Concepts of Income - Assignment Example

TITLE: HI5028 TAXATION STUDENT NAME: LECTURER: SUBMISSION DATE: Part 1: Concepts of Income a) Is it possible for an employer to provide regular payment to a former employee, can it be on the basis of compensation for a lower salary income or is it treated as a gift? Are there any tax considerations to both parties? Job cessation can occur due to several reasons including retrenchment, retirement, death or resignation. There are circumstances under which the employer may continue making regular payments to the employee even after they have ceased working for them. When an employee dies, their spouses or family members are usually paid some amount as a gift for the service of the deceased or as compensation for the same. These payments are only done for the period preceding the employees demise and are stopped when the firm deems fit. The family of the deceased has to claim any remittances that were pending to the deceased. In the case of retrenchment, the employee has to fill a form to claim the monies not paid to them for the time they worked in a firm (Hewett, 1925). The employee is often given a lump sum amount to help them push through until they get another job. If the retrenchment was forced, the employee is given a less amount that those go on voluntary retirement that get a ‘golden handshake’. A resigning employee has to give a notice to his employer so that his replacement is sourced. They also have to fill a form claiming their monetary remittances. In the case of retirement, an employee is entitled to their pension. This they receive every month and is deducted from their retirement savings. According to most states in the US, the monies due to an employee ought to be paid within the next seven days after termination of work or in the next regular payday, whichever comes first (Payment upon termination, 2013). Other than these situations, regular payments to former employees can also happen if prior arrangements between the employer and the employee are made. In some situations, if for instance an employee is unable to work again as a result of an incident that happened at work, their employer has to compensate them in order for them to be able to sustain themselves. This may be out of sympathy or as a result of a court injunction forcing the employer to pay their former employee his wages. If an employee’s idea has brought revolutionary change to the way a firm is run, the employer may decide to give regular payments even after their jobs cease at the firm maybe because their ideas are patented and so that they do not sell their ideas to other people. According to the United States Code on government organization and employees, an employer may give regular payments to their employees amounting to $7353 (Legal Information Institute, n.d). Whether a company decides to gift a former employee or compensate them, it has to do so according to state laws. These vary in every state based on their legislations. A company also has to make prior arrangements and there has to be an understanding between the former employee and their former employer. There also has to be a justification for the regular payments made to the employee. According to Pincus (1995), a firm has to make regular remittances to its employees for the sake of maintaining its status. The payments made to employees are supposed to be fair and rewarding for the amount of work they do. They ought to be taxed based on the amount of pay they receive as well as their job descriptions. Payments made to employees require that the employer fills a cessation certificate that would show that all the taxes and revenues are paid by the employee and that their records are in check. b) Explain what constitutes a business for taxation purposes so that income derived by the taxpayer must be assessed for income tax. The growth of a business is essential for the business owner and for the government. this growth can be noted through increase in sales value and volumes, more human resource employments, production of a wider range of products and services, and beginning of exportation of the same. The growth of a business provides many advantages including reduction of average costs and increasing profitability by producing and selling on a larger scale; motivation to owners to increase their efforts; and increased ability to raise finances for expansion more easily. The growth of a business is vital because it stimulates the growth of the economy of the country by contributing towards taxes by creating jobs. These taxes help to finance the expenditure of the government. A business engages with the tax system as soon as it starts up. Different forms of taxes are paid by different businesses. Sole traders and partners pay income tax based on the returns made from the business. Employing staff members to work for a firm will entail deduction of Pay As You Earn (Income tax) and National Insurance payments from their from their wages. The business has to keep records of what it pays its employees including wages, payments and benefits. Business owners deduct Income tax and Class 1 National Insurance contributions from their employees’ pay and declare them to the Inland Revenue. The employer also pays Class 1 employers’ National Insurance contributions (Schanz and Schanz, 2011). The amount of income that is taxable is derived from the financial statement of a company. It is defined as net income before income taxes as per the financial statements prepared under locally accepted principles of accounting. According to United states system, it comprises all gross income; sales as well as other income minus cost of goods sold and tax exempt income; with a reduction of acceptable tax deductions applicable to businesses (Bittker and Eustice, 2000). Small businesses have thus to register for VAT and Income tax whereas companies have to register for corporate taxation and this can be done by seeking information from the Inland Revenue/Customs department in a country. A business is often required to select a method of tax payment either through direct debit or through a regular installment payment system. The business also has to have proper documentation. It has to maintain its record system and update the records regularly. All records have to be kept for five to six years from the latest date for sending back a tax return. Small businesses; whose returns are lower than £150,000 per year; pay VAT as a set percentage of their total turnover rather than paying for every transaction made at a standard rate as for larger businesses. These businesses can wait to pay their taxes as annual returns rather than on quarterly basis and they can wait to be paid by their customers before filling returns to Customs and Excise (Businesses and taxation, n.d). The Inland Revenue System communicates through various means to business owners on the various ways of filling their tax returns. This can be done through face to face meetings, via telephone, via postal service, or via radio or television. Most businesses however prefer to fill their tax forms online. Faster communication enables equally fast tax collection. This enables faster remittance of taxes and provides an easy platform for people to access the tax forms. The communications also act as a way of giving the employees and the employer the various types of tax deductions expected of them as well as the modes of paying them (Cushway, 2005). Part 2: Deductions a) What is your view on compulsory business expenses and their deductibility under s8-1 ITAA97 where they are incurred after the business ceases to operate? How does this compare to expenses such as legal fees? According to the Income Tax Assessment Act 1997on general deductions, it is possible to deduct any loss or outgoing from your assessable income as long as they are incurred in gaining or producing thee assessable income or as long as it is necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income. A division, 35, in this subsection prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income. The exemptions to deducting a loss or outgoing include the deduction being a loss or outgoing of capital or of a capital nature; it is a loss or outgoing of a private or domestic nature; it is incurred in relation to gaining or producing your exempt income or non assessable non exempt income; or a provision of the Act prevent you from deducing it. In this case, the deductions are being made from a business that had ceased operating. The law does not prohibit it as it does not mention in its subsections the cessation of a business exempting someone from deductions. It has to be noted that for the success of any business the law has to take precedence. The other subsection highlights that a loss or outgoing that can be deducted under it is general deduction. This is to say that if one receives an amount as insurance, indemnity or other recoupment of a loss or outgoing that can be deducted in this section, it will be included in one’s assessable income (Cushway, 2005). It should be noted that the business has ceased to operate and may thus be considered as a loss that one needs to recover from. On that basis, one may qualify for deductions. As long as the deductions made are within the pretext of the law, it is logical to get it. Violating an Act may result in a legal penalty that may take a lot of time and resources to resolve. One thus has to be sure they are not violating any laws when making deductions (Income Tax Assessment Act, 1997). In relation to how deductions compare to legal fees, the law is not specific in mentioning if legal fees are deductible or not. For legal fees to be deductible as a trade or business expense, it has to be incurred in carrying on a trade or business, has to be ordinary and necessary besides being of reasonable amount, has to be paid or incurred during the taxable year in which the taxpayer seeks to deduct them and also has to be paid by the person to whom the services are rendered. Since this business in question was ceased, it will be difficult to prove that the person applying for the deductions has a business. This is because one has to prove that they are in business by showing that they devote a portion of their time to the business (Devereux, 2009). The fact that the business has ceased will also make it difficult to prove that the legal fees entitled to it is ordinary and necessary. To add on to that, it will even be harder to come up with a reasonable amount to be deducted from the taxes. This challenge will also make it difficult to pay back the fees since that has to be done during the taxable year for which the deductions are applied. However, if the applicant shows proof that they can meet all the requirements of deductible trade or business expenses, they can qualify for the deductions based on the clause on deductible non-business legal and other professional expenses. They may also apply for the deductions in connection with the determination, collection or refund of any tax for that taxable year. This may be used for future transactions as that is deductible (Legal Fees- When Are They Deductible, n.d). b) Explain the difference between capital improvements compared to Repairs and Maintenance, giving consideration to a taxpayer who owns a rental property. Capitalization refers to the proper treatment for expenses incurred in new construction. It is also required for new additions to existing buildings or for installation of material components to buildings or equipment. Capital expenditure includes amounts paid or incurred to add to the value or substantially prolong the useful life of the property owned by the taxpayer. It also reflects payments made to adapt the property to new or contrasting use. Amounts remunerated or incurred for subsidiary preservation or property maintenance are not capital expenditures. Capital improvements put property in a better operating condition, restores the property to ‘like new’ condition, involve addition of new or replacement components or subcomponents to property, involve addition of upgrades or modifications to property, extends the useful life of property, improves the efficiency and quality of property, increases the strength and capacity of the property, ameliorates a material condition or defect, adapts the property to a new use and provides a plan of rehabilitation doctrine. In comparison, repair and maintenance keep the property in efficient working circumstance, refurbish the assets to its preceding state, protects the underlying property through routine maintenance and involve incidental repairs to property. For specific deductions, the Income Assessment Act highlights that no deductions are allowed for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of an estate (IRS, 2012). According to IRS, 2010, Section 162 provides a deduction for all ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. Treas. Reg. § 1.162-4 provides that the cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted. However, this regulation also provides that repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the useful life of the property, shall either be capitalized and depreciated in accordance with § 167 or charged against the depreciation reserve. New additions that are newly installed components ought to be capitalized since they are not replacement components neither are they repairs to property. The taxpayer has to capitalize the average of related amounts paid to improve a property unit. A property unit is improved if the amounts paid for activities done after placing the property in service result in betterment of property unit, restoration of the unit or adaptation of the unit to a new and different use. The accounting policy of a taxpayer does not have to comply with the proposed regulations as long as the taxpayer can demonstrate that their income is demonstrated by their accounting policy. If a taxpayer decides to view the entire complex as a unit of property, their depreciation deductions in the initial years immediately after the purchase of the property will be less than they would have been had they allocated a section of the purchase price to the acquisition of tangible property (Skarbnik and West, 2009). The rental property owned by this taxpayer is under the capital improvements and will have deductions made as such if there are no repairs or maintenances done to the property. Those who will lease the assets will in addition pay tax deductions same to the property owner. This is because during occupation they made make modification or add equipment to the building that may increase the value of the property. In that case the additions made to the property have to be capitalized so that the building is viewed as new rather than renovated (Hume, 1995). References. Bittker, B. I. & Eustice, J.S. (2000). Federal Income Taxation of Corporations and Shareholders. Upper Saddle River, NJ: Warren Gorham & Lamont. Businesses and taxation.( 2013) The Times 100: Business Case studies. Available at: (Accessed 6 December 2013). Income Tax Assessment Act. (1997). Australian Government, Australian Taxation Office: Legal Database. Available at: (Accessed 5 December 2013). IRS. (2010). Capitalization v Repairs Audit Technique Guide. Available at: (Accessed 4 December 2013). IRS. (2012). Internal Revenue Bulletin: 2012-2014, Guidance Regarding Deduction and Capitalization of Expenditures Related to Tangible Property. Available at: (Accessed 5 December 2013). Legal Fees- When Are They Deductible. (n.d). Feeley & Driscoll, P.C. Available at: (Accessed 4 December 2013). Legal Information Institute. (n.d). 5CFR 2635.503- Extraordinary payments from former employers. Available at (Accessed 3 December 2013). Payment upon Termination. (2013). Available at: (Accessed 2 December 2013). Skarbnik, H & West, Ron. (2009). “To Capitalize or Not to Capitalize: That May Be a Difficult Question”. Taxes- The Tax Magazine. Available at: (Accessed 2 December 2013). Hewett, W. W. (1925). “The Concept of Income in Federal Taxation”. Journal of Political economy 33.2: 155. Print. Schanz, D. and Schanz, S. (2011). Business taxation and financial decisions. Heidelberg: Springer, Print. Devereux, M.P. (2009). Business Taxation In A Globalized World. Oxford Review of Economic Policy 24.4: 625-638. Pincus, K. (1995). Core Concepts of Accounting Information. New York, NY: McGraw Hill Inc. Cushway, B. (2005). Employer’s Handbook an Essential Guide to Employment Law, Personnel Policies and Procedures, 3rd Ed. London: Kogan Page. Print Hume, D. (1995). Reward Management: employee performance, motivation and pay. Oxford, UK: Blackwell Publishers. Print Read More