in the manner established by the legislation of the Republic of Armenia, shall be calculated at the rate of 10 percent.
For incomes received from royalties and lease of property, as well as sale of residential buildings, apartments thereof, and other spaces by individuals, except for individual entrepreneurs, who act as planners of residential (including multi-functional) buildings, facilities, residential houses in residential areas and complexes, 10 percent of the overall space of the building (without non-residential spaces of shared ownership), but no more than 500 m2 of space, and the income tax on proceeds of sale of spaces exceeding the space of 4 residential houses (hereinafter referring to as non-taxable threshold) in residential areas (or complexes) shall be assessed at the rate of 10 percent without consideration of tax deductions.
The royalty shall be deemed to be the compensation payable for permits for using a piece of literature, art or scientific study, or using or obtaining the right to use any copyright, patent, trademark, design or model, plan, secret formula or process, programs for electronic calculation machines and databases or industrial, commercial, scientific equipment or accessing information on industrial, commercial, scientific experience. For interests, income tax shall be calculated at the rate of 10 percent, without considering the deductions. The tax agent shall calculate the income tax on proceeds payable against purchase of property from natural persons at the rate of 10 percent.
2.5 State income tax
Most individual U.S. states collect a state income tax in addition to federal income tax. In addition, some local governments impose an income tax, often based on state income tax calculations. Forty-three states and many localities in the United States impose an income tax on individuals. Forty-seven states and many localities impose a tax on the income of corporations.
State income tax is imposed at a fixed or graduated rate on the taxable income of individuals, corporations, and certain estates and trusts. The rates vary by state. Taxable income conforms closely to federal taxable income in most states, with limited modifications. The states are prohibited from taxing income from federal bonds or other obligations. Many states allow a standard deduction or some form of itemized deductions. States allow a variety of tax credits in computing tax.
Each state administers its own tax system. Many states also administer the tax return and collection process for localities within the state that impose income tax. State income tax is allowed as a deduction in computing federal income tax, subject to limitations for individuals.
The table below outlines Minnesota’s tax rates and brackets for tax year 2014. Taxpayers who file estimated taxes may use this information to plan and pay taxes beginning in April 2014.
Rate Married joint Married Separate
More than But not more than More than But not more than
5.35 % $0 $36,080 $0 $18,040
7.05% $36,081 $143,350 $18,041 $71,680
7.85 % $143,351 $254,240 $71,681 $127,120
9.85% $254,241 $127,121
Individuals who take the itemized deduction can deduct the cost of state and local income taxes on their federal tax return. There are obvious advantages that stem from being able to deduct the full cost of the state and local taxes you have to pay every year, though much less obvious are a few strategies professionals use to mitigate the tax liability you may have from one year to the other.
Rate Head of household Single
More than But not more than More than But not more than
5.35% $0 $30,390 $0 $24,680
7.05% $30,391 $122,110 $24,681 $81,080
7.85 % $122,111 $203,390 $81,081 $152,540
9.85 % $203,391 $152,541
Forty-three states impose a tax on the income of individuals, sometimes referred to as personal income tax. State income tax rates vary widely from state to state. South Carolina has the lowest marginal tax rate at 0% for the first $2,850 of personal income, while California has the highest marginal rate of 13.3% for the portion of incomes over $1,000,000. Some states impose the tax on federal taxable income with minimal modifications, while others tax a measure bearing little resemblance to federal taxable income.
The states imposing an income tax on individuals tax all taxable income (as defined in the state) of residents. Such residents are allowed a credit for taxes paid to other states. Most states tax income of nonresidents earned within the state. Such income includes wages for services within the state as well as income from a business with operations in the state. Where income is from multiple sources, formulary apportionment may be required for nonresidents. Generally, wages are apportioned based on the ratio days worked in the state to total days worked.
All states that impose an individual income tax allow most business deductions. However, many states impose different limits on certain deductions, especially depreciation of business assets. Most of the states allow non-business deductions in a manner similar to federal rules. Few allow a deduction for state income taxes, though some states allow a deduction for local income taxes. Eight of the states allow a full or partial deduction for federal income tax.
In addition, some states allow cities and/or counties to impose income taxes. For example, most Ohio cities and towns impose an income tax on individuals and corporations. By contrast, in New York, only New York City and Yonkers impose a municipal income tax.
2.6 Tax Credits
A tax credit can substantially reduce the amount of tax you owe, or even make your tax refund bigger. However, not all tax credits are alike. Tax credits can be refundable or nonrefundable, and sometimes partly refundable.
Nonrefundable Tax Credits
A nonrefundable credit essentially means that the credit can’t be used to increase your tax refund or to create a tax refund when you wouldn’t have already had one. In other words, your savings cannot exceed the amount of tax you owe. For example, if the only credit you’re eligible for is a $500 Child and Dependent Care Expenses credit, and the tax you owe is only $200 -- the $300 excess is nonrefundable. This means that the credit will eliminate the entire $200 of tax, but you don’t receive a tax refund for the remaining $300. All nonrefundable tax credits are listed under the “Taxes and Credits” section of the 1040 and 1040A forms, or under the “Payments, Credits, and Tax” section if using the 1040EZ.
Refundable Tax Credits
Refundable tax credits, on the other hand, are treated as payments of tax you made during the year. When the total of these credits is greater than the tax you owe, the IRS sends you a tax refund for the difference.
Your tax return form will list all refundable tax credits, such as the Earned Income Credit, in the same section you report your tax payments.
A refundable tax credit is a tax credit that is treated as a payment and thus can be refunded to the taxpayer by the Internal Revenue Service. Refundable credits can be used strategically to help offset certain types of taxes that normally cannot be reduced, and they can produce a federal tax refund that is larger than the amount of money a person actually paid in during the year.
Refundable credits are contrasted with nonrefundable tax credits. The vast majority of tax credits are nonrefundable: meaning that these credits can reduce your federal income tax liability to zero, and any remaining credits won't be refunded to the taxpayer.
Earned Income Tax Credit
The 2014 maximum Earned Income Tax Credit for singles, heads of households, and joint filers is $496 if the filer has no children (Table 2.6). For one child the credit is $3,305, two children is $5,460, and three or more children is $6,143.
Table 2.6. 2014 Earned Income Tax Credit Parameters
Filing Status No
Children One
Child Two Children Three or More Children
Single or Head of Household Earned Income Level for Max Credit $6,480 $9,720 $13,650 $13,650
Maximum Credit $496 $3,305 $5,460 $6,143
Income Level When Phase out Begins $8,110 $17,830 $17,830 $17,830
Income Level When Phase-out Ends (Credit Equals Zero) $14,590 $38,511 $43,756 $46,997
Married Filing Jointly Earned Income Level for Max Credit $6,480 $9,720 $13,650 $13,650
Maximum Credit $496 $3,305 $5,460 $6,143
Earned Income Level When Phase-out Begins $13,540 $23,260 $23,260 $23,260
Earned Income Level When Phase out Ends (Credit Equals Zero) $20,020 $43,941 $49,186 $52,427
Source: Internal Revenue Service
Partially Refundable Tax Credit
The American Opportunity credit, is partially refundable, up to 40 percent. When you claim this credit for education expenses, Form 8863 separately calculates the refundable and nonrefundable portions, which means you report the amounts in two different sections of your return. For example, if you calculate a $2,000 American Opportunity credit, a maximum of $800 may be reported as a refundable tax credit with the remaining $1,200 reported as a nonrefundable credit.
Putting It All Together
To illustrate how these credits work, assume that your tax return reports $2,400 of tax before taking the Child and Dependent Care and American Opportunity credits used in the examples above. You first reduce the tax by the $1,700 of nonrefundable credits you claim ($500 for the Child and Dependent Care Credit, plus $1,200 for the American Opportunity Credit). This brings your tax bill down to $700 ($2,400 - $1,700). You then reduce the $700 by the $800 refundable portion of your American Opportunity credit. This not only eliminates the entire $700 of tax, but also gives you a $100 tax refund for the excess.
Remember, when you use TurboTax to prepare your taxes, we’ll ask you simple questions, determine which credits you qualify for, and handle all the calculations to determine what’s refundable and what’s not.
The U.S. system grants the following low income tax credits:
• Earned income credit: this refundable credit is granted for a percentage of income earned by a low income individual. The credit is calculated and capped based on the number of qualifying children, if any. This credit is indexed for inflation and phased out for incomes above a certain amount.
• Credit for the elderly and disabled: A nonrefundable credit up to $1,125
• Retirement savings credit: a nonrefundable credit of up to 50% of contributions to IRAs or similar plans, phased out at incomes above $16,000 ($24,000 for head of household and $32,000 for joint returns).
• Mortgage interest credit: a nonrefundable credit that may be limited to $2,000, granted under specific mortgage programs.
Family relief
Some systems grant tax credits for families with children. These credits may be on a per child basis or as a credit for child care expenses. The U.S. system offers the following nonrefundable family related income tax credits (in addition to a tax deduction for each dependent child):
• Child credit: Parents of children who are under age 17 at the end of the tax year may qualify for a credit up to $1,000 per qualifying child. The credit is a dollar-for-dollar reduction of tax liability, and may be listed on Line 51 of Form 1040. For every $1,000 of adjusted gross income above the threshold limit ($110,000 for married joint filers; $75,000 for single filers), the amount of the credit decreases by $50.
• Child and dependent care credit: If a taxpayer must pay for childcare for a child under age 13 in order to pursue or maintain gainful employment, he or she may claim a credit up to $3,000 of his or her eligible expenses for dependent care. If one parent stays home full-time, however, no child care costs are eligible for the credit.
• Credit for adoption expenses: a credit up to $10,000, phased out at higher incomes. Taxpayers who have incurred qualified adoption expenses in 2011 may claim either a $13,360 credit against tax owed or a $13,360 income exclusion if the taxpayer has received payments or reimbursements from his or her employer for adoption expenses. For 2012, the amount of the credit will decrease to $12,650, and in 2013 to $5,000.
Education, energy and other subsidies
Some systems indirectly subsidize education and similar expenses through tax credits.
The U.S. system has the following nonrefundable credits:
• Two mutually exclusive credits for qualified tuition and related expenses. The American Opportunity Tax Credit is 100% of the first $2,000 and 25% of the next $4000 of qualified tuition expenses per year for up to two years. The Lifetime Learning Credit[5] is 20% of the first $10,000 of cumulative expenses. These credits are phased out at incomes above $50,000 ($100,000 for joint returns) in 2009. Expenses for which a credit is claimed are not eligible for tax deduction.
• First time homebuyers credit up to $7,500 (closing date before Sept. 30, 2010).
Credits for purchase of certain nonbusiness energy property and residential energy efficiency. Several credits apply with differing rules. The federal and state systems offer numerous tax credits for individuals and businesses. Among the key federal credits for individuals are:
• Child credit: a credit up to $1,000 per qualifying child.
• Child and dependent care credit: a credit up to $6,000, phased out at incomes above $15,000.
• Earned Income Tax Credit: this refundable credit is granted for a percentage of income earned by a low income individual. The credit is calculated and capped based on the number of qualifying children, if any. This credit is indexed for inflation and phased out for incomes above a certain amount. For 2009, the maximum credit was $5,657.
• Credit for the elderly and disabled: A nonrefundable credit up to $1,125
• Two mutually exclusive credits for college expenses.
Businesses are also eligible for several credits. These credits are available to individuals and corporations, and can be taken by partners in business partnerships. Among the federal credits included in a "general business credit" are:
• Credit for increasing research expenses.
• Work Incentive Credit or credit for hiring people in certain enterprise zones or on welfare.
• A variety of industry specific credits.
In addition, a federal foreign tax credit is allowed for foreign income taxes paid. This credit is limited to the portion of federal income tax arising due to foreign source income. The credit is available to all taxpayers.
Business credits and the foreign tax credit may be offset taxes in other years.
States and some localities offer a variety of credits that vary by jurisdiction. States typically grant a credit to resident individuals for income taxes paid to other states, generally limited in proportion to income taxed in the other state(s).
American Opportunity Tax Credit is a refundable tax credit for undergraduate college education expenses. This credit provides up to $2,500 in tax credits on the first $4,000 of qualifying educational expenses. The tax credit is scheduled to have a limited life span: it will be available only for the years 2009 through 2017 , unless Congress decides to extend the credit to other years.
Individuals who pay for day care expenses for their children or disabled adult dependents may be eligible for a federal tax credit of up to 35% percent of the cost of day care.
To qualify for the child and dependent care credit, you must have a dependent child age 12 or younger, or a dependent of any age who cannot care for himself or herself. In order to claim this tax credit, you must meet each of following criteria:
• Your child or dependent must meet certain
qualifications,
• Your daycare provider must meet certain qualifications,
• You must have earned income,
• The care provided must enable you to work or to look for work, and
You must reduce your eligible daycare expenses by any amounts provided by a dependent care benefits plan through your employer.
Qualifying Child or Dependent
The child must be your dependent, age 12 or younger. If your child is age 13 or older, the child must be physically or mentally unable to care for herself or himself. You may also claim adult daycare expenses for a dependent age 13 or older or for a spouse, if that person is physically or mentally unable to care for himself or herself.
You must provide a home for the dependent, and pay over half the costs of maintaining a home for your dependent. You cannot claim childcare or adult daycare expenses for someone who does not live with you. Normally, the child must also be your dependent. If the child is not your dependent solely because you allow the non-custodial parent to claim the child as a dependent, then you may be able to claim the child care credit even though you aren't claiming the child as your dependent. Only the custodial parent can take the child care credit, however.
Don’t confuse a tax credit with a tax deduction. A tax credit directly reduces your tax, dollar for dollar. If you are supposed to pay $5,000 in tax, a $500 tax credit reduces your tax to $4,500. On the other hand, a tax deduction reduces your taxable income, which indirectly reduces your tax. If you are supposed to pay $5,000 in tax, a $500 tax deduction reduces your taxable income by $500. If you are in the 15% marginal tax bracket, it reduces your tax by only $500 * 15% = $75. Therefore a $100 tax credit is worth a lot more than a $100 tax deduction.
Within tax credits, some are refundable tax credits and some are non-refundable tax credits. Here the word refundable often causes confusion because most people refer to the difference between their tax withholding and their total tax as the tax refund.
Tax Refund (R) = Tax Withholding (W) – Total Tax (T)
When they hear that a tax credit is non-refundable, they think they are not going to get the tax credit if they receive a refund versus owe taxes when they file their tax return by April 15, because the credit is, uh, non-refundable. Actually that’s not the case.
Refundable tax credits, such as the Earned Income Tax Credit, are credits, which effectively count as though they were taxes paid. The earned income credit and other refundable tax credits add to the total amount that you have to paid in federal income taxes. If you do not owe taxes, all of that amount can be refunded to you.
In the case of non-refundable tax credits, the credit only counts toward taxes that are actually due. For example, some of the educational credits, are only applied when you actually owe taxes. Non-refundable tax credits will reduce the amount of taxes that you owe, but if there is a leftover credit, it is not refunded to you.
The best way to look at this is to use an example:
Let's say that you are eligible for a $1000 non-refundable tax credit. If you owe $800 in federal taxes, the non-refundable tax credit would pay that bill. However, the left over $200 of the credit is simply lost. If the $1000 credit were a refundable credit, then you would get that $200 added to your tax refund.
The most well known of the refundable tax credits is the Earned Income Tax Credit. To qualify for the earned income credit, you must have dependent school-age children or another qualifying dependent and must make less than an amount specified each year by the tax code. In many cases, people who have paid no income tax at all during the year may be eligible for the Earned Income Tax Credit based on their number of dependents and total income. Many people who would otherwise not be required to file income tax forms are often encouraged to do so because they may be granted a refund based solely on the earned income credit.
Tax credits offset tax liability on a dollar-for-dollar basis. Over time, tax credits have become an increasingly popular method of providing tax relief and social benefits. There are two fferent types of tax credits: those that are refundable and those that are non-refundable. If a tax credit is refundable, and the credit amount exceeds tax liability, a taxpayer receives a payment from the government. The earned income credit is refundable, and the child tax credit is refundable for all but very low-income families. If credits are not refundable, then the credit is limited to the amount of tax liability. In some cases, unused credits can be carried forward to offset tax liability in future tax years. Non-refundable credits provide limited benefits to many middle- and lower income individuals who have little or no tax liability. Many credits are phased out as income rises and thus do not benefit higher income individuals. These phase out points vary considerably across different credits. Tax credits are available for a wide variety of purposes. The major individual income tax credits are described below.
2.7 Self Employment Taxation
Taxation in US
Self-employment is the act of generating one's income directly from customers, clients or other organizations as opposed to being an employee of a business (or person). Generally tax authorities will view a person as self-employed if the person (1) chooses to be recognized as such, or (2) is generating income such that the person is required to file a tax return under legislation that subsists in the relevant jurisdiction(s). In the real world the critical issue for the taxing authorities is not that the person is trading but is whether the person is profitable and hence potentially taxable. In other words the activity of trading is likely to be ignored if no profit is present, so occasional and hobby- or enthusiast-based economic activity is generally ignored by authorities.
Self-employed people generally find their own work rather than being provided with work by an employer, earning income from a trade or business that they operate. In some countries governments (the United States and UK, for example) are placing more emphasis on clarifying whether an individual is self-employed or engaged in disguised employment, often described as the pretense of a contractual intra-business relationship to hide what is otherwise a simple employer-employee relationship.
The self-employment tax in the United States is typically set at 15.30% which is roughly the equivalent of the combined contributions of the employee and employer under the FICA tax. The rate consists of two parts: 12.4% for social security and 2.9% for Medicare. The social security portion of the self-employment tax only applies to the first $110,100 of income. There is no limit to the amount that is taxable under the 2.9% Medicare portion of the self-employment tax. Generally, only 92.35% of the self-employment income is taxable at the above rates. Additionally, half of the self-employment tax, i.e., the employer-equivalent portion, is allowed as a deduction against income. Self-employed persons sometimes declare more deductions than an ordinary employee. Travel, uniforms, computer equipment, cell phones, etc., can be deducted as legitimate business expenses. Self-employed persons report their business income or loss on Schedule C of IRS Form 1040 and calculate the self-employment tax on Schedule SE of IRS Form 1040. Estimated taxes must be paid quarterly using form 1040-ES if estimated tax liability exceeds $1,000.
Taxation in Armenia
When determining the gross income from business operations, the accrual basis of accounting shall be applied for legal entities in the manner prescribed by the Law of the Republic of Armenia “On Profit Tax”. When determining the tax base of income tax on business activities, apart from incomes deducted under Income Law, the gross income shall be deducted, based on the declaration on annual income filed by the natural person, by the amount of costs which are directly related to the incomes gained from business activities and execution of civil-legal contracts and are supported by appropriate documentation.
In particular, costs shall include: 1) material costs; 2) wages and salaries and payments made equal to wages and salaries; 3) voluntary funded pension contributions paid by the employer on behalf of its hired employee, at the maximum amount of 5% of the employee’s salary; 4) amortization allowances; 5) rentals; 6) insurance premiums; 7) taxes not subject to refund (offsetting), duties and other mandatory fees; 8) interests on loans and other borrowings; 9) fees against guarantees, security, letters of credit and other bank services; 10) promotional costs; 11) representational costs; 12) sponsorship costs; 13) judicial costs; 14) travel costs; 15) indemnification of caused damage; 16 fines, penalties and other material sanctions, save for those fines, penalties and other material sanctions which are payable to the State or community budgets, as well as those charged against contributions to the funded pension system; 17) costs of audit, legal, other consulting, information and management services; 18) costs of factoring, trust (power of attorney related) operations; 19) understated costs for the preceding three years as identified during the reporting year. 3. Contributions made by the taxpayer to other persons‟ paid-in capital shall not be treated as costs.
The taxpayer shall independently perform the final calculation of the actual income tax amount at the rates set out in table and accordingly reflect it in the annual income declaration. Taxpayers earning income from business operations (other than the ones subject to presumptive taxation) in the course of the year shall make advance payments of income tax. Advance payments shall be made on a quarterly basis - by the 15th day of the last month of each quarter - at the one-sixth amount of the actual income tax amount paid for the previous year. In case the taxpayer fails to make advance payments in a timely manner, and in other legally identified cases, the tax authorities shall set forth claims in relation to these advance and fines thereof as prescribed by law.
The taxpayer who is a newly opened business shall be entitled to not make advance payments of income tax until June 15 of the next year by giving an notice to the tax authorities. If the taxpayer has incurred losses during the previous year, or the amount of income tax for the previous year has not exceeded AMD 500,000 (five hundred thousand) or the taxpayer has not been acting as a duly registered payer of VAT, then the taxpayer shall have the right not to make advance payments of income tax after filing the annual income report. Before calculating the actual amount of income tax for the previous year not later than by March 15, the taxpayer shall make the first advance payment of income tax at an amount which shall not be less than the last advance payment effected for the previous year.
Where the tax base for the year in question is anticipated by the taxpayer to be lower than the income compared to the previous year, the taxpayer shall determine independently the quarterly size of the advance payment. If the total annual amount of advance payments is less than 2/3 of the actual income tax for the year in question, then the taxpayer shall pay a fine against the difference between 1/6 amount of the actual income tax and actual advance payment made for the quarter in question, from the day of making the advance payment through the day when the amount of actual income tax becomes known to the tax office (day of filing the annual income return statement).
After the completion of the reporting year, the taxpayer shall assess the amount of income tax based on the calculated tax base, along with offsetting it against the amounts of advance payments made for the reporting year in question. If the amount of actual income tax for the reporting year is less than the total amount of advance payments made for the same year, then the difference shall be subject to refund. In such a case the calculation of fines imposed against the amounts of advance payments shall be ceased on the day when the amount of actual income tax becomes known to the tax office (when the annual income return is filed) but no later than on May 1. The amounts of fines calculated against advance payments shall not be subject to recalculation or refund.
If the aggregate amount of advance payments is less than the amount of actual income tax for the reporting year in question, then only the income tax shall be recalculated, and the taxpayer shall be obliged to pay the resulting difference to the State budget. In this case the calculation of fines on advance payments shall cease on the day when the amount of income tax becomes known to the tax office (the annual income return statement is filed). For late payment of income tax, from May 1 fines shall accrue on the outstanding amount of the income tax at the amount set forth in Article 23 of the Law “On Taxes”.
With respect to activities subject to taxation under the presumptive tax regime, taxpayers shall make income tax advance payments at the amount of 5000 drams on a monthly basis by the 20th day of the following month.
Minimal amount of income tax
Where the amount of advance payment assessed for each quarter defined as prescribed is less than 1 percent of the amount specified, the taxpayer (with the exception of activities subject to taxation under the presumptive tax regime) shall effect quarterly payments of the minimal income tax. The minimal income tax shall be calculated against the income calculated on the accrual basis which is generated during the previous quarter from sale of goods, products and delivery of services - and which does not include paid indirect taxes on the earned income - and against the difference between the amount which is less than 50 percent of the income for the same period and amortization allowances for fixed assets.
For taxpayers who use the tariffs set out by the government or its authorized body, as well as individual entrepreneurs who deliver services in the areas of health and education, or are involved in printing and distribution of newspapers and magazines, cutting of precious stones, as well as in international freight forwarding operations, the Government of the Republic of Armenia may establish other deductions for the tax base of the minimal income tax. The positive difference between the aggregate annual amount of minimal income tax and actual income tax for the reporting period shall be deducted from the income tax for the coming years.
Chapter III
Income Tax Accounting
3.1 Accounting Periods and Methods
To effectively manage a company, it is important for managers to understand both the generally accepted accounting principles (GAAP) that govern financial reporting and the tax implications of transactions. The objective of GAAP for financial reporting is to provide useful information to decision makers about companies. By taking advantage of opportunities in the Internal Revenue Code, companies can pay less in taxes to the government, which results in more cash to pursue profitable business opportunities.
1. Because the objectives of GAAP and the IRC differ, there are differences between when an event is recognized for tax purposes and when it is recognized for financial purposes, there will be differences between tax expense on the income statement and taxes actually paid.
2. If a corporation reports different revenues and/or expenses for financial reporting than it does for income tax reporting, it must determine:
Differences Between Taxable and Financial Income
a) The current and non current deferred income tax liabilities and/or assets to report on its balance sheet, and
b) The income tax expense to match against its pretax financial income on the income statement.
Causes of Differences
• Permanent differences
• Temporary differences
• Operating loss carry backs and carry forwards
• Tax credits
• Intraperiod tax allocations
Some revenue and expense items that a corporation reports for financial accounting purposes are never reported for income tax purposes. These permanent differences never reverse in a later accounting period.
Figure 3.1 Permanent Differences Classification
Special dividend deduction. For income tax purposes corporations are allowed a special deduction (usually 70% or 80%) for certain dividends from investments in equity securities.
A temporary difference causes a difference between a corporation’s pretax financial income and taxable income that “originates” in one or more years and “reverses” in later years.
Temporary Differences: Future Taxable Amounts
1. A depreciable asset purchased after 1986 may be depreciated using MACRS over the prescribed tax life for income purposes. For financial reporting purposes, however, it may be depreciated by a financial accounting method (often straight-line) over a different period.
2. Gross profit on installment sales normally is recognized at the point of sale for financial reporting purposes. However, for income tax purposes, in certain situations it is recognized as cash is collected.
3. Product warranty costs, bad debts, compensation expense for share option plans, and losses on inventories in a later year may be estimated and recorded as expenses in the current year for financial reporting purposes. However, they may be deducted as actually incurred to determine taxable income.
Interperiod Income Tax Allocation: Conceptual Issues
1. Should corporations be required to make interperiod income tax allocations for temporary differences, or should there be no interperiod tax allocation?
2. If interperiod tax allocation is required, should it be based on a comprehensive approach for all temporary differences or on a partial approach for only the temporary differences that it expects to reverse in the future?
3. Should interperiod tax allocation be applied using the asset/liability method, the deferred method, or the net-of-tax method?
Interperiod Income Tax Allocation: Conceptual Issues
The FASB concluded that GAAP requires:
1. Interperiod income tax allocation of temporary differences is appropriate.
2. The comprehensive allocation approach is to be applied.
3. The asset/liability method of income tax allocation is to be used.
The FASB established four basic principles that a corporation is to apply in accounting for its income taxes at the date of its financial statements.
1. Recognize a current tax liability or asset for the estimated income tax obligation or refund on its income tax return for the current year
2. Recognize a deferred tax liability or asset for the estimated future tax effects of each temporary difference
3. Measure its deferred tax liabilities and assets based on the provisions of the enacted tax law; the effects of future changes in tax law or rates are not anticipated
4. Reduce the amount of deferred tax assets, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized
Steps in Recording and Reporting of Current and Deferred Taxes
Step 1. Measure the income tax obligation by applying the applicable tax rate to the current taxable income.
Step 2. Identify the temporary differences and classify each as either a future taxable amount or a future deductible amount.
Step 3. Measure the year-end deferred tax liability for each future taxable amount using the applicable tax rate.
Step 4. Measure the deferred tax asset for each future deductible amount using the applicable tax rate.
Step 5. Reduce deferred tax assets by a valuation allowance if, based on available evidence, it is more likely than not that some or all of the year-end deferred tax assets will not be realized.
Step 6. Record the income tax expense (including the deferred tax expense or benefit), income tax obligation, change in deferred tax liabilities and/or deferred tax assets, and change in valuation allowance (if any).
Determining Taxable Income
Both permanent and temporary differences are considered when determining taxable income.
Pretax financial income xx
Add: Deductible temporary items xx
Fines xx
Excess charitable contributions xx
Expenses to earn tax exempt income xx xx
Less: Taxable temporary items xx
Tax exempt interest xx
Proceeds of life insurance xx
Excess of percentage depletion over
cost depletion xx
Dividends received deduction xx xx
Taxable income xx
Operating Loss Carry backs and Carry forwards
Businesses don’t always earn a profit. This is particularly likely to occur when they are first starting out or when economic conditions are bad. If you’re in this unfortunate situation, you may be able to obtain some tax relief. This could provide you with a refund of all or part of previous years’ taxes in as little as 90 days—a quick infusion of cash that should be very helpful.
If, like most small business owners, you’re a sole proprietor, you may deduct any loss your business incurs from your other income for the year—for example, income from a job, investment income, or your spouse’s income (if you file a joint return). If your business is operated as an LLC, S corporation, or partnership, your share of the business’s losses are passed through the business to your individual return and deducted from your other personal income in the same way as a sole proprietor. However, if you operate your business through a C corporation, you can’t deduct a business loss on your personal return. It belongs to your corporation.
If your losses exceed your income from all sources for the year, you have a “net operating loss” (NOL for short). While it’s not pleasant to lose money, an NOL can provide important tax benefits: It may be used to reduce your tax liability for both past and future years.
Figuring a Net Operating Loss
Figuring the amount of an NOL is not as simple as deducting your losses from your annual income. First, you must determine your annual losses from your business (or businesses). If you’re a sole proprietor who files IRS Schedule C, the expenses listed on the form will exceed your reported business income. If your business is a partnership, LLC, or S corporation shareholder, your share of the business’s losses will pass through the entity to your personal tax return. Your business loss is added to all your other deductions and then subtracted from all your income for the year. The result is your adjusted gross income (AGI).
To determine if you have an NOL, you start with your AGI on your tax return for the year reduced by your itemized deductions or standard deduction (but not your personal exemption). This must be a negative number or you won’t have an NOL for the year. Your adjusted gross income already includes all the deductions you have for your losses. You then add back to this amount any non business deductions you have that exceed your non business income. These include the standard deduction or itemized deductions, deduction for the personal exemption, non business capital losses, IRA contributions, and charitable contributions. If the result is still a negative number, you have an NOL for the year. You can use Schedule A of IRS Form 1045, Application for Tentative Refund, to calculate an NOL.
Carrying a Loss Back
You may apply an NOL to past tax years by filing an application for refund or amended return for those years. This is called carrying a loss back. (IRC Sec. 172.) As a general rule, it’s advisable to carry a loss back, so you can get a quick refund from the IRS on your prior years’ taxes. However, it may not be a good idea if you paid no income tax in prior years, or if you expect your income to rise substantially in future years and you want to use your NOL in the future when you’ll be subject to a higher tax rate.
Ordinarily, you may carry back an NOL for the two years before the year you incurred the loss. However, the carry-back period is increased to three years if the NOL is due to a casualty or theft, or if you have a qualified small business and the loss is in a presidentially declared disaster area. (A qualified small business is a sole proprietorship or partnership that has average annual gross receipts of $5 million or less during the three-year period ending with the tax year of the NOL.) The carryback period for a farming business loss is five years.
The NOL is used to offset the taxable income for the earliest year first, and then applied to the next year or years. This will reduce the tax you had to pay for those years and result in a tax refund. Any part of your NOL left after using it for the carry-back years is carried forward for use for future years.
There are two ways to claim a refund for prior years’ taxes: You can file IRS Form 1040-X, Amended U.S. Individual Income Tax Return within three years, or you can seek a quicker refund by filing IRS Form 1045, Application for Tentative Refund. If you file Form 1045, the IRS is required to send your refund within 90 days. However, you must file Form 1045 within one year after the end of the year in which the NOL arose.
Carrying a Loss Forward
You have the option of applying your NOL only to future tax years. This is called carrying a loss forward. You can carry the NOL forward for up to 20 years and use it to reduce your taxable income in the future. When you do this, you must attach a statement that includes a computation showing how you figured the NOL deduction. If you deduct more than one NOL in the same year, your statement must cover each of them.
The tax deduction for a net operating loss (NOL) can help you recover some of the loss. The recovery usually isn't in the same year as the loss and you won't get back everything you lost. Also, figuring out how much you can deduct is complicated. Your potential tax savings, however, make it worth your time to learn how NOLs work. Generally, NOLs come up when you have more tax deductions than taxable income. You can figure this out easily by completing your tax return. You may have an NOL if you have a negative number on the line for taxable income before you deduct your personal exemptions (line 41 on Form 1040).
NOLs usually happen in business - from sole proprietorships to big corporations. It's possible, though, for an individual taxpayer's casualty and theft losses or business expenses to create an NOL. In such cases, you follow the rules for non-corporate taxpayers, such as sole proprietorships and independent contractors.
Other forms of businesses, like partnerships, limited liability companies (LLCs) and S-Corporations, generally can't take deductions for NOLs.
The idea behind NOLs is simple enough: If your business losses are more than your total income for the year, you can use the excess loss to lower your income and reduce your taxes in another year. For example, if you have an NOL in 2013, you can use it to lower your taxes in 2014 or 2015, or possibly in 2012 and later. This is done through the carryback and carryforward rules.
Use the information on your tax return and Form 1045 to figure this out. Be careful. The rules and formulas are complicated, and they're different for non-corporate and corporate taxpayers.
Non-Corporate Taxpayers
There are a number of deductions you may have taken when completing your tax return that you can't include when figuring out your NOL. For example, when calculating your NOL, you can't include:
• Personal exemptions for yourself, spouse, children and other dependents
• Net capital losses - the amount that your capital losses are more than your capital gains. Capital gains and losses come from the sale of capital assets, like stocks
• NOL deductions from prior years
• Non-business deductions for things like alimony you paid; certain itemized deductions, like medical payments and charitable contributions; and the standard deduction, if you didn't itemize
The NOL calculation does include:
• Itemized deductions for casualty and theft losses, state income tax on business profits, and any employee business expenses
• Moving expenses
• The deduction of half of your self-employment tax
Example
Say you're the sole owner of a small business, and you also have a part-time job. Your 2010 tax return looks like this:
Your income totals $5,500:
• Wages from part-time job = $3,500
• Interest income from personal savings account =
$500
• Net long-term capital gain on the sale of gold held for investment = $1,500
Your deductions total $18,350:
• Net business losses = $7,500 (gross income $68,500 minus $76,000 in expenses)
• Net short-term capital loss on sale of stock =
$1,500
• Standard deduction = $5,700 (you're single)
• Personal exemption = $3,650
Your deductions are more than your income, so you may have an NOL. To find out, go to Form 1045 and take out certain items:
• Non-business net short-term capital loss on sale
of stock = $1,500
• Non-business deductions = $5,200 (standard
deduction minus non-business interest income,
or $5,700 - $500)
• Personal exemption = $3,650
• Total = $10,350
So, for 2010, you have an NOL of $2,500: Deductions - Form 1045 removed items - total income ($18,350 - $10,350 - $5,500)
Corporate Taxpayers
The main differences between corporate and non-corporate NOLs are that corporations:
• Can't use the domestic production activities deduction to create or increase an NOL
• Can use the deduction for dividends paid on certain preferred stock of public utilities, without limiting it to its taxable income for the year
• Can take the deduction for dividends received, without regard to the aggregate limits that normally apply
The last difference is probably the most used and most important for many corporations. Normally, a corporation can deduct dividends-received from other U.S. corporations, but the deduction is limited to a total of either 70 or 80 percent of the corporation's taxable income. However, if the corporation has an NOL, the limit doesn't apply.
For example. In 2010, corporation A had $500,000 of gross income from business operations and $625,000 of allowable business expenses. It also received $150,000 in dividends from a U.S. corporation for which it can take an 80 percent deduction, which normally would be limited to 80 percent of its taxable income before the deduction. Its NOL is $95,000:
• Gross income = $650,000 (Business income + dividends, or $500,000 + $150,00), minus
• $625,000, deductions for expenses minus
• $120,000, deduction for dividends-received ($150,000 x 80 percent). If the special rule wasn't there, the corporation's deduction for the dividends-received would've been $20,000, or 80 percent of its taxable income before the deduction ($25,000 x 80 percent)
Example
Glenn Johnson is in the retail record business. He is single and has the following income and deductions on his Form 1040 for 2013.
INCOME
Wages from part-time job $1,225
Interest on savings 425
Net long-term capital gain on sale of real estate used in business 2,000
Glenn's total income $3,650
DEDUCTIONS
Net loss from business (gross income of $67,000 minus expenses of $72,000) $5,000
Net short-term capital loss
on sale of stock 1,000
Standard deduction 6,100
Personal exemption 3,900
Glenn's total deductions $16,000
Glenn's deductions exceed his income by $12,350 ($16,000 − $3,650). However, to figure whether he has an NOL, certain deductions are not allowed. He uses Form 1045, Schedule A, to figure his NOL. The following items are not allowed on Form 1045, Schedule A.
Non business net short-term capital loss $1,000
Non business deductions
(standard deduction, $6,100) minus
non business income (interest, $425) 5,675
Deduction for personal exemption 3,900
Total adjustments to net loss $10,575
Therefore, Glenn's NOL for 2013 is figured as follows:
Glenn's total 2013 income $3,650
Less:
Glenn's original 2013 total deductions $16,000
Reduced by the disallowed items − 10,575 − 5,425
Glenn's NOL for 2013 $1,775
The IRC allows a corporation reporting an operating loss for income tax purposes in the current year to carry this loss back or carry it forward to offset previous or future taxable income.
1. A corporation must recognize the tax benefit of an operating loss carry back in the period of the loss as an asset on its balance sheet and as a reduction of the operating loss on its income statement.
2. A corporation must recognize the tax benefit of an operating loss carry forward in the period of the loss as a deferred tax asset. However, it must reduce the deferred tax asset by a valuation allowance if it is more likely than not that the corporation will not realize some or all of the deferred tax asset.
3.2 Tax Accounting Under GAAP and IRS
Income tax requirements differ considerably from jurisdiction to jurisdiction. The application of the existing requirements to these different circumstances can be difficult, resulting in complex and potentially diverse interpretations. The Accounting Standards of the Republic of Armenia which have been adopted by the Ministry of Finance and Economy and are based on IAS (International Accounting Standards). The common approach for accounting for income tax shared by IAS 12 and SFAS 109 (US GAAP) is the temporary difference approach. However, the standards provides for exceptions to the temporary difference approach relating to the recognition and measurement of deferred tax assets and liabilities and the allocation of tax. The international accounting standards board constantly working on to remove any exceptions to the temporary differences resulting in simpler requirements based more on principle.
In relation to international standards for presentation financial statements, when determining the object of taxation, accounting of the income and expenses shall be performed on the accrual basis. The taxpayer accounts income and expenses respectively from the moment of the acquisition of the right to receive such income or to recognize the expenses, irrespective of the actual period of deriving such income or making the payments. According to Profit Tax Law of the Republic of Armenia, when accounting income on the accrual basis, the taxpayer shall take into consideration, that the right to receive income is deemed acquired when the corresponding amount is subject to unconditional payment (compensation) to the taxpayer, or when the taxpayer has fulfilled the liabilities of the transaction or the contract, even if the moment of fulfillment of this right is deferred, or the payments are made in parts [1]. From another hand, consistent with international accounting stan¬dards revenue from the sale of goods should be recognized when all the following conditions have been satisfied:
(a) the enterprise has transferred to the buyer the significant risks and rewards of ownership of the goods;
(b) the enterprise retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the enterprise; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably [2].
According to the tax law US companies are required to file tax return and when a company prepares its tax return for a particular year, the revenues and expenses (any gains/losses) included o the return are, by and large, the same as those reported on the company’s income statement for the same year. However, in some instances tax lows and financial accounting standards differ. The reason why differ is that the fundamental objectives of financial reporting and those of tax authorities are not the same. The differences in recognition for financial statements and for tax purposes are reconciled through deferred taxes.
Mentioned disparate revenue recognition approaches in tax and financial accounting fields making timing and temporary differences in tax expenses reporting. The income statement liability method focuses on timing differences, whereas the balance sheet liability method focuses on temporary differences. Timing differences are differences between taxable profit and accounting profit that originate in one period and reverse in one or more subsequent periods. Temporary differences are differences between the tax base of an asset or liability and its carrying amount in the balance sheet. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
The objective of accounting for income tax in US companies is to recognize a deferred tax liability or deferred tax asset for the tax consequences of amounts that will become taxable or deductible in future years as a result of transaction or events that already have occurred. The current US GAAP focuses on the balance sheet and the recognition of liabilities and assets. Conceptually, though, the balance sheet approach strives to establish deferred tax assets and liabilities that meet the definitions of assets and liabilities provided by the Financial Accounting Standards Board’s conceptual framework. The accounting for income taxes in GAAP is covered in IAS 12 (“Income Taxes”). Similar to U.S. GAAP, GAAP uses the asset and liability approach for recording deferred taxes. The differences between GAAP and U.S. GAAP involve a few exceptions to the asset-liability approach; some minor differences in the recognition, measurement, and disclosure criteria; and differences in implementation guidance.
Accomplishment of current tax assets and liabilities recognition in Armenian companies bases on following principles. Current tax for current and prior periods should, to the extent unpaid, be recognized as a liability. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess should be recognized as an asset. When a tax loss is used to recover current tax of a previous period, an enterprise recognizes the benefit as an asset in the period in which the tax loss occurs because it is probable that the benefit will flow to the enterprise and the benefit can be reliably measured. A deferred tax liability is recognizing for all taxable temporary differences. When the carrying amount of the asset exceeds its tax base, the amount of taxable economic benefits will exceed the amount that will be allowed as a deduction for tax purposes. This difference is a taxable temporary difference and the obligation to pay the resulting income taxes in future periods is a deferred tax liability. As the enterprise recovers the carrying amount of the asset, the taxable temporary difference will reverse and the enterprise will have taxable profit. This makes it probable that economic benefits will flow from the enterprise in the form of tax payments.
Consequently, current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period. Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences.
Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either:
• taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or
• deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.
Tax assets and tax liabilities in Armenian enterprises presented separately from other assets and liabilities in the balance sheet. Hence, deferred tax assets and liabilities is distinguished from current tax assets and liabilities. When an enterprise makes a distinction between current and non-current assets and liabilities in its financial statements, it is not classifying deferred tax assets (liabilities) as current assets or liabilities (see figure 3.2).
Recognizes differed tax liabilities gradually declining in future, in financial statements Armenian enterprises bringing tax expenses, differed tax actives, is making deductible expenses in future taxation process. When in financing and tax accounting incomes and expenses is been timing congruent, its not making differed tax actives and liabilities’.
t0 t1
REPORTING PERIOD
Income (IF) and expenses (EF) of
Financial Accounting
.
Income (IT) and expenses (ET) of
Tax Accounting
Figure 3.2 Timing harmonious incomes and expenses in
Financial and Tax Accounting framework
In Armenian enterprises accounting practice the differed tax liabilities taking place in cases, when:
- recognized income in financial accounting > recognized income in tax
accounting
IF >IT (figure 3.3)
- recognized expenses in financial accounting < recognized expenses in tax
accounting
EF < ET (figure 3.4)
t0 t1
REPORTING PERIOD (IF >IT)
Incomes recognized by
Financial Accounting
POST
REPORTING PERIOD
.
Differed Tax Incomes recognized by
Liabilities Tax Accounting
Figure 3.3 The timing process of presentation Differed Tax Liabilities in Financial Statement (when IF >IT)
In practice activity Armenian enterprises differed tax assets generally is occurred in two cases, when:
- recognized income in financial accounting > recognized income in tax
accounting
IF < IT (figure 3.5)
- recognized expenses in financial accounting > recognized expenses in tax
accounting
EF > ET (figure 3.6)
t0 t1
REPORTING PERIOD (EF < ET)
Expenses recognized by
Differed Tax Financial Accounting
Liabilities
POST REPORTING
PERIOD
.
Expenses recognized by
Tax Accounting
Figure 3.4 The timing process of presentation Differed Tax
Liabilities in Financial Statement (when EF < ET)
REPORTING PERIOD (IF < IT)
Incomes recognzed by
Differed Tax Financial Accounting
Assets
POST
REPORTING PERIOD
.
Incomes recognized by
Tax Accounting
Figure 3.5 The timing process of presentation Differed Tax
Assets in Financial Statement (when IF < IT)
t0 t1
REPORTING PERIOD (EF >ET)
Incomes recognized by
Financial Accounting
POST REPORTING
PERIOD
.
Differed Tax Expenses recognized by
Assets Tax Accounting
Figure 3.6 The timing process of presentation Differed Tax
Assets in Financial Statement (when EF >ET)
The more situations for differed tax assets formation in practice is related to depreciation accounting process, when Armenian Law of Profit Tax suggested only straight-line method, but simultaneously IAS 16 “Property, Plant and Equipment” offers variety of depreciation methods an asset on a systematic basis over its useful life. These methods besides of straight-line method include also diminishing balance method and the units of production method. Straight-line depreciation results in a constant charge over the useful life if the asset's residual value does not change. The diminishing balance method results in a decreasing charge over the useful life [3]. Consequently, using accelerating depreciating method is bringing temporary differences in tax expenses recognition and as a result in balance shit is presented as a differed tax assets.
For example, is purchased fixed assets by $ 3000, with 5 year useful life exploitation and $1000 per year returns. The profit tax percentage for all period of fixed asset operation is 20%. Consequently, by the and of assets exploitation period (5-th year) the enterprise will be have revenue $5000, proceeds profit $2000 and accordingly will get hold of tax obligation $400.
By the requirements of Armenian Profit Tax Law, based on Straight – Line method value of depreciation for all years of assets exploitation will be:
$3000 : 5 years = $600
According to enterprise accounting policy, accelerating approach of amortization will present depreciation value by each years of assets exploitation period such us:
1 + 2 + 3 + 4 + 5 = 15
I year 5/15 x 3000 = 1000
II year 4/15 x 3000 = 800
III year 3/15 x 3000 = 600
IV year 2/15 x 3000 = 400
V year 1/15 x 3000 = 200
In this case Tax Accounting will be recognize profit tax expenses as $80 constant value for all period asset operation (see table 3.1), but from another hand, in financial accounting tax expenses will be present by differed time attitude (see table 3.2), in consequence making differed tax assets.
Table 3.1
Profit Tax Formation in case of using Straight Line Depreciation method
Items Years
1 2 3 4 5 Total
Revenue 1 000 1 000 1 000 1 000 1 000 5 000
Expenses 600 600 600 600 600 3 000
Profit before tax 400 400 400 400 400 2 000
Profit Tax 80 80 80 80 80 400
Net Profit 320 320 320 320 320 1 600
Table 3.2
Profit Tax Formation in case of using Accelerating Depreciation
Items Years
1 2 3 4 5 Total
Revenue 1 000 1 000 1 000 1 000 1 000 5 000
Expenses 1 000 800 600 400 200 3 000
Profit before tax 0 200 400 600 800 2 000
Profit Tax 0 40 80 120 160 400
Net Profit 0 160 320 480 640 1 600
In Armenian companies arrangement of differed tax assets is presented by financial accounting according following transactions:
First year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
Kt Profit Tax Liabilities……………………80
Recognition of differed tax assets
Dt Differed Tax Assets………………..80
Kt Differed Tax Expenses…………………80
Profit Tax Expense presentation in Financial Statement =
Current tax Expanses + Differed Tax Expenses = 80 – 80
Second year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
Kt Profit Tax Liabilities……………………80
Recognition of differed tax assets
Dt Differed Tax Assets………………..40
Kt Differed Tax Expenses…………………40
Profit Tax Expense presentation in Financial Statement =
Current tax Expenses+Differed Tax Expenses = 80 - 40 = 40
Third year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
Kt Profit Tax Liabilities……………………80
Recognition of differed tax assets
Dt Differed Tax Assets………………..0
Kt Differed Tax Expenses…………………0
Profit Tax Expense presentation in Financial Statement = Current tax Expenses + Differed Tax Expenses = 80 - 0 = 80
Fourth year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
Kt Profit Tax Liabilities……………………80
Declining of differed tax assets
Dt Differed Tax Expenses…………………40
Kt Differed Tax Assets………………..40
Profit Tax Expense presentation in Financial Statement =
Current tax Expenses + Differed Tax Expenses =
= 80 + 40 = 120
Expenses recognized Revenues recognized
by Financial Accounting by Financial Accounting
Profit presentation
In Financial Statements’
Differed Tax
Adjustments
+ , -
Profit Recognition
through Tax Accounting
Figure 3.7 The mechanism of profit configuration.
Fifth year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
Kt Profit Tax Liabilities……………………80
Declining of differed tax assets
Dt Differed Tax Expenses…………………80
Kt Differed Tax Assets………………..80
Profit Tax Expense presentation in Financial Statement =
Current tax Expanses + Differed Tax Expenses = 80 + 80
Accordingly, in Armenian companies in order for transfor-ming from financial accounting into tax accounting profit in use adjustments processing, related to recognition and downgrading differed tax assets and liabilities (see figure 3.7).
Incidentally, IAS 12 describes recognition and measurement of deferred taxes using a temporary difference approach, similar to the method of FAS 109, Accounting for Income Taxes. Although there are significant differences in the treatment of tax basis, uncertain tax positions and recognition of deferred tax assets and liabilities, FASB and IASB working on the issue of differences. The IASB (International Accounting Standards Board) issued an Exposure Draft of an IFRS to replace IAS 12 Income Taxes with the intention of eliminating many of the differences between the IFRS and FASB standards.
Tax Accounting US-RA Comparative Interpretation making conclusion, that there are several differences between IFRS and GAAP relating to accounting for and reporting of income taxes.
Firstly, the tax rate used for measuring deferred taxes under GAAP is the enacted tax rate in place when the timing difference is expected to reverse, whereas under IFRS, the substantially enacted tax rate is used. Secondly, under GAAP, the classification of the deferred tax asset or liability is either short-term or long-term depending on the underlying relationship of the timing difference. Under IFRS, deferred tax assets and liabilities are always recorded as long-term.
3.3 Accounting of Payroll Liabilities
Payroll taxes are taxes imposed on employers or employees, and are usually calculated as a percentage of the salaries that employers pay their staff. Payroll taxes generally fall into two categories: deductions from an employee’s wages, and taxes paid by the employer based on the employee's wages. The first kind are taxes that employers are required to withhold from employees' wages, also known as withholding tax, pay-as-you-earn tax (PAYE), or pay-as-you-go tax (PAYG) and often covering advance payment of income tax, social security contributions, and various insurances (e.g., unemployment and disability). The second kind is a tax that is paid from the employer's own funds and that is directly related to employing a worker. These can consist of fixed charges or be proportionally linked to an employee's pay. The charges paid by the employer usually cover the employer's funding of the social security system, and other insurance programs. The economic burden of the payroll tax falls on the worker, regardless of whether the tax is remitted by the employer or the employee, as the employers’ share of payroll taxes is passed on to employees in the form of lower wages than would otherwise be paid.
In the United States, payroll taxes are assessed by the federal government, all fifty states, the District of Columbia, and numerous cities. These taxes are imposed on employers and employees and on various compensation bases and are collected and paid to the taxing jurisdiction by the employers. Most jurisdictions imposing payroll taxes require reporting quarterly and annually in most cases, and electronic reporting is generally required for all but small employers
Income tax withholding
Federal, state, and local withholding taxes are required in those jurisdictions imposing an income tax. Employers having contact with the jurisdiction must withhold the tax from wages paid to their employees in those jurisdictions. Computation of the amount of tax to withhold is performed by the employer based on representations by the employee regarding his/her tax status on IRS Form W-4.
Amounts of income tax so withheld must be paid to the taxing jurisdiction, and are available as refundable tax credits to the employees. Income taxes withheld from payroll are not final taxes, merely prepayments. Employees must still file income tax returns and self assess tax, claiming amounts withheld as payments.
Social Security and Medicare taxes
Federal social insurance taxes are imposed on employers[and employees, ordinarily consisting of a tax of 6.2% of wages up to an annual wage maximum ($110,100 in 2013) for Social Security and a tax of 1.45% of all wages for Medicare. To the extent an employee's portion of the 6.2% tax exceeded the maximum by reason of multiple employers, the employee is entitled to a refundable tax credit upon filing an income tax return for the year.
Unemployment taxes
Employers are subject to unemployment taxes by the federal and all state governments. The tax is a percentage of taxable wages with a cap. The tax rate and cap vary by jurisdiction and by employer's industry and experience rating. Some states also impose unemployment, disability insurance, or similar taxes on employees.
Reporting and payment
Employers must report payroll taxes to the appropriate taxing jurisdiction in the manner each jurisdiction provides. Quarterly reporting of aggregate income tax withholding and Social Security taxes is required in most jurisdictions. Employers must file reports of aggregate unemployment tax quarterly and annually with each applicable state, and annually at the Federal level.
Each employer is required to provide each employee an annual report on IRS Form W-2 of wages paid and Federal, state and local taxes withheld, with a copy must to the IRS and many states. These are due by January 31 and February 28 (March 31 if filed electronically), respectively, following the calendar year in which wages are paid. The Form W-2 constitutes proof of payment of tax for the employee.
Employers are required to pay payroll taxes to the taxing jurisdiction under varying rules, in many cases within one banking day. Payment of Federal and many state payroll taxes is required to be made by electronic funds transfer if certain dollar thresholds are met, or by deposit with a bank for the benefit of the taxing jurisdiction.
Income tax withheld on wages is based on the amount of wages less an amount for declared withholding allowances (often called exemptions). Amounts of tax withheld are determined by the employer. Tax rates and withholding tables apply separately at the federal, most state, and some local levels. The amount to be withheld is based on both the amount wages paid on any paycheck and the period covered by the paycheck. Federal and some state withholding amounts are at graduated rates, so higher wages have higher withholding percentages. Withheld income taxes are treated by employees as a payment on account of tax due for the year, which is determined on the annual income tax return filed after the end of the year (federal Form 1040 series, and appropriate state forms). Withholdings in excess of tax so determined are refunded.
Employees must provide their employer with a Federal Form W-4. Many states require a similar form. The form provides the employer with a Social Security number. Also, on the form employees declare the number of withholding allowances they believe they are entitled to. Allowances are generally based on the number of personal exemptions plus an amount for itemized deductions, losses, or credits. Employers are entitled to rely on employee declarations on Form W-4 unless they know they are wrong.
Payroll taxes are the state and federal taxes that you, as an employer, are required to withhold and/or to pay on behalf of your employees. You are required to withhold state and federal income taxes as well as social security and Medicare taxes from your employees' wages. You are also required to pay a matching amount of social security and Medicare taxes for your employees and to pay State and Federal unemployment tax.
Have each new employee complete IRS form W-4. You will use this form to calculate the amount of federal income tax to withhold from the employee's wages. Most of the states have income tax structures that are based on the federal system, so you will use the W-4 to calculate the amount of state income tax to withhold as well.
The employer also must pay State and Federal Unemployment Taxes (SUTA and FUTA). The FUTA rate is 6.2 %, but you can take a credit of up to 5.4% for SUTA taxes that you pay. If you are eligible for the maximum credit your FUTA rate will be 0.8%. The wage base for FUTA is $7,000. You will stop paying FUTA for each employee once his or her wages exceed $7,000 for the year. You will need to check with your state about SUTA tax rates and the wage base. Generally, your SUTA tax rate is based on the amount of unemployment claims that are filed by employees that you have terminated. When your business is new, your SUTA tax rate starts at the maximum and declines if you build a history of few claims.
3.4 Withholding of Tax
Withholding of Federal Taxes
Many companies, are very labor-intensive. Payroll liabilities make up a significant portion of current liabilities for companies. Here, we will look at how payroll is calculated for both the employee and employer.
Lets assume, that company hired worker at $60 000 annual with salary payments of $5 000 per mount. Before worker make any spending plans, thought, he need to realize, that his payroll check will be much less, than $5 000 a month. Before deposing monthly payroll check in workers bank account, the employer will “withhold” amounts for (1) federal and state income taxes; (2) Social Security and Medicare, (3) health, dental, disability, and life insurance premiums, and (4) employee investments to retirement or saving plans. Realistically, then $ 5 000 monthly salary translates to less than $4000 in actual take home-pay.
Now assume, that you are employer. You hire an employee at starting annual salary of $60 000. Your cost for this employee will be much more than $5 000 per month. Besides the $5 000 monthly salary, you will incur significant costs for (1) federal and state unemployment taxes, (2) the employer portion of Social Security and Medicare, (3) employer contribution for health, dental, disability and life insurance, and (4) employer contributions to retirement and saving plans. With this additional costs, a $ 5 000 monthly salary could very easily create total costs in this additional costs of $ 6 000 per month. The table 3.3 summarizes payroll items for employer and employees.
Table 3.3
Employee Payroll Employer Payroll
Federal and state income
taxes Federal and state unemployment taxes
Employee portion of Social Security and Medicare Employer portion of Social Security and Medicare
Employee contributions for health, dental, disability and life insurance Employer contributions for health, dental, disability and life insurance
Employee investment in re¬tir¬e-ment or saving plans Employer contribution to re¬tir¬e-ment or saving plans
Additional, employee benefits paid for by the employer are referred to as fringe benefits. Employers often pay all or part. Employ often pay all or part of employees insurance premiums and make contributions to retirement or saving plans. Many companies provides additional fringe benefits specific to the company or industry. For instance, an important additional fringe benefit in the airline industry is the ability for the employee and family to fly with thicket discounts or free.
To understand, how employee and employer payroll costs are recorded, assume, that your company has a total payroll for the month of April of $100 000 for its 20 employees. Its withholdings and payroll taxes will be:
Federal and state income tax withhold ………………..$24 000
Health insurance premiums paid by employee………. $5 000
Contribution to retirement plan paid by employer……... $10 000
FICA tax rate (Social Security and Medicare)…………..7.65%
Federal and state unemployment tax rate………………..6.2%
The company records the employer salary expense, withholdings and salaries payable on 31 April as follows:
Dt Salaries Expense………………………………….. 100 000
Kt Income tax payable…………………………….. 24 000
Kt FICA tax payable (=7.65% x $100 000)………... 7 650
Kt Salaries payable (to balance) ………………..… 68 350
The company records its employer-provided fringe benefits as follows:
Dt Fringe expenses……………………………….……. 15 000
Kt Account payable (to insurance company)………….. 5 000
Kt Accounts payable (to funding institutions)…..…… 10 000
The company pays employers FICA taxes at the same rate that the employees pay (7.65%) and also pays unemployment taxes at the rate of 6.2%. The company records its employers payroll taxes as follows:
Dt Payroll tax Expense ……………………………. 13 850
Kt FICA tax payable (=0.0765 x $100 000) …………. 7 650
Kt Unemployment tax payable…(=0.062 x $100 000)… 60200
The company incurred an additional $28 850 in expenses ($15 000 for fringe benefits plus $13 850 for employer payroll taxes) beyond the $100 000 salary expense. Also notice, that FICA tax payable in the employee withholding is the same amount recorded for payroll tax. That’s because the employee pays 7.65% and the employer matches this amount with an additional 7.65%.The amounts withheld are then transferred at regular intervals, monthly or quarterly, to their designated receptions. Income taxes, FICA taxes and unemployment taxes are transferred to various government agenesis and fringe benefits are paid to the companies contractual suppliers.
Withholding Income Tax by the Tax Agent in Armenia
The income tax shall be withheld (levied) by the tax agent. Where organizations implementing projects under treaties signed and ratified on behalf of the Republic of Armenia are exempt from withholding income tax on incomes paid to individuals at the source of incomes, these organizations may, at their own discretion, act as tax agents on the basis of the declaration filed with the tax office, and perform withholding of tax on personal taxable income. In this case the tax agent shall withhold tax starting from the month of filing the declaration.
The tax agent shall not withhold (levy) any taxes if:
1) The paid incomes result from business activity (delivery of goods, performance of works and delivery of services), and a written civil-legal agreement has been signed with the tax agent and the Taxpayer Identification Number (TIN), passport details and residence address in the Republic of Armenia and number of state business registration certificate of the taxpayer are indicated therein, or
2) The incomes are payable to the notary.
Each month the tax agents shall calculate the income tax at the rates along with deducting the amounts of benefits defined by the Law of the Republic of Armenia “On Temporary Incapacity Benefits”, as well as the funeral benefit payable in case of death of a hired employee. Furthermore, benefits defined in this Clause are considered as deducted starting the 20th day of the next month after the deduction is performed.
On a monthly basis, by the 20th day of the next month, tax agents must submit exclusively electronically to the tax office a summary income tax return in the defined format which shall contain the following:
1) personal data (first and last names, patronymic, residence (registration) address, social security card number) of the natural person receiving income from the given tax agent (except for those receiving only passive incomes), incomes calculated for these individuals, income tax withholdings, and for persons participating in the fully-funded pension system, also calculated and withheld fully-funded pension contributions, as well as other information identified in Article 7 of the Law “On Personified Record Keeping on Income Tax and Funded Contributions”;
2) Brief information from the given tax agent about passive income calculated by the tax agent exclusively for the natural persons gaining passive incomes and the income tax withheld from these incomes,
3. In cases when no income tax withholdings are made (levied) at the source for incomes in compliance with the provisions of this Law and the Agreements concluded and ratified on behalf of the Republic of Armenia subject to be received by natural person not considered as an individual entrepreneur or a notary, then the natural person not considered as an individual entrepreneur or a notary shall calculate the income tax on monthly basis, which is reflected in the annual income statement submitted to the tax authority in the manner and timelines. If tax agents independently discover any errors in income tax reports for previous reporting periods, then they may submit exclusively electronically the adjusted reports to the tax authorities based on which the tax liabilities for these periods shall be recalculated.
The income tax calculated be paid to the state budget no later than on the 20th day of the next month after assessing the incomes of natural persons. Income tax on other income received from legal entities is normally withheld at the source. The individual receiving the income from other sources than Armenian legal entities shall declare it to the tax authorities and shall pay the tax him/herself. Amounts withheld (imposed) by a tax agent shall be considered as the final amount of the income tax for foreign citizens and persons without citizenship in Armenia, with the exception of the cases when such person is a resident or he/she implements entrepreneurial activity in the Republic of Armenia. In the mentioned cases, foreign citizens and persons without citizenship must apply to the tax authorities of the location of their activity or domicile, in order to perform a recalculation and submit Annual Income Calculation
Resolution N 1410-N of Government RA 2011 October 06
Individual Income Tax Return Statement
Part I Number of document registration (fill out by IRS)____________________
Document entry date (fill out by IRS)___________________
Individual number of taxpayer Statement Period Taxpayer account number
Social Security Number
Firs, middle and last name of taxpayer Taxpayer Permanent Address
Taxpayer Temporary Address Work telephone Home telephone
Business activity location License number ID number
Passport number Issued Date
Duration residential time during statement period Date of birth
Part II. Salary, revenue from individual employment contracts
Revenue from individual employment contracts [1]
Expenses from individual employment contracts [2]
Salary and sufficient payments [3]
Another deduction [4]
Tax Base from individual employment contracts [5]
An Additional Incomes Income
Sum [6] Rate[7] Income tax [8]
Royalty [9]
Dividends [10]
Leasing incomes [11]
Capital Gain [12]
Total [13]
Part III Business Activities Incomes
Business Activities Incomes [14]
Business Activities Expenses [15]
Tax loses from pervious period [16]
Tax Base from Business Activities [17]
Part IV Calculation of Annual Income Tax
Individual employment contracts [25]
Business Activities [26]
Accrud Social Security Payments [27]
Income receiving months [28]
Individual Total Deducti ons [29]
Taxable Income [30]
Charity contributions [31]
Annual Taxable Income [32]
Tax from Annual Taxable Income [33]
Income Tax for Statement Period [34]
Minimum Income Tax [35]
Gross Income Tax Liabilities [36]
Non Offsetting Tax Liabilities [37]
Withholding Income Tax from Employer [38]
Withholding Income Taxes in Abroad [39]
The offsetting portion of Withholding Income Taxes in Abroad [40]
Tax concession [41]
Total of deductible annual income tax [42]
Income tax return [43]
Taxpayer Signature
Appendix 2
Juguryan G. Armen
Khachatryan N. Nonna
PERSONAL INCOME TAX ACCOUNTING
Джугурян Армен Геворкович
Хачатрян Нонна Николаевна
УЧЕТ ПОДОХОДНОГО НАЛОГА
(сравнительный анализ между США и РА)
Ճուղուրյան Արմեն Գևորգի
Խաչատրյան Նոննա Նիկոլայի
ԵԿԱՄՏԱՅԻՆ ՀԱՐԿԻ ՀԱՇՎԱՌՈՒՄԸ
(ԱՄՆ – ՀՀ համեմատական վերլուծություն)
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