Accounting Principles - Taxes

Financial Accounting > Taxes

A tax may be considered as a contribution imposed by the government upon its citizens for its support. In exchange the government extends its protections to the life and property of citizens through its various police organizations. A tax is somewhat different from an assessment. An assessment is something which is levied but once, usually for the purpose of some local improvement. A tax recurs from year to year.
Taxes may be divided into various classes, such as federal, State, county, municipal, etc. The federal government imposes a tax on corporations which is equal to one per cent. on the net income. So much has been written on this subject that it is not thought necessary to discuss it in detail. The full text of the original law affecting corporations, including the interesting corespondence between a number of prominent accountants and the Attorney-General of the United States at the time the law was promulgated, as well as the interpretation of the law and instructions of the Commissioner of Internal Revenue will be found in Montgomery’s “Auditing,” pages 601 to 630, inclusive. It may be mentioned in this connection, however, that at the session of Congress which adjourned on August 26, 1912, there was introduced a bill extending the excise tax on net profits, as in the case of corporations, to firms and individuals engaged in business. The bill did not pass. Corporations are also taxed by the State for capital employed within the respective States, the form of report for which will be found on page 337 hereof. In some States counties impose taxes for schools and roads.

In New York City there is a tax on personal property imposed om corporations, as well as a tax on real estate.

In order that a clearer conception of the question of taxes may be had it would probably be of interest to run through the procedure for computing the tax as it exists in the city of New York. An authority on the subject has very aptly said that “the city’s money is spent before it gets it and that this fact effects the financial situation and real estate taxation to some degree.” The budget of appropriations for an ensuing year is made in the fall. The budget is based on the estimate made by the various city departments and is presented to the Board of Estimate and Apportionment. As approved by this board the budget becomes effective, and with the beginning of the new year the various departments begin their disbursements in accordance therewith. Asessments of property having been made during the preceding year, on October 15 the tax department opens its books on the assessed values of real and personal property. These books, which are subject to inspection and corrections by the affected parties, remain open until November 15, although hearings of complaints are heard until the first of February, when the books are closed and the assessment rolls are made up. On the first of March the assessment rolls are sent to the Board of Aldermen, which fixes the tax rate, taking into consideration the budget, the estimated revenues reported by the comptroller and the total assessed value of real and personal property subject to general taxation. As an illustration of the manner in which the tax rate is fixed the figures for the year 1912 may be used:
Assessed values:

Real property $7,861,898,890.00
Personal property 342,963,540.00 $8,204,862,430.00
Appropriations:
City $170,873,102.43
County 10,604,762.66 $181,477,865.09
Less estimated revenues 30,971,807.62
Amount to be raised $150,506,057.41

Deducting $30,971,807.62 from $181,477,865.09 will give the amount to be raised by general tax. By dividing $150,506,057.47 by $8,204,862,430 it will be seen that the ratio of the former to the latter is .0183 plus, or 1.83 plus per cent. This rate, while being the average for the entire city, fluctuates as among counties, varying from 1.83 per cent. in New York County to 1.92 per cent. in Richmond County. Taxes are now (1913) due and payable in the city of New York in two instalments, the first half on May 1, the second half on November 1. If the first half is paid in May interest is allowed on the amount from May I to November I. If not paid, interest is charged for the same period. In the month of November taxes are payable without interest, except as to the adjustment necessary to provide for the first half, while, on the first of December, a penalty of 1 per cent. is added, and on the 15th of January interest begins to run at the rate of 7 per cent.

“Whenever any tax or assessment shall remain unpaid for three years or any water rent shall remain unpaid for four years the tax lien on the property will be sold to satisfy such arrears of taxes, assessments or water rents, and all taxes, assessments and water rents up to a day to be named in the advertisement of sale as stated therein.”

An important point in connection with taxes is the accrual and treatment of taxes paid in advance. The accruing of the taxes will depend very largely on the fiscal period and the date at which the books are closed. Concerns which close their books monthly find it necessary to accrue from month to month if the taxes are of sufficient size and importance to warrant this treatment. In this way the proper charge is made to the expense accounts for the month and the proper liability accumulated through the accrual account. This stands until sucn time as the taxes for the year are paid. The accrual account is then (in New York State) automatically converted into a prepaid account, since the taxes will have been paid for the entire year. For the purpose of making this clear the following illustration will serve:

Assuming the assessed value of a piece of property in New York County to be $100,000 and the tax fate for the year 1912 1.83 per cent., the tax for the year will be $1,830, or $152.50 per month. If the books were closed monthly or, at least, if monthly statements of income and profit and loss were prepared, then the entry to be made each month would be as follows:

Taxes $152.50
To Taxes accrued $152.50

This entry would be repeated each month and the charge to taxes would be closed out monthly to profit and loss. The taxes accrued account would accumulate so that at the end of the first six months, or at June 30, the account would show $915. If the tax bill for the first six months is now paid, taxes accrued will be charged and cash credited in the amount of $915. A further complication may, however, in practice take place in connection with the taxes for the first six months as well as those for the year. Tax bills are not sent out by the city. It is necessary to request them from the receiver of taxes. Assuming now that the request for a tax bill for the first six months of the year has been made prior to May 1, and, as a matter of fixing the date, has been received on April 23, at the end of April the taxes accrued will amount to $610, but the tax bill will amount to $915. This means that the bill includes not only the first four months but also the months of May and June. The question which now arises is the treatment of the tax bill. One method of treatment would be to charge taxes accrued and credit cash with $915. This will convert the taxes accrued account automatically into a prepaid taxes account and the prepayment will be in the amount of $305. The more scientific manner of treating the matter would be to charge taxes paid in advance and credit taxes accrued with $305 and subsequently charge taxes accrued and credit cash with $915 when the payment is made. The amount of $305 in the taxes prepaid account will be disposed of in the months of May and June by charging taxes in the respective months and crediting taxes paid in advance. The second six months would not differ in any respect from the first six months except that in case payment of the first six months had not been made when due. Under such circumstances the principle involved would be the same, but the amounts would change. The charge to the taxes account would be made regularly from month to month, but the taxes accrued account would increase gradually in accordance therewith. If the tax bill is paid before the end of the year there will be an unexpired portion to be taken care of. If not paid until after the end of the year this, of course, will not be true.

The question of interest is one which sometimes causes discussion. The question is whether interest on taxes should be charged to the interest account or to the account for taxes. If the matter is to be scientifically treated it is probable that the interest should be charged to the interest account, since the concern under discussion has in effect a contract as to the dates upon which payments are to be made. If payments are not made and the taxpayer has the use of the money he pays therefor interest. If the capitalistic theory is to be consistently maintained, interest on taxes will have to be charged to interest. It is very probable, however, that in the majority of cases interest will be, even though erroneously, added to the taxes paid.

In some States taxes are payable for the year in advance. In such cases the treatment of the taxes becomes analogous with that of interest paid in advance. The taxes are set up in a prepaid account and charged out to the expense account as time passes.

It will be noted in many published balance sheets, and most especially in the case of banks, that the taxes are shown on the liability side under a caption called reserve for taxes. This would appear to be merely a loose manner of expressing the situation, since, as a rule, a reserve has not been created for taxes any more than for any other current liability. It would seem that this item might with most propriety be called taxes accrued. There would be no objection and perhaps in certain instances it might be desirable to make a distinction between the taxes accrued and due and those accrued and not due. Difficulty is also encountered at times in ascertaining the proper amount of taxes for the year. This is before the tax rate is ascertained and before the tax bills can be obtained. It is customary in such cases to use the rate and assessed value for the preceding year. This, of course, is in effect an estimated amount, and it may reasonably happen that the correct amount for the year when ascertained will disagree with the estimated amount. The proper method of treatment is to proceed with the monthly charge to taxes and credit to taxes accrued on the estimated basis until such time as the correct amount has been ascertained, when the charge should be revised and the adjustment necessary to put the account on the proper basis be made. Thus, it might happen that in the case of a given concern the amount of taxes estimated for the year might be $1,500. Such an amount would mean $125 a month. If the charge for taxes were made monthly, then at the end of the month of April there would have been charged to taxes and credited to taxes accrued $500. If now the tax bill for the year is obtained and it is found that the taxes for the year will amount to $1,830, then it is apparent that instead of having charged $500, $610 should have been charged. It will then be necessary to make a supplementary charge for the four months of $110, the difference between $500 and $610, or the difference per month between $125 and $152.50. If, perchance, the estimate will in any case have been too high, the adjustment necessary must be the reverse of the one just described. As a practical matter, however, this is not liable to occur, since taxes are inclined to increase rather than to decrease.

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