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Recent Case Study On Income Tax

Who do taxes hurt and who do they help?

Come tax time, everyone's feeling the pinch, but let's take a look at three case studies to see how IRS rules can actually affect tax payers.

Victim #1: Frank Frugale, The Lower Income Earner

Frank started in the working world earning $36,000 per year at a non-profit. He makes $1,500/month before taxes, but his employer needs to withhold money for Medicare and Social security—about 7.65%, plus about $135 for federal income taxes—leaving Frank to live on about $1,250.25 each month.

We hope he has roommates.

Frank is comparatively lucky: he lives in a state that doesn't charge income tax. If he did, he'd have even more carved out of his tiny paycheck.

By age 40, let's say that Frank is still single (online dating has been unkind to him), but he's poured his love-sick heart into work, so now he's earning $54,000 dollars/year. After taxes, he gets two paychecks of $1,766.16 each month.

He may not be lucky in love, but he is smart in money: Frank has opened up an IRA and contributes about $4,000 a year. He's saving cash for his retirement, and since the IRA contributions are tax deductible, he's only being taxed for $50,000 rather than $54,000, so he's saving about $42 in taxes every payday. That's about $1,000 less he's paying each year. Aw yeah, stickin' it to the man.

By 65, Frank is living in a little apartment and is still single except for his goldfish named Frankenstein. Since he's worked all his life, he collects social security, thanks to all those payments he's made. He can also take out up to $25,000 per year on his IRA without being taxed on that income. A lifetime of not earning a ton has made him enjoy the little things and his goldfish has a small appetite, so he can stretch his pennies.

Victim #2: Marketing Mike

Mike is 25 and he's still in school, getting a professional degree after staying undeclared and hitting up one too many parties in his first go through college. He doesn't mind, though, because he has his sights set on a good job at a PR firm.

He's working part time at a web design company. He only makes $5,000 per year, but that doesn't mean he doesn't pay taxes. Since he freelances for the company, nothing is held out of his paycheck and he still has to file taxes.

By 40, Mike is making $100,000 a year after working his way up the ladder at the PR firm and catering to celebrities with big egos. At his last college party, Mike met Donna. They're now married with two kids, and Donna is adding $50,000 to the household from her job.

Mike and Donna file taxes jointly, and for each child, they get to deduct $3,500. They also get deductions on their house and IRA contributions. Together, they lower the amount of income they can get taxed on by about $25,000, saving about $8,000 on taxes.

The house is proving a bit of a liability, though. Mike fell from the roof trying to fix a leak, and he lives in a state that charges property taxes. The house is worth $360,000, and the property tax in the state is 0.82%, which means Mike and Donna have to find about $3,000 to pay for those taxes.

To even buy the house, Mike had to sell the stocks he had bought during his 20s with his first paycheck. The stock in Acme Company doubled in value from $1,000 to $2,000, but when Mike sells, he has to pay taxes on the gains. Capital gains taxes are 15% when Mike sold those stocks, so he'll have to pay $150 from his $2,000 ($1,000 x 0.15).

By 65, Mike still has all his hair. Equally lucky, he's still married to Donna, and they've been saving for retirement from the start, so they have $50,000 together from their IRAs and social security now that they're getting grey and want to stop work. They don't pay taxes on social security, but any withdrawals over $25,000 on those IRAs are taxed, just as they would be if Donna and Mike were working. Donna and Mike are paying about $4,000 on those IRA withdrawals, which is pricey.

Victim #3: Richard, the Entrepreneur

Richard knew he was going to go into business ever since third grade, when he charged $5 for kids who wanted to come to his birthday parties. He wasn't the most popular kid, but he could always afford candy (and birthday cakes shaped like Monopoly money). By 25, Richard had fast-tracked through business school and was hired to work in Silicon Valley for $175,000/year.

Richard could have spent money on a condo, fancy clothes, and a Bugatti. But he kind of loved his rusty Honda and always wore sneakers and jeans to fit in with the tech crowd. A lot of his money went into a savings account. Since he's earning a lot, though, he's taking a big hit from the IRS. He's paying about $9,000 for FICA taxes (Social Security taxes) and about $25,700 in income taxes. It might not be lonely at the top, but it's expensive.

By 30, Richard decides to show those guys in Silicon Valley a thing or two and starts his own business. He makes extra-important gadgets for tech guys (we have no idea what the gadgets do because it was all explained by an engineer).

By 40, the business is making $1 million in profits a year and Richard wants to take some of that money out of the company because he just got engaged. He's got a big Star Wars-themed wedding to plan (because he's very comfortable with tech stereotypes) and a house to buy.

Richard's business is a corporation (his lawyer recommended that, and so did his accountant) and that means he has to pay corporate tax. Profits of $1 million a year make the IRS very happy because it puts the company into the highest federal corporate tax bracket (35%). On top of that, Richard's company has to pay state corporate taxes. Together, those eat up $400,000.

To pay for his house and wedding, Richard decides to take out the $600,000 that's left after paying his taxes. Since his company is a corporation and he's the only owner, he can pay the money to himself as a dividend. If his company was public and he had lots of investors, he'd have to spread the wealth around.

The $600,000 dividend is taxed like regular income, and on income that high, Richard is paying $180,000 in federal income taxes plus state income taxes. Richard is rich, but…ouch.

By 65, Richard has decided he has had enough of the cutthroat world of business. He becomes a university professor, teaching students how to launch their own hugely successful gadget companies. The university pays him $125,000 per year and he works much shorter hours than he ever did, so it's a good deal. He now has time to stop and smell the roses (literally—he put in rose bushes in his garden last year).

Last year, Richard decided to sell his business. After all taxes were paid, Richard got $10 million for the company he spent years building. Not bad. After that time in his 40s when the government dinged him, Richard wanted to be smarter about taxes. He invested the $10 million in municipal bonds, which are sold by his state.

Here's the exciting part: Interest on municipal bonds in his state is free of taxes both from the federal and state government. The bonds pay 5% interest and are very stable, which means that Richard gets $500,000 each year without paying a cent in taxes. Take that, IRS. Sure, he has to pay taxes on the $125,000 he gets from the university, but that's peanuts to the money he's hauling in.

Bottom line: everyone pays the piper (er, IRS) in one way or another.

  • 2018 (3) TMI 540 - ITAT PUNE

    Capgemini Technology Services India Limited, Versus The Dy. Commissioner of Income Tax, And Vice-Versa

    Adjustment made in the transfer pricing order u/s 92CA(3) - Adjustment made under the transfer pricing provision on account of interest on delayed recoveries of debtors balances from Associated Enterprises (AEs) - Held that - Similar issue of charging of interest on delayed recoveries of debtors from AEs arose before the Tribunal in assessee s own case for assessment years 2005-06 to 2009-10 2016 (6) TMI 1286 - ITAT PUNE as held that the transact....... + More

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    The Principal Commissioner of Income Tax-2 Versus ICICI Bank Ltd.

    Validity of reopening of assessment - eligible reasons to believe - proof of change of opinion - Held that - The basis of the reopening notice is that the amount of ₹ 97.74 lakhs had remained to be disallowed in the regular proceedings leading to assessment order dated 25th February, 2005 as the expenses were not routed through profit and loss account. This basis is incorrect as the assessment order dated 25th February, 2005 under Section 1....... + More

  • 2018 (3) TMI 536 - BOMBAY HIGH COURT

    The Principal Commissioner of Income Tax-5 Pune Versus M/s. Amphenol Interconnect India P. Ltd.

    Determine the ALP of the export sales to AEs - considering TNMM and MAM - manufacturing of electric connectors, accessories, cable assemblies and system integration - Held that - We find that the TPO has while stating that FAR analysis has to be carried out, does not indicate that it was carried out. Tribunal in the impugned order has done the necessary FAR analysis. As compared the risk and functional differences involved in finished goods being....... + More

  • 2018 (3) TMI 535 - BOMBAY HIGH COURT

    The Pr. Commissioner of Income-Tax-4, Mumbai Versus M/s. Vensimal Securities Ltd.

    Penalty u/s 271(1)(c) - addition on account of bad debts - Held that - We set aside the impugned order of the Tribunal dated 2nd September, 2014 and restore the issue to the Tribunal for fresh consideration keeping in view the decision of our Court in M/s. Shree Gopal Housing & Plantation Corporation (2018 (2) TMI 604 - BOMBAY HIGH COURT) and also considering the respondent-assessee s submission that no penalty is imposable under Section 271(....... + More

  • 2018 (3) TMI 534 - BOMBAY HIGH COURT

    ALD Automotive Pvt. Ltd., Versus Deputy Commissioner of Income Tax-15 (1) & Another

    Disallowance of returned loss holding that the assessee s business has not been set up - grievance of the Appellant is that the business has been set up as it evident from the fact that the Appellant had purchased two vehicles and also taken office on hire - Held that - In the present facts, the purchase of two cars was preparatory to setting up of business. However, in the absence of necessary permission for operating license as required from th....... + More

  • 2018 (3) TMI 533 - BOMBAY HIGH COURT

    Pr. Commissioner of Income Tax Versus Auro Gold Jewellery Pvt. Ltd

    Condonation of delay - reason for delay - Held that - We find that on 14th January, 2016 when the impugned order of the Prothonotary & Senior Master was passed, the appellant was represented by the Managing Clerk and its Advocate. The Affidavit-insupport seeking condonation of delay is bereft of any particulars. The Affidavit also does not mention the date when the deponent, Assessing Officer learnt about the dismissal of the Appeals. There i....... + More

  • 2018 (3) TMI 532 - BOMBAY HIGH COURT

    Pr. Commissioner of Income Tax, Central-3 Versus Amritlal Jain

    Condonation of 632 days delay - rejection of the Appeal for non-removal of office objections - Held that - We have perused the Affidavit-in-support of the Notice of Motion. It does not indicate the date when the applicant came to know about the rejection of the Appeal for non-removal of office objections. The Affidavit-insupport is bereft of any particulars. It is most casual and even the date when the deponent came to know of the rejection of th....... + More

  • 2018 (3) TMI 531 - BOMBAY HIGH COURT

    Commissioner of Income-Tax (Exemptions) , Pune Versus Lata Mangeshkar Medical Foundation

    Condonation of delay - period of limitation provided - Held that - It is for the general benefit of the entire community so as to ensure that stale and old matters are not agitated and the party who is aggrieved by an order can expeditiously move higher forum to challenge the same, if he is aggrieved by it. As observed by the Apex Court in many cases, the law assist those who are vigilant and not those who sleep over their rights as found in the ....... + More

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    Vodafone M-Pesa Limited Versus Principal Commissioner of Income-Tax And 6 Others

    Stay of demand - determination of fair market value of the shares issued at a premium - Held that - In view of the fact that the petitioner s Appeal is pending before the CIT (A) and the issue of the fair market value of the shares issued at a premium by the petitioners to its holding Company would be an issue which would be subject matter of consideration in the appeal and would be appropriately dealt with by him in appeal. - It is the petitione....... + More

  • 2018 (3) TMI 529 - DELHI HIGH COURT

    Principal Commissioner of Income Tax-3 Versus M/s E-Smart Systems Private Limited

    Addition u/s 68 - ITAT deleted the addition - Held that - Initially burden cast upon the assessee had been adequately discharged by sufficient evidence. The fact that the share applicants were Directors of the assessee was also undisputed. - In these circumstances, the findings of the ITAT are essentially factual....... + More

  • 2018 (3) TMI 528 - BOMBAY HIGH COURT

    Cybertech Systems & Software Ltd. Versus The Dy. Commissioner of Income Tax 8 (1) , Mumbai

    Penalty u/s 271(1)(c) - denial of exemption to interest income under Section 10B - Held that - We find that the issue arising in these appeals is covered in favour of the assessee by the full bench decision of Karnataka High Court in Commissioner of Income Tax Vs. Hewlett Packard Global Soft Ltd. 2017 (11) TMI 205 - KARNATAKA HIGH COURT . We find that for subsequent assessment years, the assessee has been granted the benefit of deduction under Se....... + More

  • 2018 (3) TMI 527 - BOMBAY HIGH COURT

    CMI FPE Ltd. Versus The Union of India & Others

    Reopening of assessment - grievance of the petitioner that order is been passed in breach of principles of natural justice as no hearing was given to him - Held that - We are of the view that the CIT(A), the authority to whom the appeal would lie from the impugned order dated 29th December, 2017, would be able to provide the relief to the petitioners which they seek before us if they are right in their contention. Issue gives rise to factual inve....... + More

  • 2018 (3) TMI 526 - BOMBAY HIGH COURT

    The Commissioner of Income Tax, Aurangabad Versus Shri Tuljabhavani S.S.K. Ltd.,

    Additions made on account of Cane Development Fund, Area Development Fund, Small Savings, Hutment Fund, C.M. Fund, Mewad Relief Fund - Held that - Amounts collected by the society towards Cane Development Fund shall be treated as income of the assessee and no claim for deduction shall be entertained and decided by the Tribunal. As regards Area Development Fund, the matters were remitted to the Tribunal. The Tribunal has to consider the case put f....... + More

  • 2018 (3) TMI 525 - ITAT KOLKATA

    DCIT, Circle-7, Kolkata Versus M/s BCH Electric Ltd. (formerly Known M/s Bharti Industries Ltd.). And Vice-Versa

    Allowing the claim of pre-operative expenses - Held that - The assessee having found that it had committed an error by wrongly capitalizing the employee cost for February and March, 2009 in the books of accounts and also not claiming deduction for the same in the original return of income, later on proceeded to file a revised return for assessment year 2009-10 and claimed the same as deduction and correspondingly debiting prior period expenses fo....... + More

  • 2018 (3) TMI 524 - ITAT VISAKHAPATNAM

    ITO, Ward-2 (2) , Guntur Versus Yarlagadda Surendra Babu Guntur And Vice-Versa

    Deemed dividend addition u/s 2(22)(e) - Held that - In this case, the assessee has taken a loan from the company for construction of house. The assessee had mortgaged his properties for availing credit limits by the company and dried up his resources for getting financial assistance from the banks. Therefore, he had no option except to take the loan from the assessee company or to get released the properties mortgaged to the Bank. Since the prope....... + More

  • 2018 (3) TMI 523 - ITAT VISAKHAPATNAM

    Satyanarayana & Others Versus CIT, Rajahmundry And Satyanarayana & Others Versus The ITO, Ward-2 Amalapuram

    Revision u/s 263 - disallowance u/s 40(a)(ia) - Held that - As per the provisions of I.T. Act, the interest and remuneration is required to be allowed as evidenced by the partnership deed. Since the partnership deed filed in the paper book permits the payment of remuneration and interest, the AO has not committed any error in allowing the interest and remuneration paid to the partners from the estimated income. Hence the assessment made by the AO....... + More

  • 2018 (3) TMI 522 - ITAT VISAKHAPATNAM

    Income Tax Officer Ward-3 (3) Visakhapatnam Versus Sri J Lakshmi Narayana Kumar

    Unexplained cash credits u/s 68 - Held that - CIT(A) has observed that the bank account clearly indicates the possibility of cash withdrawals forming part of source for subsequent cash credits and no other evidence was shown by the revenue demonstrating that the cash withdrawals are used for any other purpose either for personal or business credits. Therefore, we do not find any infirmity in the order of the Ld.CIT(A) and the same is upheld. Appe....... + More

  • 2018 (3) TMI 521 - ITAT VISAKHAPATNAM

    The KCP Ltd. Versus DCIT, Circle-1, Vijayawada

    Revision u/s 263 - not examining the rental receipts understated by the assessee compared to the TDS receipts as per Form No.26AS and the excess depreciation claimed by the assessee in respect of motor cars and long term capital gain loss claimed by the assessee - Held that - The assessee has received the rents as per Form No 26AS a sum of ₹ 25 lakhs, whereas the assessee had admitted a sum of ₹ 12,28,020/- in the return of income and....... + More

  • 2018 (3) TMI 520 - ITAT CHANDIGARH

    M/s Kinko Computer Industries Versus The DCIT Circle, Parwanoo

    Deduction u/s 80IC - manufacture of external hard disk and DVD writer - even qua the laptops and mouse the deduction allowed was withdrawn - AO was of the view that the assessee needed to demonstrate that the commodity which was subjected to the process of manufacture could be identified as a different character in name as well as in use i.e; a distinct commodity had come into creation as a result of his manufacturing activity. - Held that - Apex....... + More

  • 2018 (3) TMI 519 - ITAT DELHI

    DCIT, Central Circle, Ghaziabad Versus Kuantum Papers Ltd., (Formerly Known As M/s Abc Papers Ltd.,)

    Depreciation on paper brands - allowable capital expenditure - Held that - As relying on DCIT vs. ABC Paper Ltd 2017 (5) TMI 1539 - ITAT DELHI wherein held since the assessee had purchased the user of brand name, trademark, logo for 3 years and similarly, the intellectual property right such as design, drawings, manufacturing processes and technical knowhow in respect of the products manufactured by unit was acquired, we hold that the expenditure....... + More

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