Accounting Unit 9: Taxes: Part One

Listen to the recording as you read the text. Then complete the activities.

In the 21st Century, the number of different taxes that we are obliged to pay has reached record levels which means as a society we are even less willing to pay them.

As well as income tax we are exposed to many other taxes including corporation tax, capital gains tax, consumption tax and property taxes. All of this can be too much to handle for an SME so accountants are often used to try to minimize the tax liability of a company.

Certain taxes are unavoidable though. As a registered business entity you will have to pay a consumption tax, which would either be sales tax in the US or value added tax in the rest of the world. Sales tax is levied against the consumer, which means that the company has no liability other than the act of collecting the tax which is calculated on the sale price of a product. This tax is held by the company until a determined time when it is paid to the appropriate governmental department. As there is no tax due from the production of the goods, sales tax does not affect the profit of an organization, unlike VAT which is levied on both the consumer and the producer.

Capital gains tax, which is basically a tax on the sale of a non-inventory asset that has increased in value since purchase. The difference in value is then treated as a taxable source of income and thus has tax levied against it. The rate of taxation varies depending on the income tax bracket of the individual or corporation selling the asset and whether it is a short or long-term gain. Short term gains are anything up to one year. As any accountant dealing with capital gains tax knows, it is advisable to wait for over 12 months after the point of purchase before selling the asset so that long-term capital gains tax is due at a lower rate. Tax due on both short and long-term gains can be deferred by a variety of methods.

Corporation tax is the taxation method for taxing the income of a business entity classified as a corporation; the tax rate is dependent on the taxable earnings of that corporation. As with income tax, the tax due may be reduced with the aid of tax credits.

Tax credits are offered to businesses for a variety of reasons with the most common of these being, encouragement to invest in alternative energies, encouragement to employ certain individuals, disaster relief or on earnings outside the US. These credits are then offset against the tax liability reducing the tax due.

Even individuals are confronted by an often confusing array of taxes. The most common of these taxes is income tax, which taxes our earnings. People are often unaware how much income tax they pay as it is dealt with by the employer who, while calculating the wages for an employee also calculates the income tax due and deducts this from the pay packet.

The PAYE system in England is the system of paying wages and appropriate taxes and insurances on the cost of employees. This system allows employers to withhold any deductions due on an employee’s salary, while calculating the correct payments for statutory sick and maternity pay.

Tax affects everyone from an employee to the CEO of the largest corporation but if you are in the position where you employee a good accountant, you can actually lower your liability by exploiting loopholes in the anti-avoidance legislation.

A common method of avoiding income tax is for an employee in the higher tax bracket to channel their wages through a shell company, thus changing the type of taxation from income to corporation. Then drawing the maximum salary whilst remaining on the lower tax bracket, after a certain number of years the shell company is then liquidated.

Accountants can also advise on the best type of investments so as to receive tax credits from the government.

There is an old expression: “Only two things in life are certain, death and taxes.” Well, we can’t do anything about the former, but a good accountant can help with the latter.

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