Get Complete eBook Download by Email at discountsmtb@hotmail.com
2023
Comprehensive
Volume
Young • Nellen
Maloney • Persellin
Cuccia • Lassar • Cripe
Comprehensive
Volume
Included:
Young • Nellen
Maloney • Persellin
Cuccia • Lassar • Cripe
2023
SE/Young, Nellen, Maloney, Persellin, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2023 ISBN-13: 9780357719688
Printer: Binding: Casebound Trim: 8.5” x 10.875” CMYK
©2023
Designer: Chris Doughman
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Get Complete eBook Download link Below for Instant Download:
https://browsegrades.net/documents/286751/ebook-payment-link-forinstant-download-after-payment
Get Complete eBook Download by Email at discountsmtb@hotmail.com
2021 Tax Rate Schedules
Single—Schedule X
If taxable
income is:
Over—
$
Head of household—Schedule Z
But not
over—
0
$ 9,950
9,950
40,525
of the
amount
over—
The tax is:
$
………10%
$ 0
995.00 1 12%
9,950
If taxable
income is:
Over—
$
But not
over—
The tax is:
of the
amount
over—
0
$ 14,200
………10%
$ 0
14,200
54,200
$ 1,420.00 1 12%
14,200
40,525
86,375
4,664.00 1 22%
40,525
54,200
86,350
6,220.00 1 22%
54,200
86,375
164,925
14,751.00 1 24%
86,375
86,350
164,900
13,293.00 1 24%
86,350
164,925
209,425
33,603.00 1 32%
164,925
164,900
209,400
32,145.00 1 32%
164,900
209,425
523,600
47,843.00 1 35%
209,425
209,400
523,600
46,385.00 1 35%
209,400
523,600
………
157,804.25 1 37%
523,600
523,600
………
156,355.00 1 37%
523,600
Married filing jointly or Qualifying widow(er)—­
Schedule Y–1
Married filing separately—Schedule Y–2
If taxable
income is:
Over—
If taxable
income is:
Over—
$
But not
over—
0
$ 19,900
19,900
81,050
of the
amount
over—
The tax is:
$
………10%
$ 0
1,990.00 1 12%
19,900
$
But not
over—
0
$ 9,950
9,950
40,525
The tax is:
$
of the
amount
over—
………10%
$ 0
995.00 1 12%
9,950
81,050
172,750
9,328.00 1 22%
81,050
40,525
86,375
4,664.00 1 22%
40,525
172,750
329,850
29,502.00 1 24%
172,750
86,375
164,925
14,751.00 1 24%
86,375
329,850
418,850
67,206.00 1 32%
329,850
164,925
209,425
33,603.00 1 32%
164,925
418,850
628,300
95,686.00 1 35%
418,850
209,425
314,150
47,843.00 1 35%
209,425
628,300
………
168,993.50 1 37%
628,300
314,150
………
84,496.75 1 37%
314,150
2022 Tax Rate Schedules
Single—Schedule X
If taxable
income is:
Over—
$
Head of household—Schedule Z
But not
over—
The tax is:
0
$ 10,275
10,275
41,775
1,027.50 1 12%
41,775
89,075
4,807.50 1 22%
89,075
170,050
170,050
215,950
539,900
of the
amount
over—
If taxable
income is:
Over—
The tax is:
$ 14,650
10,275
14,650
55,900
1,465.00 1 12%
14,650
41,775
55,900
89,050
6,415.00 1 22%
55,900
15,213.50 1 24%
89,075
89,050
170,050
13,708.00 1 24%
89,050
215,950
34,647.50 1 32%
170,050
170,050
215,950
33,148.00 1 32%
170,050
539,900
49,335.50 1 35%
215,950
215,950
539,900
47,836.00 1 35%
215,950
………
162,718.00 1 37%
539,900
539,900
………
161,218.50 1 37%
539,900
$
$
0
………10%
$
Married filing jointly or Qualifying widow(er)—
Schedule Y–1
Married filing separately—Schedule Y–2
If taxable
income is:
Over—
If taxable
income is:
Over—
$
of the
amount
over—
0
………10%
$
But not
over—
But not
over—
0
$ 20,550
20,550
83,550
The tax is:
………10%
$
2,055.00 1 12%
of the
amount
over—
$
The tax is:
0
of the
amount
over—
0
$ 10,275
………10%
20,550
10,275
41,775
$ 1,027.50 1 12%
10,275
0
$
But not
over—
$
$
0
83,550
178,150
9,615.00 1 22%
83,550
41,775
89,075
4,807.50 1 22%
41,775
178,150
340,100
30,427.00 1 24%
178,150
89,075
170,050
15,213.50 1 24%
89,075
340,100
431,900
69,295.00 1 32%
340,100
170,050
215,950
34,647.50 1 32%
170,050
431,900
647,850
98,671.00 1 35%
431,900
215,950
323,925
49,335.50 1 35%
215,950
647,850
………
174,253.50 1 37%
647,850
323,925
………
87,126.75 1 37%
323,925
19688_end02-07_hr.indd 2
23/03/22 1:40 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Tax Formula for Individuals
Income (broadly defined). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Exclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gross income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Deductions for adjusted gross income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjusted gross income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: The greater of—
Total itemized deductions
or standard deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Personal and dependency exemptions*. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduction for qualified business income** . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Taxable income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax on taxable income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Tax credits (including Federal income tax
withheld and prepaid). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax due (or refund). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$xx,xxx
(x,xxx)
$xx,xxx
(x,xxx)
$xx,xxx
(x,xxx)
(x,xxx)
(x,xxx)
$xx,xxx
$ x,xxx
(xxx)
xxx
$
*Exemption deductions are not allowed from 2018 through 2025.
**Only applies from 2018 through 2025.
Note: For 2021, individuals using the standard deduction may also subtract from adjusted gross income, cash charitable
contributions of up to $300 ($600 if married, filing jointly).
Basic Standard Deduction Amounts
Filing Status
Single
Married, filing jointly
Surviving spouse
Head of household
Married, filing separately
2021
2022
$12,550
25,100
25,100
18,800
12,550
$12,950
25,900
25,900
19,400
12,950
Amount of Each Additional Standard Deduction
Filing Status
Single
Married, filing jointly
Surviving spouse
Head of household
Married, filing separately
2021
2022
$1,700
1,350
1,350
1,700
1,350
$1,750
1,400
1,400
1,750
1,400
Personal and Dependency Exemption
2021
2022
$4,300
$4,400
Note: Exemption deductions have been
suspended from 2018 through 2025.
However, the personal and dependency
exemption amount is used for other purposes
(including determining whether a “qualifying
relative” is a taxpayer’s dependent).
19688_end02-07_hr.indd 3
23/03/22 1:40 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
19688_end02-07_hr.indd 4
23/03/22 1:40 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Comprehensive
Volume
2023
General Editors
James C. Young
Ph.D., CPA
Mark B. Persellin
Ph.D., CPA, CFP®
Annette Nellen
J.D., CPA, CGMA
Andrew D. Cuccia
Ph.D., CPA
Sharon S. Lassar
Ph.D., CPA
David M. Maloney
Ph.D., CPA
Bradrick M. Cripe
Ph.D., CPA
Contributing Authors
James H. Boyd
Steven C. Dilley
Annette Nellen
Toby Stock
Ph.D., CPA
Arizona State University
J.D., Ph.D., CPA
Michigan State University
J.D., CPA, CGMA
San Jose State University
Ph.D., CPA
Ohio University
Bradrick M. Cripe
Sharon S. Lassar
Mark B. Persellin
James C. Young
Ph.D., CPA
Northern Illinois University
Ph.D., CPA
University of Denver
Ph.D., CPA, CFP®
St. Mary’s University
Ph.D., CPA
Northern Illinois University
D. Larry Crumbley
David M. Maloney
William A. Raabe
Kristina Zvinakis
Ph.D., CPA
Texas A&M University –
Corpus Christi
Ph.D., CPA
University of Virginia
Ph.D., CPA
Philadelphia, Pennsylvania
Ph.D.
The University of Texas
at Austin
Andrew D. Cuccia
Ph.D., CPA
University of Oklahoma
Australia • Brazil • Canada • Mexico • Singapore • United Kingdom • United States
19688_fm_hr_i-xIii.indd 1
31/03/22 9:15 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
South-Western Federal Taxation: Comprehensive
Volume, 2023 Edition
James C. Young, Annette Nellen, David M.
Maloney, Mark B. Persellin, Andrew D.
­Cuccia, Sharon S. Lassar, Bradrick M. Cripe
SVP, Product: Erin Joyner
VP, Product: Thais Alencar
Last three editions, as applicable: © 2023, © 2022, © 2021
Copyright © 2023 Cengage Learning, Inc. ALL RIGHTS RESERVED.
No part of this work covered by the copyright herein may be reproduced
or distributed in any form or by any means, except as permitted by U.S.
copyright law, without the prior written permission of the copyright owner.
Unless otherwise noted, all content is Copyright © Cengage Learning, Inc.
Product Director: Joe Sabatino
For product information and technology assistance, contact us at
Product Manager: Jonathan Gross
Cengage Customer & Sales Support, 1-800-354-9706
or support.cengage.com.
Product Assistant: Flannery Cowan
For permission to use material from this text or product, submit all
Learning Designer: Kristen Meere
requests online at www.cengage.com/permissions.
Sr. Content Manager: Nadia Saloom
Digital Project Manager: Steven McMillan
VP, Product Marketing: Jason Sakos
Director, Product Marketing: Danae April
All tax forms within the text are: Source: Internal Revenue Service
Tax software: Source: Intuit ProConnect Tax
Becker CPA Review: Source: Becker CPA
Excel screenshots: Source: Used with permissions from Microsoft
Product Marketing Manager: Colin M. Kramer
Intuit ProConnect Tax, Becker, Microsoft and Checkpoint and all Intuit
IP Analyst: Ashley Maynard
logos are registered trademarks of Intuit ProConnect Tax, Becker, Microsoft
IP Project Manager: Nick Barrows
Production Service: Straive
Designer: Chris Doughman
Cover Image Source: Pgiam/E+/Getty Images
ProConnect Tax, Becker, Microsoft and Checkpoint-based trademarks and
and Checkpoint in the United States and other countries.
ISSN: 0741-5184
2023 Annual Edition
Student Edition ISBN: 978-0-357-71968-8
Looseleaf Edition ISBN: 978-0-357-71970-1
Interior Image Source:
Concept Summary:
Cengage
iStock.com/enot-poloskun
200 Pier 4 Boulevard
Global Tax Issues: Enot-Poloskun/
Boston, MA 02210
E+/Getty Images
USA
Ethics & Equity: iStock.com/LdF
Comprehensive Tax Return Problems:
Cengage is a leading provider of customized learning solutions with
iStock.com/peepo
employees residing in nearly 40 different countries and sales in more than
Financial Disclosure Insights: Vyaseleva
125 countries around the world. Find your local representative at
Elena/Shutterstock.com
www.cengage.com.
Framework 1040: Concept Photo/
Shutterstock.com
To learn more about Cengage platforms and services, register or access
your online learning solution, or purchase materials for your course,
visit www.cengage.com.
Printed in the United States of America
Print Number: 01
Print Year: 2022
19688_fm_hr_i-xIii.indd 2
31/03/22 9:15 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Work like a pro.
Get the #1 cloud-based professional
tax software for free.1, 2
Go beyond the basics and connect with the modern tools you need to work efficiently.
• Work with confidence.
Get returns done right the first time with access to all the forms you need, backed by
industry-leading calculations and diagnostics.
• Work smarter.
Save time with logical data-entry worksheets instead of traditional forms-based methods.
Plus, get quick training resources so it’s easy to stay up to speed.
• Work from anywhere.
It’s all online, so there’s nothing to install or maintain. And whether you’re on your mobile
phone or laptop, PC or Mac — you’re always good to go.
How to Register for/Access Intuit ProConnect Tax Online
1. Visit https://www.intuit.com/partners/education-program/products/proconnect-tax-online/
student-signup/ and complete the Student Registration form.
a. Instructors should use this form: https://www.intuit.com/partners/education-program/
products/proconnect-tax-online/educator-signup/
2. Once Intuit verifies student/educator status (via SheerID), registrants will receive instructions
on their screen. An e-mail confirmation of verification will also be sent.
3. Students/educators can use their credentials to log in to the educational version of
ProConnect at www.taxeducation.intuit.com.
Only one sign-up per student. No special code required. If you have trouble accessing or using the software,
reach out to us at taxeducation_support@intuit.com anytime for help.
1
Based on Intuit internal data of the number of paid users of ProConnect Tax for Tax Year 2019 compared to publicly available statements from competitors for the same time period.
2
If you sign-up for the free version of ProConnect Tax for students and educators, you will not have access to certain features, including functionality such as Electronic Filing Services and
Intuit Link.
© 2022 Intuit Inc. All rights reserved. Intuit, the Intuit logo, ProConnect and QuickBooks among others, are trademarks or service marks of Intuit Inc. in the United States and other countries.
Terms and conditions, features, support, pricing, and service options subject to change without notice.
19688_fm_hr_i-xIii.indd 3
31/03/22 9:15 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
19688_fm_hr_i-xIii.indd 4
31/03/22 9:15 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
Committed to Educational Success
S
outh-Western Federal Taxation (SWFT) is the
most trusted and best-selling taxation series
used by colleges and universities. We are focused
exclusively on providing the most useful, comprehensive,
and up-to-date tax texts, online study aids, tax preparation tools, and research tools to help instructors and students succeed in their tax courses and beyond.
SWFT is a comprehensive package of teaching and
learning materials, significantly enhanced with each edition to meet instructor and student needs and to add
overall value to learning taxation.
Comprehensive Volume, 2023 Edition provides a
dynamic learning experience inside and outside of the
classroom. Built with resources and tools that have been
identified as the most important, our complete learning
system provides options for students to achieve success.
In addition, Comprehensive Volume, 2023 Edition provides accessible, comprehensive, and authoritative coverage of the relevant tax code and regulations as they
pertain to the individual and business taxpayer, as well
as coverage of all major developments in Federal income
taxation.
In revising the 2023 Edition, we focused on:
• Accessibility. Clarity. Substance. The authors
and editors made this their focus as they revised
the 2023 edition. Coverage has been streamlined
to make it more accessible to students, and difficult concepts have been clarified, all without
losing the substance that makes up the SouthWestern Federal Taxation series.
• Developing professional skills. SWFT excels
in bringing students to a professional level
in their tax knowledge and skills, to prepare
them for immediate success in their careers.
We include development of written and verbal
communication skills, the use of tax preparation
and tax research software, orientation toward
success on the CPA Exam (including the
upcoming CPA Evolution version of the exam),
exposure to tax policy and tax law development,
consideration of the time value of money in
the tax planning process, and experience with
advanced spreadsheet applications and data
analytics.
• CNOWv2 as a complete learning ­system.
Cengage Learning understands that digital learning solutions are central to the classroom. Through
sustained research, we continually refine our learning solutions in CNOWv2 to meet evolving student
and instructor needs. ­CNOWv2 fulfills learning
and course management needs by offering a personalized study plan, video lectures, auto-graded
homework, auto-graded tests, and a full eBook
with features and advantages that address common
challenges.
v
19688_fm_hr_i-xIii.indd 5
31/03/22 9:16 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Learning Tools and Features to Help Students Make the Connection
Full-Color Design: We understand that students struggle with learning difficult tax law concepts and
applying them to real-world scenarios. The 2023 edition uses color to bring the text to life, capture student attention,
and present the tax law in an understandable and logical format.
Property Transactions:
Determination of Gain or Loss,
Basis Considerations, and
Nontaxable Exchanges
13
C h a p t e r
❏❏ Selected content is streamlined
to guide students in focusing on
the most important concepts for
the CPA Exam while still providing
in-depth coverage of topics.
L e a r n i n g O b j e c t i v e s : After completing Chapter 13, you should be able to:
LO.1
Perform the computation of realized gain or loss on
property dispositions.
LO.6
Apply the nonrecognition provisions and basis
determination rules for like-kind exchanges.
LO.2
Distinguish between realized and recognized gain
or loss.
LO.7
Explain the nonrecognition provisions available on
the involuntary conversion of property.
LO.3
Illustrate how basis is determined for various methods
of asset acquisition.
LO.8
Describe the provision for the permanent exclusion
of gain on the sale of a personal residence.
LO.9
Apply various tax planning opportunities related to
selected property transactions.
LO.4
LO.5
Describe various loss disallowance provisions.
The Big Picture
Explain the rationale for nonrecognition (postponement) of gain or loss in certain property transactions.
Alice owns a house that she inherited from her grandmother, Paula, seven months ago. Paula lived in the house
for over 50 years. Alice has many fond memories associated with the house, because she spent many summer
vacations there. This has caused her to delay making a decision regarding what she is going to do with the house.
Based on the estate tax return, the fair market value of the house at the date of Paula’s death was
$475,000. According to Paula’s attorney, she paid $275,000 for the house. The real estate market for residential housing currently is robust in the city in which the house is located. So based on a recent appraisal,
the house is worth $800,000. Alice is considering two options. The first is to give the house to her son,
Michael. Michael, his wife Sandra, and their daughter Peggy would live in the house. The second option is
to sell the house. Projected selling expenses would be about 7 percent of the selling price.
Alice would also like to know the tax consequences of selling her boat, which she purchased for $22,000
four months ago. She has been using it exclusively for personal use but is disappointed with its layout and
capacity. Because it is a new model, there is significant demand for the boat, and based on listings in her
area, she anticipates that she can sell it for $20,000 to $23,000.
While you are talking, Alice mentions that earlier this year, she sold some Green Corporation stock at a
loss. A few days later, after hearing Green Corporation’s quarterly earnings report, she decided to buy back
the shares. You ask her to provide additional information to determine the tax effects of these transactions.
Alice also has owned a building (adjusted basis $50,000) that was used in her business. The building
was recently destroyed by a fire, but fortunately, it was fully insured. The insurance company paid Alice
$100,000 to compensate her for the loss. Now she is looking to acquire suitable replacement property for
her business. If possible, she would like to claim a casualty loss, but certainly does not want to recognize
any taxable gain from this event as she needs the funds for replacement property.
Alice has come to you for advice regarding the tax consequences of these various transactions. Alice’s objectives are to minimize the recognition of any realized gain and to maximize the recognition of any realized loss.
Chapter Outline
13-5 Involuntary Conversions—§ 1033, 13-29
13-5a Involuntary Conversion Defined, 13-31
13-5b Computing the Amount Realized, 13-31
13-5c Replacement Property, 13-32
13-5d Time Limitation on Replacement, 13-33
13-5e Nonrecognition of Gain, 13-34
13-5f Reporting Considerations, 13-35
13-1 Determination of Gain or Loss, 13-2
13-1a Realized Gain or Loss, 13-3
13-1b Recognized Gain or Loss, 13-8
13-1c Nonrecognition of Gain or Loss, 13-8
13-2 Basis Considerations, 13-9
13-2a Determination of Cost Basis, 13-9
13-2b Gift Basis, 13-12
13-2c Inherited Property, 13-14
13-2d Disallowed Losses, 13-16
13-2e Property Converted from Personal Use to Business or
Income-Producing Use, 13-19
13-2f Summary of Basis Adjustments, 13-20
13-6 Sale of a Residence—§121, 13-35
13-6a Principal Residence, 13-36
13-6b Requirements for Exclusion Treatment, 13-36
13-6c Calculating the Exclusion, 13-38
13-6d Exceptions to the Two-Year Rules, 13-39
13-7 Tax Planning, 13-41
13-7a Cost Identification and Documentation Considerations,
13-41
13-7b Selection of Property for Making Gifts, 13-41
13-7c Selection of Property to Pass at Death, 13-42
13-7d Disallowed Losses, 13-42
13-7e Like-Kind Exchanges, 13-43
13-7f Involuntary Conversions, 13-43
13-7g Sale of a Principal Residence, 13-44
13-3 Nontaxable Exchanges, 13-22
13-2
Part 4
Property Transactions
Framework 1040
This chapter covers
the boldfaced portions
of the Tax Formula for
Individuals that was
introduced in Concept
Summary 3.1. Below
those portions are the
sections of Form 1040
where the results are
reported.
Chapter 13
Realization Events
$ xx,xxx
(x,xxx)
$xx,xxx
FORM 1040 (p. 1)
Capital gain or (loss). Attach Schedule D if required. If not required, check here
▶
FORM 1040 (Schedule 1)
3
4
Business income or (loss). Attach Schedule C .
Other gains or (losses). Attach Form 4797 . .
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Less: Deductions for adjusted gross income .....................................................................
(x,xxx)
Adjusted gross income ...........................................................................................................
$ xx,xxx
Less: The greater of total itemized deductions or the standard deduction ...............................
(x,xxx)
Charitable contributions if you take the standard deduction* .........................................
(xxx)
Personal and dependency exemptions** ........................................................................
(x,xxx)
$ xx,xxx
$ x,xxx
Less: Tax credits (including income taxes withheld and prepaid) .............................................
Tax due (or refund) .................................................................................................................
Realization events include the sale or other disposition of property (i.e., transactions in
which taxpayers change, in a meaningful way, their ownership interest in an asset). A
sale is the most common realization event involving property. The term other disposition
is defined broadly in the tax law and includes a wide variety of realization events including exchanges, barter transactions, trade-ins, condemnations, and bond retirements.
This term also applies when the taxpayer identifies a change in property (or property
rights) even if they do not receive anything on the “disposition” (e.g., a casualty, theft,
the expiration of an option, or certain assets becoming worthless).
Identifying a specific economic event (e.g., a sale) is a key factor in determining whether
a disposition has occurred.1 A change in the value of the property is not sufficient.2
(xxx)
$
xxx
* For 2021, married taxpayers may claim up to $600 of cash charitable donations ($300 if unmarried).
** Exemption deductions are not allowed from 2018 through 2025.
*** Only applies from 2018 through 2025.
19688_ch13_hr_002-069.indd 2
3/12/2022 3:52:28 AM
Example
19688_ch13_hr_002-069.indd 1
3/12/2022 3:52:30 AM
1
his chapter and Chapter 14 explain the income tax consequences of property
transactions (the sale or other disposition of property).
Computation of Realized Gain or Loss
Realized gain or loss is the difference between the amount realized from the sale or
other disposition of property and the property’s adjusted basis on the disposition date.
If the amount realized exceeds the property’s adjusted basis, the result is a realized gain .
On the other hand, if the property’s adjusted basis exceeds the amount realized, the
result is a realized loss .3
Carl sells Swan Corporation stock with an adjusted basis of $3,000 for $5,400. Carl’s realized gain
is $2,400 ($5,400 2 $3,000). If Carl had sold the stock for $1,750, he would have had a realized loss
of $1,250 ($1,750 2 $3,000).
2
Concept Summary 13.1
Realized Gain or Loss
Realized Gain
+
is
nt
ou =
m
If a
13-1 Determination of Gain or Loss
As discussed in Chapter 4, taxpayers do not recognize gross income until there has
been a realization. “Realization events” include the sale or other disposition of property.
Property includes both tangible assets (property having a physical existence, like land, a building, or equipment) and intangible assets (like investments and goodwill). Tangible assets include
both real property (e.g., land or a building) and personal property (e.g., equipment, furniture,
or a car). These property types do not change from taxpayer to taxpayer. However, how that
property is used (e.g., for business, investment, or personal purposes) can vary by taxpayer. How
property dispositions are taxed depends on the type of property involved and how it is used.
Realization events related to property involve a significant change in ownership rights, and
once a realization event has occurred, a realized gain or loss must be determined. Many, but
not all, realized gains and losses also are recognized (i.e., included in the determination of
taxable income) at the time of the realization event. So realization is an accounting concept,
and recognition is a tax concept. These matters are discussed in more depth in this section.
Example
Concept Summary 13.1 summarizes this calculation. The various terms used in Concept Summary 13.1 are discussed on the following pages.
This chapter discusses the determination of realized and recognized gain or loss and
the basis of property. Chapter 14 covers the classification of the recognized gain or loss
as ordinary or capital.
LO.1
13-1
Lori owns Tan Corporation stock that she bought for $3,000. The stock has appreciated in value and
is now worth $5,000. Lori has no realized gain because a change in value is not an identifiable event
for tax purposes. Here, Lori has an unrealized gain of $2,000 ($5,000 2 $3,000).
The same is true if the stock had declined in value to $1,000. Because there was no identifiable
event, there is no realized loss. Here, Lori would have an unrealized loss of $2,000 ($1,000 2 $3,000).
• Is there a realized gain or loss?
• If so, is the gain or loss recognized?
• If the gain or loss is recognized, is it ordinary or capital?
• What is the basis of any replacement property that is acquired?
Perform the computation
of realized gain or loss on
property dispositions.
Read the chapter and formulate your response.
(x,xxx)
Deduction for qualified business income*** ...................................................................
Taxable income ......................................................................................................................
Tax on taxable income (see Tax Tables or Tax Rate Schedules) ...............................................
T
13-3
13-4e Reporting Considerations, 13-29
13-1a Realized Gain or Loss
Tax Formula for Individuals
Income (broadly defined) ........................................................................................................
Less: Exclusions .....................................................................................................................
Gross income .......................................................................................................................
7
13-4 Like-Kind Exchanges—§ 1031, 13-22
13-4a Like-Kind Property, 13-23
13-4b Exchange Requirement, 13-24
13-4c Boot, 13-25
13-4d Basis and Holding Period of Property
Property Transactions: Determination of Gain or Loss, Basis Considerations, and Nontaxable Exchanges
Received, 13-26
ISTOCKPHOTO.COM/MICHAEL COURTNEY
Sale or Gift of Inherited House and Other Property Transactions
Amount Realized
Money received
+ Fair market value of any other property received
+ Debt relief (debt given up less any debt assumed)
– Selling expenses
= Amount realized
Adjusted Basis
Cost (or other basis) on date of acquisition
+ Capital improvements and additions
– Cost recovery/depreciation and other
Part 4 Property Transactions
capital recoveries
= Adjusted basis
–
13-4
Chapter 13
Amount Realized
If a
The amount realized from a sale or other disposition of property is a measure of the eco-
mo =
unnomic value received for property given up. In general, it is the sum of any money received
t is
4
–
Realized
Lossdebt relief) plus the fair market value of other property received.
(which
includes
any
1
3
Reg. § 1.1001–1(c)(1).
Lynch v. Turrish, 1 USTC ¶18, 3 AFTR 2986, 38 S.Ct. 537 (1918).
§ 1001(a) and Reg. § 1.1001–1(a).
Debt relief includes any liability (e.g., a mortgage) assumed by the buyer when the
property is sold. Debt relief also occurs if property is sold subject to the mortgage (i.e.,
the seller remains liable for the debt even though the buyer will be making the payments). In addition, debt relief is not limited by the fair market value of the property.5
Selling price:
Cash
Mortgage assumed by purchaser
Less:
Broker’s commission
Closing cost credit provided by Ridge
Amount realized
2
Amount Realized
Example
3
19688_ch13_hr_002-069.indd 2-3
❏❏ Examples are clearly labeled and
directly follow concepts to assist
with student application. An
average of over 40 examples in
each chapter use realistic situations
to illustrate the complexities of
the tax law and allow students to
integrate chapter concepts with
illustrations and examples.
Property Transactions: Determination of Gain or Loss, Basis Considerations, and Nontaxable Exchanges
Ridge sells an office building and the associated land on October 1, 2022. Under the terms of the
sales contract, Ridge is to receive $600,000 in cash. The purchaser is to assume Ridge’s mortgage
of $300,000 on the property. To assist the purchaser, Ridge agrees to pay $15,000 of the purchaser’s closing costs (a “closing cost credit”). The broker’s commission on the sale is $45,000.
The amount realized by Ridge is calculated as follows:
Juan sells a machine used in his landscaping business to Peter for $20,000 cash plus four acres of
property that Peter owns in a nearby town with a fair market value of $36,000. Juan’s amount real($20,000 cash 1 $36,000 land).
ized on this sale is $56,000
3/12/2022 3:52:32 AM
$600,000
300,000
$ 45,000
15,000
13-5
Example
6
$900,000
(60,000)
$840,000
Adjusted Basis
Example
4
Barry owns property on which there is a mortgage of $20,000. He sells the property to Cole for
the mortgage. Barry’s amount realized from the sale
$50,000 cash and Cole’s agreement to assume
is $70,000 ($50,000 cash 1 $20,000 debt relief ).
The adjusted basis of property disposed of is the property’s original basis adjusted to
the date of disposition.9 Original basis is the cost or other basis of the property on the
date acquired by the taxpayer. Capital additions increase and capital recoveries decrease
the original basis.10 As a result, adjusted basis is determined as follows:
In a property transaction, the fair market value of property received is the price determined
by a willing seller and a willing buyer when neither is compelled to sell or buy and both
have reasonable knowledge of relevant facts.6 All of the relevant factors must be considered,7
and if the fair market value of the property received cannot be determined, the value of the
property given up by the taxpayer is assumed to be equivalent and may be used.8
Example
5
Return to the facts of Example 3. There are several ways one can determine the fair market value
of the land Juan is receiving.
•
An appraiser can be paid to provide an appraisal of the land.
•
City or county property tax assessment information may also be helpful; the city or county
assessor determines the fair market value of property so that property taxes are levied
appropriately.
•
If the exchange is between a willing buyer and seller, determining the fair market value of
Juan’s landscaping machine could answer the question (i.e., given the facts of the case, it
should be worth $56,000).
In calculating the amount realized, selling expenses (e.g., advertising, commissions,
and legal fees) relating to the sale are deducted. As a result, the amount realized is the
net amount the taxpayer received directly or indirectly, in the form of cash or anything
else of value, from the disposition of the property.
The calculation of the amount realized may appear to be one of the least complex areas
associated with property transactions. However, because numerous positive and negative
adjustments may be required, this calculation can be complex and confusing. In addition,
determining the fair market value of the items received by the taxpayer can be difficult. The
following example provides insight into various items that can affect the amount realized.
4
§ 1001(b) and Reg. § 1.1001–1(b). The amount realized also includes any
real property taxes treated as imposed on the seller that are actually paid
by the buyer. The reason for including these taxes in the amount realized
is that by paying the taxes, the purchaser is, in effect, paying an additional
amount to the seller of the property. Refer to text Section 10-2b for a discussion of this subject.
5
Crane v. Comm., 47–1 USTC ¶9217, 35 AFTR 776, 67 S.Ct. 1047 and Comm. v.
Tufts, 83–1 USTC ¶9328, 51 AFTR 2d 83–1132, 103 S.Ct. 1826. Although a legal
distinction exists between the direct assumption of a mortgage and the taking
19688_ch13_hr_002-069.indd 4-5
of property subject to a mortgage, the Federal income tax consequences in
calculating the amount realized are the same.
Comm. v. Marshman, 60–2 USTC ¶9484, 5 AFTR 2d 1528, 279 F.2d 27
(CA–6) and Reg. §§ 1.737–1(b), 20.2031–1(b), and 25.2512–3(a).
7
O’Malley v. Ames, 52–1 USTC ¶9361, 42 AFTR 19, 197 F.2d 256 (CA–8)
and Alan Baer Revocable Trust v. U.S., 2010–1 USTC ¶60,590, 105 AFTR
2d 2010–1544.
8
U.S. v. Davis, 62–2 USTC ¶9509, 9 AFTR 2d 1625, 82 S.Ct. 1190.
6
Cost (or other adjusted basis) on date of acquisition
1 Capital additions
2 Capital recoveries
5 Adjusted basis on date of disposition
A taxpayer’s original basis also includes any liability incurred to acquire the property.
Veronica purchased a residence for $250,000. Whether Veronica uses $250,000 from her personal
assets to pay for the residence or uses $50,000 from her personal assets and borrows the remaining
$200,000, her basis in the residence is $250,000. It does not matter whether Veronica borrows from
the seller (via a land contract) or from a local bank or any other lender (via a mortgage).
Example
7
Many assets are acquired without purchasing them (e.g., via gift or inheritance). We’ll
discuss how to determine basis for these assets later in the chapter.
Capital Additions
Capital additions include the cost of improvements made to the property that lengthen its
useful life or increase its production capacity or efficiency. These costs are different from
repair and maintenance expenses, which are neither capitalized nor added to the original
basis (refer to text Section 6-3i). As a result, repair and maintenance expenses are deductible
in the current taxable year if they are related to business or income-producing property.
Any liability on property that is assumed by the buyer also is included in the buyer’s
original basis of the property. The same rule applies if property is acquired subject to a
liability. Amortization of the discount on bonds increases the adjusted basis of the bonds.11
Capital Recoveries
Capital recoveries decrease the adjusted basis of property.
Depreciation and Cost Recovery The original basis of depreciable property is
reduced by any cost recovery or depreciation allowed while the property is held by the
taxpayer. The amount subtracted annually from the original basis is the greater of the
allowed or allowable cost recovery or depreciation.12
9
§ 1011(a) and Reg. § 1.1011–1.
§ 1016(a) and Reg. § 1.1016–1.
See text Section 14-3b for a discussion of bond discount and the related
amortization.
10
12
§ 1016(a)(2) and Reg. § 1.1016–3(a)(1)(i). In most cases, these amounts are
the same (refer to text Section 8-1c).
11
3/12/2022 3:52:34 AM
vi
19688_fm_hr_i-xIii.indd 6
31/03/22 9:16 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Computational Exercises: Students need to learn to apply the rules and concepts covered in each chapter
to truly understand them. These exercises, many of which mirror text examples, allow students to practice and apply what
they are learning.
❏❏ Found in the end-of-chapter sections of the textbook
❏❏ CNOWv2 provides algorithmic versions of these problems
Computational Exercises
17. LO.1, 2 Sally owns real property for which the annual property taxes are $9,000.
She sells the property to Kate on March 9, 2022, for $550,000. Kate pays
the real property taxes for the entire year on October 1, 2022.
a. How much of the property taxes can be deducted by Sally and how much by Kate?
b. What effect does the property tax apportionment have on Kate’s adjusted basis
in the property?
c. What effect does the apportionment have on Sally’s amount realized from the
sale?
d. How would the answers in parts (b) and (c) differ if Sally paid the taxes?
18. LO.1 Melba purchases land from Adrian. Melba gives Adrian $225,000 in cash and
agrees to pay Adrian an additional $400,000 one year later plus interest at 5%.
a. What is Melba’s adjusted basis for the land at the acquisition date?
b. What is Melba’s adjusted basis for the land one year later?
Research and Data Analytics Problems:
❏❏ Research Problems provide students with vital practice in an increasingly demanded skill area.
These end-of-chapter items ask students to find and analyze tax documents, helping them to
understand the application of this information in various scenarios. These essential features
­prepare students for professional tax environments.
Becker Professional Education Review Questions: End-of-chapter CPA Review Questions
from Becker PREPARE STUDENTS FOR SUCCESS. Students review key concepts using proven questions from Becker Professional
Education®—one of the industry’s most effective tools to prepare for the CPA Exam.
❏❏ Located in select
end-­of-chapter sections
❏❏ Tagged by concept in
­CNOWv2
❏❏ Questions similar to what
students would actually
find on the CPA Exam
14-38
Part 5
Property Transactions
Becker CPA Review Questions
1. Jasmin purchased 100 shares of Pinkstey Corporation (publicly traded company)
on January 1 of year 1 for $5,000. The FMV of the shares at the end of year 1 was
$6,000. On January 1 of year 4, Pinkstey Corporation declared a 2-for-1 stock split
when the fair market value of the stock was $65 per share. On January 1 of year 5,
Jasmin sold all of her Pinkstey Corporation stock when the fair market value was
$40 per share. Which of the following statements is true?
a. Jasmin reports $6,500 in gross income for the 2-for-1 stock split in year 4.
b. Jasmin’s basis in the Pinkstey Corporation stock at the end of year 4 is
$65 per share.
c. Jasmin has no taxable income for the Pinkstey Corporation stock in year 4.
d. Jasmin owns 100 shares in Pinkstey Corporation stock at the end of year 4.
2. Alice gifted stock to her son, Bob, in year 5. Alice bought the stock in year 1 for
$8,300. The value of the stock on the date of gift was $6,400. Bob sold the stock
in year 7 for $15,800. What is Bob’s recognized gain or loss on the sale in year 7?
a. $0
c. $9,400 gain
b. $7,500 gain
d. $15,800 gain
3. Jerry inherits an asset from his uncle, who purchased the asset five days before he
died. Which of the following statements is correct?
a. If Jerry sells the asset a few days after receiving it, any gain or loss on the sale
will be short term.
b. Jerry’s basis in the asset is the carryover basis from his uncle.
c. Jerry’s basis is the FMV on the alternate valuation date or date it is distributed
to him.
d. Jerry’s basis is the FMV on his uncle’s date of death.
19688_fm_hr_i-xIii.indd 7
4. Which of the following statements is not correct?
a. The basis of an asset that is purchased must be adjusted for depreciation
allowable.
vii
31/03/22 9:17 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
See how the SWFT series helps students understand the big picture
and the relevancy behind what they are learning.
The Big Picture
The Big Picture: Tax Solutions for the Real
World. Taxation comes alive at the start of each
chapter as The Big Picture examples provide a glimpse
into the lives, families, careers, and tax situations
of typical taxpayers. Students will follow a family,
individual, or other taxpayer throughout the chapter, to
discover how the concepts they are learning apply in
the real world.
Finally, to solidify student comprehension, each
chapter concludes with a Refocus on The Big
Picture summary and tax planning scenario. These
scenarios re-emphasize the concepts and topics
from the chapter and allow students to confirm their
understanding of the material.
DRAGANA GORDIC/SHUTTERSTOCK.COM
Effect of a For-Profit Business on a Tax-Exempt Entity
Hopeful, Inc., is a tax-exempt organization under § 501(c)(3) that provides temporary lodging and psychological services for abused women and children. Its annual operating budget is $12 million. More than
two decades ago, Jennifer Abbott was a recipient of the services provided by Hopeful. Now Hopeful’s
administrator has been notified by the attorney for Jennifer’s estate that her will transfers to Hopeful her
shares in the outstanding stock of Taste Good Ice Cream, a chain of 40 gourmet ice cream shops located
in Virginia, North Carolina, and South Carolina. The business has existed for eight years and has produced
substantially higher profits each year.
Hopeful’s board is considering the following options regarding the bequest from Jennifer and has hired
you to provide an analysis of the tax consequences of each option.
• Sell the stock of Taste Good Ice Cream, and add the net proceeds to Hopeful’s endowment.
• Continue to conduct the Taste Good Ice Cream business as a division of Hopeful.
• Continue to conduct the business as a wholly owned subsidiary of Hopeful.
With the second and the third options, the existing Taste Good management team will remain in place.
After-tax profits not needed to expand the ice cream shop chain will be transferred to Hopeful, to be used
in carrying out its exempt purpose.
Read the chapter and formulate your response.
Framework 1040:
Fitting It All Together.
This chapter-opening feature
demonstrates how individual
income tax topics fit together,
using the Income Tax Formula
for Individuals as the framework.
The framework helps students
organize their understanding of
the chapters and topics to see
how they relate to the basic tax
formula and then identify where
these items are reported on the
Form 1040. Framework 1040
helps students navigate topics by
explaining how tax concepts are
organized.
Framework 1040
This chapter covers
the boldfaced portions
of the Tax Formula
for Individuals that
was introduced in
Concept Summary 3.1
on p. 3-3. Below those
portions are the
sections of Form 1040
where the results are
reported.
Tax Formula for Individuals
Income (broadly defined)....................................................................................................... $ xx,xxx
Less: Exclusions ................................................................................................................... (x,xxx)
Gross income ...................................................................................................................... $ xx,xxx
FORM 1040 (p. 1)
7
Capital gain or (loss). Attach Schedule D if required, If not required, check here
FORM 1040 (Schedule 1)
3
4
5
Business income or (loss). Attach Schedule C . . . . . . . . . . . . .
Other gains or (losses). Attach Form 4797 . . . . . . . . . . . . . .
Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E
Less: Deductions for adjusted gross income .................................................................... (x,xxx)
Adjusted gross income.......................................................................................................... $ xx,xxx
Less: The greater of total itemized deductions or the standard deduction .................... (x,xxx)
Use this chapter-opening
Framework 1040, which
shows the topics as they
appear in the individual
tax formula, to
understand where on
Form 1040 these chapter
topics appear.
FORM 1040 (p. 1)
12a Standard deduction or itemized deductions (from Schedule A)
.
.
.
.
.
.
.
.
.
Charitable contributions if you take the standard deduction* .......................................
(xxx)
Personal and dependency exemptions** ...................................................................... (x,xxx)
Deduction for qualified business income*** ................................................................. (x,xxx)
Taxable income .................................................................................................................... $ xx,xxx
Tax on taxable income (see Tax Tables or Tax Rate Schedules) ............................................. $ x,xxx
(xxx)
Less: Tax credits (including income taxes withheld and prepaid) ..........................................
Tax due (or refund) ............................................................................................................... $ xxx
*For 2021, married taxpayers may claim up to $600 of cash charitable donations ($300 if unmarried).
**Exemption deductions are not allowed from 2018 through 2025.
***Only applies from 2018 through 2025.
viii
19688_fm_hr_i-xIii.indd 8
31/03/22 9:17 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Financial Disclosure Insights:
Tax professionals need to understand
how taxes affect the financial statements.
Financial Disclosure Insights, appearing
throughout the text, use current information
about existing taxpayers to highlight booktax reporting differences, effective tax rates,
and trends in reporting conventions.
8-6
Part 3
Deductions and Credits
Financial Disclosure Insights
A common book-tax difference relates to
the depreciation amounts that are reported for GAAP and
Federal income tax purposes. Typically, tax depreciation
deductions are accelerated; that is, they are claimed in earlier
reporting periods than is the case for financial accounting
purposes.
Almost every tax law change since 1980 has included
depreciation provisions that accelerate the related deductions
relative to the expenses allowed under GAAP. Accelerated cost
Tax and Book Depreciation
recovery deductions represent a means by which the taxing
jurisdiction infuses the business with cash flow created by the
reduction in the year’s tax liabilities.
For instance, recently, about one-quarter of General Electric’s deferred tax liabilities related to depreciation differences.
Ford’s depreciation differences amounted to about one-third
of its deferred tax liabilities. And for the trucking firm Ryder
Systems, depreciation differences accounted for virtually all
of the deferred tax liabilities.
Taxpayers may elect the straight-line method to compute cost recovery allowances
for each of these classes of property. Certain property is not eligible for accelerated cost
gross receipts for the year are derived from real property trades or businesses in which
it materially participates.
Ethics & Equity
Punching the Time Clock at Year-End
As the end of the tax year approaches, Julie, a
successful full-time real estate developer and investor, recognizes that her income tax situation for the year could be bleak.
Unless she and her spouse, Ralph, are able to generate more
hours of participation in one of her real estate rental activities,
they will not reach the material participation threshold. Consequently, the tax losses from the venture will not be deductible.
To ensure deductibility, Julie suggests the following plan:
•
She will document the time she spends “thinking” about
her rental activities.
•
During the week, Ralph will visit the apartment building
to oversee (in a management role) the operations of the
rentals.
•
On weekends, she and Ralph will visit the same units to
further evaluate the operations.
•
Also on the weekends, they will be on the lookout for
other rental properties to buy and visit open houses of
homes they find on the market. Julie plans to count both
her and Ralph’s weekend hours toward the tally of total
participation.
Julie contends that the law clearly allows the efforts
of one’s spouse to count for purposes of the material
participation tests. Likewise, nothing in the tax law requires
taxpayers to be efficient in their hours of participation. How
do you react?
Ethics & Equity: Ethics & Equity
features will spark critical thinking and
invite classroom discussion, enticing
students to evaluate their own value
system. Suggested reactions to Ethics &
Equity scenarios appear in the Solutions
Manual.
Real Estate Rental Activities with Active Participation
The second exception to the passive activity loss limits is more significant in that it is
individuals Kong (age 60) and Lian (age 12) are two generations apart.
Tax Planning: Chapters include
a separate section calling attention
to how taxpayers can use the law to
reach financial and other goals. Tax
planning applications and suggestions
also appear throughout each chapter
as pertinent topics are discussed.
Global Tax Issues
27-5 Tax Planning
27-5a The Federal Gift Tax
For gifts that generate a tax, consideration must be given to the present value to the
donor of the gift taxes paid. Because the donor loses the use of these funds, the
expected interval between a gift (the imposition of the gift tax) and death (the imposition of the estate tax) may make the gift less attractive from an economic standpoint.
On the plus side, however, are the estate tax savings that result from any gift tax paid.
Because these funds are no longer in the gross estate of the donor (except for certain
gifts within three years of death), the estate tax thereon is avoided.
Gifts possess distinct advantages over transfers made at death. First, and often most
important, income from the property is generally shifted to the donee. If the donee is in a
Filing a Joint Return
John is a U.S. citizen and resident, but he spends
much of his time in London, where his employer sends him on
frequent assignments. John is married to Victoria, a citizen and
resident of the United Kingdom.
Can John and Victoria file a joint return for U.S. Federal
income tax purposes? Although § 6013(a)(1) specifically pre cludes the filing of a joint return if one spouse is a nonresident
alien, another Code provision permits an exception. Under
§ 6013(g), the parties can elect to treat the nonqualifying
spouse as a “resident” of the United States. This election would
allow John and Victoria to file jointly.
LO.10
But should John and Victoria make this election? If
Victoria has considerable income of her own (from non-U.S.
sources), the election could be ill-advised. As a nonresident
alien, Victoria’s non-U.S. source income would not be subject
to the U.S. income tax. If she is treated as a U.S. resident,
however, her non-U.S. source income will be subject to
U.S. tax. Under the U.S. global approach to taxation, all
income (regardless of where earned) of anyone who is a
resident or citizen of the United States is subject to tax.
Recognize strategies to
minimize Federal gift and
estate taxes.
Global Tax Issues: The
­ lobal Tax Issues feature gives
G
­insight into the ways in which
taxation is affected by international
concerns and illustrates the effects
of various events on tax liabilities
across the globe.
ix
19688_fm_hr_i-xIii.indd 9
31/03/22 9:18 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Take your students from Motivation to Mastery with CNOWv2
CNOWv2 is a powerful course management tool and online homework
resource that elevates student thinking by providing superior content designed
with the entire student workflow in mind.
❏❏ Motivation: engage students and better prepare them for class
❏❏ Application: help students learn problem-solving behavior and skills
to guide them to complete taxation problems on their own
❏❏ Mastery: help students make the leap from memorizing concepts to
actual critical thinking
Motivation —
To help with student engagement and
preparedness, CNOWv2 for SWFT offers:
❏❏ “Tax Drills” test students on key
concepts and applications. With
three to five questions per learning
objective, these “quick-hit” questions
help students prepare for class
lectures or review prior to an exam.
Application —
Students need to learn problem-solving
behavior and skills, to guide them to complete
taxation problems on their own. However,
as students try to work through homework
problems, sometimes they become stuck and
need extra help. To reinforce concepts and
keep students on the right track, CNOWv2 for
SWFT offers the following:
❏❏ End-of-chapter homework from the
text is expanded and enhanced to follow
the workflow a professional would use
to solve various client scenarios. These
enhancements better engage students
and encourage them to think like a tax
professional.
x
19688_fm_hr_i-xIii.indd 10
31/03/22 9:18 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
❏❏ Algorithmic versions of end-of-chapter homework are available for computational exercises and at least
15 problems per chapter.
❏❏ “Check My Work” Feedback. Homework questions include immediate feedback so students can learn as they
go. Levels of feedback include an option for “check my work” prior to submission of an assignment.
❏❏ Post-Submission Feedback. After submitting an assignment, students receive even more extensive feedback
explaining why their answers were incorrect. Instructors can decide how much feedback their students receive
and when, including the full solution.
❏❏ Built-in Test Bank for online assessment.
Mastery —
❏❏ Tax Form Problems
the option to complete
Intuit ProConnect Tax
other homework items
end-of-chapter manually
environment.
give students
the Cumulative
problems and
found in the
or in a digital
❏❏ An Adaptive Study Plan comes complete with an eBook, practice quizzes,
glossary, and flashcards. It is designed to
help give students additional support and
prepare them for the exam.
CNOWv2 Instant Access Code ISBN:
978-0-357-90091-8 (two-semester access)
Contact your Cengage Learning Consultant
about different bundle options.
xi
19688_fm_hr_i-xIii.indd 11
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
xii
Extensively Revised. Definitively Up to Date.
Each year the South-Western Federal Taxation
series is updated with thousands of changes to each
text. Some of these changes result from the feedback
we receive from instructors and students in the form
of reviews, focus groups, web surveys, and personal
e-mail correspondence to our authors and team members. Other changes come from our careful analysis
of the evolving tax environment. We make sure that
every tax law change relevant to the introductory
taxation course was considered, summarized, and
fully integrated into the revision of text and supplementary materials.
The South-Western Federal Taxation authors
have made every effort to keep all materials up to date
and accurate. All chapters contain the following general
changes for the 2023 edition:
•• Updated materials to reflect changes made
through legislative action, new administrative
rulings, and court decisions.
•• Streamlined chapter content (where applicable)
to clarify material and make it easier for students
to understand.
•• Revised numerous materials as the result of
changes caused by indexing of statutory amounts.
•• Revised Problem Materials, Computational
Exercises, and CPA Exam problems.
•• Updated Chapter Outlines to provide an overview
of the material and to make it easier to locate
specific topics.
•• Revised Financial Disclosure Insights and Global
Tax Issues for current developments.
•• Added a “Planning” icon to end-of-chapter
questions requiring tax planning considerations.
In addition, the following materials are available online:
•• An appendix that helps instructors broaden and
customize coverage of important tax provisions
of the Affordable Care Act. (Instructor Companion
Website at www.cengage.com/login)
•• An appendix that covers depreciation and
the Accelerated Cost Recovery System (ACRS).
(Instructor Companion Website at
www.cengage.com/login)
•• An appendix that has comprehensive tax
return problems for the 2021 tax filing year
(Appendix F). (Instructor Companion Website
at www.cengage.com/login)
19688_fm_hr_i-xIii.indd 12
Chapter 1
•• Expanded discussion on the relevance of taxation
to accounting and finance professionals to include
the role of a corporate tax director in global
growth strategy (added to the planning function),
ESG reporting (likely covered in other accounting
and business courses and now part of AACSB
accreditation standards), and tax advocacy.
•• Added information on space travel tax proposals.
•• Added information (and a related example) on
Preparer Tax Identification Numbers (PTINs).
•• Updated figures based on revised IRS data and
inflation adjustments.
•• Added Research Problem 5 on the data security
question tied to the “Safeguards Rule” that is on
Form W–12 to obtain or renew a PTIN (ties to the
CPA Evolution Model Curriculum).
Chapter 2
•• Based on adopter feedback, added 15 basic
(simple) research problems involving the
legislative sources, administrative sources, and
judicial sources of tax law.
•• Updated chapter materials (including various
references and citations); modified exhibits and
concept summaries for new sources (including
IRS FAQs).
•• Updated end-of-chapter materials as needed.
Chapter 3
•• Updated chapter materials to reflect 2021 tax
legislation and 2022 inflation adjustments.
•• Updated chapter materials to reflect changes in
Form 1040 and related schedules; updated various
exhibits, including when Form 1040 Schedules
1 through 3 are used and when the 0%, 15%, and
20% break points occur for the alternative tax on
net capital gains.
•• Revised and clarified materials as needed; updated
end-of-chapter materials to reflect 2021 tax
legislation and 2022 inflation adjustments.
Chapter 4
•• Updated Global Tax Issues feature entitled “From
‘All Sources’ Is a Broad Definition” for the number
of recent expatriations.
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
•• Added an Ethics & Equity feature discussing the
discrepancy between alimony deducted on tax returns
and that reported as income prior to the TCJA of 2017.
•• Revised the discussion of the Applicable Financial
Statement (AFS) income inclusion rule and
related examples for exceptions included in the
Regulations issued since last edition.
•• Added a new exercise on the AFS income
inclusion rule and available exceptions.
Chapter 5
•• Reduced coverage of voluntary death benefit
payments by employers (employers are more likely
to have group term life insurance for employees).
•• Added a brief explanation of the foreign housing
exclusion or deduction.
•• Added a discussion question involving critical
thinking and the need to examine the facts to
understand why an individual received funds. This
determination is necessary in order to determine
whether the funds are excludible from gross income.
Chapter 6
•• Revised Concept Summary 6.4 (Classification of
Expenses) by focusing on activity type (business;
personal; investment/production of income).
•• Updated and revised chapter materials to reflect
changes in tax law and inflation adjustments.
•• Deleted discussion question about legal fees incurred
in connection with a divorce; created new discussion
about the § 162(m) compensation limitation.
•• Updated end-of-chapter materials as needed.
Chapter 7
•• Updated chapter materials as needed (including
end-of-chapter materials).
•• Added new research problem, asking students
to gather information on whether to repeal or
permanently extend the excess business loss
limitation provision [§ 461(l)].
Chapter 8
•• Updated chapter materials as needed to reflect
changes to § 179 limits (including SUVs), luxury
automobile limits, and updated Form 4562 and
Schedule C (Form 1040).
•• Added a new Excel problem, asking students
to build a spreadsheet to calculate MACRS cost
recovery and end-of-year adjusted basis for
MACRS 3-, 5-, and 7-year assets.
•• Updated balance of end-of-chapter materials as
needed.
19688_fm_hr_i-xIii.indd 13
xiii
Chapter 9
•• Updated text and end-of-chapter materials for
revised standard mileage amounts; updated
materials on retirement plans.
•• Revised and clarified other materials based on
feedback from adopters.
Chapter 10
•• Added information about Notice 2020-75 and
SALT workarounds some states have enacted for
pass-through entities and their owners.
•• Revised and clarified text as needed; updated endof-chapter materials as needed.
Chapter 11
•• Updated chapter materials based on feedback
from adopters and IRS updates; revised end-ofchapter materials as needed.
•• Added a new discussion question on the average
period of customer use rental exception.
•• Added an additional reference to Research
Problem 3 (Reg. § 1.163–15) allowing students
to include this expanded tracing rule in their
research.
Chapter 12
•• Updated chapter materials for inflation
adjustments.
•• Updated for TCJA change to the research tax credit
for tax years beginning after December 31, 2021.
Chapter 13
•• Revised and updated chapter materials as needed.
Chapter 14
•• Updated chapter materials as needed.
Chapter 15
•• Modified The Big Picture example to include a
“name, image, and likeness” (NIL) contract and
ask whether the activity is a trade or business.
•• Added a The Big Picture example related to
what activities constitute a trade or business for
purposes of § 199A.
•• Updated example illustrating the completion of
2021 Form 8995–A and Schedule A (Form 8995–A).
•• Revised and clarified materials based on feedback
from adopters.
•• Updated end-of-chapter materials as needed
(including revisions for inflation adjustments to
threshold limits and 2021 Form 8995).
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
xiv
Chapter 16
•• Added an example of the 12-month rule of Reg.
§ 1.263(a)–1(f).
•• Reduced coverage of the installment sale method.
•• Reduced Exhibit 18.1 to focus on the most
common contract and indirect costs.
•• Added new tax planning items.
Chapter 17
•• Revised and clarified chapter materials as needed
(including inflation adjustments).
•• Added discussion regarding 2022 change in
computation of adjusted taxable income for
purposes of the business interest expense
limitation; depreciation (and some other items) no
longer reduce ATI. Added an example illustrating
the impact of this change.
•• Added new Research Problem 6 requiring data
analytics and the use of visual presentation (i.e.,
pie chart).
•• Revised and updated remaining chapter text and
end-of-chapter materials as needed.
Chapter 18
•• Emphasized the tax planning aspects of two
problems.
•• Modified a “thin capitalization” problem to
emphasize critical thinking and practice-related
aspects of the problem.
•• Further streamlined the writing in the chapter to
reduce passive voice sentences.
•• Revised and updated chapter materials as needed.
Chapter 19
•• Revised and updated chapter materials based
on adopter feedback; updated end-of-chapter
materials as needed.
•• Added new Research Problem 5 requiring the use
of Thomson Reuters Checkpoint™.
Chapter 20
•• Revised and clarified chapter materials as needed.
•• Added new Financial Disclosure Insights feature
entitled “Blank Check Companies.”
19688_fm_hr_i-xIii.indd 14
Chapter 21
•• Added references to § 721(c) and new Schedules
K–2 and K–3.
•• Expanded discussion for new tax basis capital
account reporting. The chapter provides more
detailed comparisons between tax basis capital
accounts, GAAP capital accounts, and § 704(b)
book capital accounts, as well as ramifications of
new reporting requirements.
•• Added reference to the new § 1061 regulation project.
Chapter 22
•• Updated Exhibit 22.1 statistics comparing business
entities.
•• Made minor revisions and clarifications, including
many date changes.
•• Added two new Research Problems, including
one requiring the use of Thomson Reuters
Checkpoint™.
•• Added two new Becker CPA Review Questions.
Chapter 23
•• Revised Learning Objective 4 and the title of
text Section 23-4 to include the term “public
charities.”
•• Revised introduction to taxation of exempt
entities, and how the entity’s net earnings can
be used.
•• Updated statistics about the exempt economy and
Federal taxation of it, unrelated business income,
and concerning private foundations and university
endowments.
•• Revised the introduction to the tax on lobbying by
exempt entities.
•• Replaced Research Problem 2.
Chapter 24
•• Updated discussion of P.L. 86–272 for the
August 2021 update to the MTC’s Statement of
Information Concerning Practices of Multistate
Tax Commission and Signatory States Under
Public Law 86–272.
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
Chapter 25
•• Expanded the discussion of text Section 25-5e
[Global Intangible Low-Taxed Income (GILTI)],
including Concept Summary 25.5 on computing
GILTI, and Exhibit 25.8 on computing gross and
net tested income, and added a number
of new examples to illustrate the text
materials.
•• Updated and added statistics about the global
economy, worldwide tax rates, treaty withholding
rates, advance pricing agreements, FTC deferrals,
and CFCs.
•• Added new discussion question, computational
exercise, and problem related to GILTI.
•• Based on adopter feedback, revised remainder of
text and end-of-chapter materials.
Chapter 26
•• Updated statistics about the IRS and the tax
collection/enforcement process.
•• Updated statistics about the tax gap and the
return on investment in the IRS, IRS user fees, and
taxpayer attitudes toward tax cheating.
xv
•• Updated materials and statistics about the
abatement of penalties for first-time offenders.
•• Included the GLBA responsibilities of the
tax preparer as to data security for taxpayer
information and operating/storage systems.
•• Added a new Excel requirement to one
computational exercise and one problem.
Chapter 27
•• Updated chapter materials to reflect inflation
adjustments to §§ 2010, 2032A, 2503(b), and
6601(j).
•• Replaced Research Problem 6 with a question
about the Ultra-Millionaire Tax Act.
•• Based on adopter feedback, revised other chapter
text and end-of-chapter materials as needed.
Chapter 28
•• Updated end-of-chapter materials as needed;
revised other materials as needed.
Tax Law Outlook
From your SWFT Series Editors:
Legislation related to the COVID-19 pandemic was a vehicle for tax changes in 2021, including a wide variety of tax changes incorporated into the American Rescue Plan Act of 2021. The Biden administration and
Congress continue to discuss a wide variety of tax law changes. Although the Build Back Better plan was not
enacted, pieces of that proposal are likely to be debated (and possibly adopted) before the end of 2022. In
addition, it is likely that Congress will return to its pattern of extending expired and expiring tax provisions
sometime in 2022.
Annually, the Joint Committee on Taxation publishes a report of all expired and expiring provisions in the
tax law. The report released in January 2022 lists 40 provisions that expired in 2021 (jct.gov/publications/
2022/jcx-1-22/). This list does not include the change to § 174 for R&D expenditures to be capitalized and
amortized (rather than currently expensed) for tax years beginning after 2021. The Build Back Better Act
passed by the House in November 2021 extended that date by four years. If that act does not become law, it
is likely that Congress will find another way to extend the effective date of this change that originated with
the Tax Cuts and Jobs Act of 2017.
Taxpayers and their advisers will need to evaluate how these changes affect their financial planning strategies and adjust their plans appropriately. The SWFT editors will be monitoring these activities and provide
updates to adopters as needed.
19688_fm_hr_i-xIii.indd 15
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
xvi
Supplements Support Students and Instructors
Built around the areas students and instructors have identified as the most important, our integrated supplements
package offers more flexibility than ever before to suit the way instructors teach and students learn.
Online and Digital Resources
for Students
Online access to ProConnect™ Tax software is offered
with each NEW copy of the textbook—at no additional
cost to students.*
www.cengage.com Students can use
CNOWv2 is a powerful course management and online
homework tool that provides robust instructor control
and customization to optimize the student learning experience and meet desired outcomes.
www.cengage.com to select this textbook and access
Cengage Learning content, empowering them to choose
the most suitable format and giving them a better chance
of success in the course. Buy printed materials, eBooks,
and digital resources directly through Cengage Learning
and save at www.cengage.com.
CNOWv2 Instant Access Code ISBN:
978-0-357-90091-8 (two-semester access)
Online Student Resources
Contact your Cengage Learning Consultant about different bundle options.
Students can go to www.cengage.com for free resources
to help them study as well as the opportunity to purchase additional study aids. These valuable free study
resources will help students earn a better grade:
Thomson Reuters Checkpoint™
is the leading online tax
research database used by
professionals. Checkpoint™ helps introduce students to
tax research in three simple ways:
•• Intuitive web-based design makes it fast and
­simple to find what you need.
•• Checkpoint™ provides a comprehensive collection
of primary tax law, cases, and rulings along
with analytical insight you simply can’t find
anywhere else.
•• Checkpoint™ has built-in productivity tools such
as calculators to make research more efficient—a
resource more tax pros use than any other.
Six months’ access to Checkpoint™ (after activation) is
packaged automatically with every NEW copy of the
textbook.*
More than software: Put the
experience of ProConnect™
Tax on your side.
•• Get returns done right the first time with access
to all the forms you need, backed by industryleading calculations and diagnostics.
•• Save time with logical data-entry worksheets
instead of traditional forms-based methods.
•• It’s all online, so there’s nothing to install or maintain.
•• Flashcards use chapter terms and definitions to aid
students in learning tax terminology for each chapter.
•• Online glossary for each chapter provides terms
and definitions from the text in alphabetical order
for easy reference.
•• Learning objectives can be downloaded for each
chapter to help keep students on track.
•• Tax tables used in the textbook are downloadable
for reference.
The first-of-its-kind digital subscription designed specially to
lower costs.
Students get total access to everything Cengage
has to offer on demand—in one place. That’s 20,000
eBooks, 2,300 digital learning products, and dozens of
study tools across 70 disciplines and over 675 courses.
www.cengage.com/unlimited
Printed Resources for Students
Looseleaf Edition (978-0-357-71970-1)
This version provides all the pages of the text in an unbound, three-hole-punched format for portability and
ease of use. Online access to ProConnect™ Tax software
is included with every NEW textbook as well as Checkpoint™ from Thomson Reuters.*
*NEW printed copies of the textbook are automatically packaged with access to Checkpoint™ and ProConnect™ Tax software. If students
purchase the eBook, they will not automatically receive access to Checkpoint™ and ProConnect™ Tax software.
19688_fm_hr_i-xIii.indd 16
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
Comprehensive Supplements Support
Instructors’ Needs
CNOWv2 is a powerful course management and online
homework tool that provides robust instructor control and
customization to optimize the student learning experience
and meet desired outcomes. In addition to the features
and benefits mentioned earlier for students, CNOWv2
includes these features for instructors.
•• Learning Outcomes Reporting and the ability to analyze student work from the gradebook.
Each exercise and problem is tagged by topic,
learning objective, level of difficulty, estimated
completion time, and business program standards
to allow greater guidance in developing assessments and evaluating student progress.
•• Built-in Test Bank for online assessment. The
Test Bank files are included in CNOWv2 so that
they may be used as additional homework or tests.
Solutions Manual
Written by the South-Western Federal Taxation
­editors and authors, the Solutions Manual features solutions arranged in accordance with the sequence of chapter material.
Solutions to all homework items are tagged with
their Estimated Time to Complete, Level of Difficulty, and
Learning Objective(s), as well as the AACSB’s and A
­ ICPA’s
core competencies—giving instructors more control than
ever in selecting homework to match the topics c­ overed.
The Solutions Manual also contains the solutions to
­Appendix F: Practice Set Assignments—Comprehensive
Tax Return Problems and answers with explanations to the
end-of-chapter Becker CPA Review Questions. Available
on Instructor Companion ­Website at www.cengage
.com/login.
PowerPoint® Lectures with Notes
The Instructor PowerPoint® Lectures contain more than
30 slides per chapter, including outlines and instructor
guides, concept definitions, and key points. Available
on Instructor Companion Website at www.cengage
.com/login.
Test Bank
Written by the South-Western Federal Taxation ­editors
and authors, the Test Bank contains approximately 2,200
items and solutions arranged in accordance with the
sequence of chapter material.
19688_fm_hr_i-xIii.indd 17
xvii
Each test item is tagged with its Estimated Time to
Complete, Level of Difficulty, and Learning Objective(s),
as well as the AACSB’s and AICPA’s core competencies—
for easier instructor planning and test item selection. The
2023 Test Bank is available in Cengage’s test generator
software, Cognero.
Cengage Learning Testing Powered by Cognero is a
flexible, online system that allows you to:
•• author, edit, and manage Test Bank content from
multiple Cengage Learning solutions
•• create multiple test versions in an instant
•• deliver tests from your LMS, your classroom, or
wherever you want
•• create tests from school, home, the coffee shop—
anywhere with Internet access (No special installs
or downloads needed.)
Test Bank files in Word format as well as versions to
­import into your LMS are available on the Instructor Companion Website. Cognero Test Banks are available
via single sign-on (SSO) account at www.cengage
.com/login.
Other Instructor Resources
All of the following instructor course materials are
available online at www.cengage.com/login. Once
logged into the site, instructors should select this textbook
to access the online Instructor Resources.
•• Instructor Guide
•• Edition-to-edition correlation grids by chapter
•• An appendix that helps instructors broaden and
customize coverage of important tax provisions of
the Affordable Care Act
•• Depreciation and the Accelerated Cost Recovery
System (ACRS) appendix
•• Comprehensive Tax Return Problems appendix
Custom Solutions
Cengage Learning Custom Solutions develops personalized solutions to meet your taxation education needs.
Consider the following for your adoption of South-­
Western Federal Taxation 2023 Edition.
•• Remove chapters you do not cover or rearrange
their order to create a streamlined and efficient text.
•• Add your own material to cover additional topics
or information.
•• Add relevance by including sections from
Sawyers/Gill’s Federal Tax Research or your
state’s tax laws and regulations.
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xviii
Preface
Acknowledgments
We want to thank all the adopters and others who participated in numerous online surveys as well as the following individuals who provided content reviews and feedback in the development of the South-Western Federal Taxation 2023 titles.
James C. Young / Annette Nellen / David M. Maloney / Mark B. Persellin /
Andrew D. Cuccia / Sharon S. Lassar / Bradrick M. Cripe
Ken Abramowicz, University of Alaska
Fairbanks
Lindsay G. Acker, University of Wisconsin –
Madison
Deborah S. Adkins, Nperspective, LLC
Mark P. Altieri, Kent State University
Susan E. Anderson, Elon University
Henry M. Anding, Woodbury University
Jennifer A. Bagwell, Ohio University
George Barbi, Lanier Technical College
Terry W. Bechtel, Texas A&M University –
Texarkana
Chris Becker, LeMoyne College
Tamara Berges, UCLA
Ellen Best, University of North Georgia
Tim Biggart, Berry College
Rachel Birkey, Illinois State University
Israel Blumenfrecht, Queens College
Patrick M. Borja, Citrus College / California
State University, Los Angeles
Dianne H. Boseman, Nash Community
College
Cathalene Bowler, University of Northern
Iowa
Madeline Brogan, Lone Star College –
Montgomery
Darryl L. Brown, Illinois Wesleyan
­University
Timothy G. Bryan, University of Southern
Indiana
Robert S. Burdette, Salt Lake Community
College
Ryan L. Burger, Concordia University
Nebraska
Lisa Busto, William Rainey Harper College
Julia M. Camp, Providence College
Al Case, Southern Oregon University
Machiavelli W. Chao, Merage School of
Business, University of California,
Irvine
Eric Chen, University of Saint Joseph
Christine Cheng, Louisiana State University
James Milton Christianson, Southwestern
University and Austin Community
College
Wayne Clark, Southwest Baptist University
Ann Burstein Cohen, University at Buffalo,
The State University of New York
Ciril Cohen, Fairleigh Dickinson University
Seth Colwell, University of Texas – Rio
Grande Valley
Dixon H. Cooper, University of Arkansas
John P. Crowley, Castleton University
Susan E. M. Davis, South University
Dwight E. Denman, Newman University
19688_fm_hr_i-xIii.indd 18
James M. DeSimpelare, Ross School of
Business at the University of Michigan
John Dexter, Northwood University
James Doering, University of Wisconsin –
Green Bay
Michael P. Donohoe, University of Illinois
at Urbana Champaign
Deborah A. Doonan, Johnson & Wales
University
Monique O. Durant, Central Connecticut
State University
Wayne L. Edmunds, Virginia Commonwealth University
Rafi Efrat, California State University,
Northridge
Frank J. Faber, St. Joseph’s College
A. Anthony Falgiani, University of South
Carolina, Beaufort
Jason Fiske, Thomas Jefferson School of Law
John Forsythe, Eagle Gate College
Alexander L. Frazin, University of
Redlands
Carl J. Gabrini, College of Coastal Georgia
Kenneth W. Gaines, East-West University,
Chicago, Illinois
Carolyn Galantine, Pepperdine University
Sheri Geddes, Hope College
Alexander Gelardi, University of St. Thomas
Joel Gelb, Farleigh Dickinson University
Daniel J. Gibbons, Waubonsee
Community College
Martie Gillen, University of Florida
Charles Gnizak, Fort Hays State University
J. David Golub, Northeastern University
George G. Goodrich, John Carroll
University
Marina Grau, Houston Community
College – Houston, TX
Vicki Greshik, University of Jamestown
College
Jeffrey S. Haig, Santa Monica College
Marcye S. Hampton, University of Central
Florida
June Hanson, Upper Iowa University
Donald Henschel, Benedictine University
Kenneth W. Hodges, Sinclair Community
College
Susanne Holloway, Salisbury University
Susan A. Honig, Herbert H. Lehman ­College
Jeffrey L. Hoopes, University of North
Carolina
Christopher R. Hoyt, University of Missouri
(Kansas City) School of Law
Marsha M. Huber, Youngstown State
­University
Carol Hughes, Asheville-Buncombe
­Technical Community College
Helen Hurwitz, Saint Louis University
Richard R. Hutaff, Wingate University
Zite Hutton, Western Washington University
Steven L. Jager, Cal State Northridge
Janeé M. Johnson, University of Arizona
Brad Van Kalsbeek, University of Sioux
Falls
Carl Keller, Missouri State University
Cynthia Khanlarian, Concord University
Bob G. Kilpatrick, Northern Arizona
University
Gordon Klein, UCLA Anderson School
Taylor Klett, Sam Houston State University
Aaron P. Knape, Peru State College
Cedric Knott, Colorado State University –
Global Campus
Ausher M. B. Kofsky, Western New
­England University
Emil Koren, Saint Leo University
Jack Lachman, Brooklyn College – CUNY
Adena LeJeune, Louisiana College
Gene Levitt, Mayville State University
Teresa Lightner, University of North Texas
Sara Linton, Roosevelt University
Roger Lirely, The University of Texas at Tyler
Jane Livingstone, Western Carolina
University
Heather Lynch, Northeast Iowa
Community College
Mabel Machin, Florida Institute of Technology
Maria Alaina Mackin, ECPI University
Anne M. Magro, George Mason University
Richard B. Malamud, California State
­University, Dominguez Hills
Harold J. Manasa, Winthrop University
Barry R. Marks, University of Houston –
Clear Lake
Dewey Martin, Husson University
Anthony Masino, East Tennessee State
University
Norman Massel, Louisiana State University
Bruce W. McClain, Cleveland State U
­ niversity
Jeff McGowan, Trine University
Allison M. McLeod, University of North Texas
Meredith A. Menden, Southern New
Hampshire University
Robert H. Meyers, University of Wisconsin –
Whitewater
John G. Miller, Skyline College
Tracie L. Miller-Nobles, Austin Community
College
Jonathan G. Mitchell, Stark State College
Richard Mole, Hiram College
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
David Morack, Lakeland University
Lisa Nash, University of North Georgia
Mary E. Netzler, Eastern Florida State
College
Joseph Malino Nicassio, Westmoreland
County Community College
Mark R. Nixon, Bentley University
Garth Novack, Pantheon Heavy Industries
& Foundry
Claude R. Oakley, DeVry University, Georgia
Al Oddo, Niagara University
Sandra Owen, Indiana University –
Bloomington
Vivian J. Paige, Old Dominion University
Carolyn Payne, University of La Verne
Ronald Pearson, Bay College
Thomas Pearson, University of Hawaii at
Manoa
Nichole L. Pendleton, Friends University
Chuck Pier, Angelo State University
Lincoln M. Pinto, DeVry University
Sonja Pippin, University of Nevada – Reno
Steve Platau, The University of Tampa
Elizabeth Plummer, TCU
Walfyette Powell, Strayer University
Darlene Pulliam, West Texas A&M ­University
Thomas J. Purcell, Creighton University
John S. Repsis, University of Texas at
Arlington
Jennifer Hardwick Robinson, Trident
Technical College
Shani N. Robinson, Sam Houston State
University
Donald Roth, Dordt College
Richard L. Russell, Jackson State University
Robert L. Salyer, Northern Kentucky
­University
Rhoda Sautner, University of Mary
Bunney L. Schmidt, Keiser University
Allen Schuldenfrei, University of
­Maryland – Baltimore County
Eric D. Schwartz, LaRoche College
Tony L. Scott, Norwalk Community College
Randy Serrett, University of Houston –
Downtown
Wayne Shaw, Southern Methodist University
Paul A. Shoemaker, University of
Nebraska – Lincoln
Kimberly Sipes, Kentucky State University
Georgi Smatrakalev, Florida Atlantic
­University
Randy Smit, Dordt College
Leslie S. Sobol, California State University
Northridge
Eric J. Sommermeyer, Wartburg College
Marc Spiegel, University of California, Irvine
Teresa Stephenson, University of Alaska
Anchorage
Beth Stetson, Oklahoma City University
Debra Stone, Eastern New Mexico
University
Frances A. Stott, Bowling Green State
­University
Todd S. Stowe, Southwest Florida College
Julie Straus, Culver – Stockton College
Martin Stub, DeVry University
xix
James Sundberg, Eastern Michigan
­University
Kent Swift, University of Montana
Robert L. Taylor, Lees-McRae College
Francis C. Thomas, Richard Stockton
College of New Jersey
Randall R. Thomas, Upper Iowa University
Ronald R. Tidd, Central Washington
­University
MaryBeth Tobin, Bridgewater State
­University
James P. Trebby, Marquette University
Heidi Tribunella, University of Rochester
James M. Turner, Georgia Institute of
­Technology
Anthony W. Varnon, Southeast Missouri
State University
Adria Palacios Vasquez, Texas A&M
University – Kingsville
Stanley Veliotis, Fordham University
Terri Walsh, Seminole State College
of Florida
Natasha R. Ware, Southeastern University
Mark Washburn, Sam Houston State
­University
Bill Weispfenning, University of
Jamestown (ND)
Kent Williams, Indiana Wesleyan University
Candace Witherspoon, Valdosta State
University
Sheila Woods, DeVry University, Houston, TX
Xinmei Xie, Woodbury University
Thomas Young, Lone Star College – Tomball
Special Thanks
We are grateful to the faculty members who have diligently worked through the problems and test questions to ensure
the accuracy of the South-Western Federal Taxation homework, solutions manuals, test banks, and comprehensive
tax form problems. Their comments and corrections helped us focus on clarity as well as accuracy and tax law currency. We also thank Thomson Reuters for its permission to use Checkpoint™ with the text.
Sandra A. Augustine, (retired) Hilbert College
Robyn Dawn Jarnagin, University of
­Arkansas
Kate Mantzke, Northern Illinois University
Ray Rodriguez, Murray State University
Miles Romney, Florida State University
19688_fm_hr_i-xIii.indd 19
George R. Starbuck, McMurry
University
Donald R. Trippeer, State University of
New York College at Oneonta
Raymond Wacker, Southern Illinois
­University, Carbondale
Michael Weissenfluh, Tillamook Bay
Community College
Marvin Williams, University of
Houston – Downtown
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
The South-Western Federal Taxation Series
To find out more about these books, go to www.cengage.com.
Individual Income Taxes, 2023 Edition
(Young, Nellen, Raabe, Persellin, Lassar, Cuccia, Cripe,
Editors) provides accessible, comprehensive, and authoritative
coverage of the relevant tax code and regulations as they pertain
to the individual taxpayer, as well as coverage of all major
developments in Federal taxation.
(ISBN 978-0-357-71982-4)
Corporations, Partnerships, Estates &
Trusts, 2023 Edition
(Raabe, Young, Nellen, Cripe, Lassar, Persellin, Cuccia, Editors)
covers tax concepts as they affect corporations, partnerships, estates,
and trusts. The authors provide accessible, comprehensive, and
authoritative coverage of relevant tax code and regulations, as well
as all major developments in Federal income taxation. This marketleading text is intended for students who have had a previous course
in tax.
(ISBN 978-0-357-71996-1)
xx
19688_fm_hr_i-xIii.indd 20
31/03/22 9:19 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
xxi
Comprehensive Volume, 2023 Edition
(Young, Nellen, Maloney, Persellin, Cuccia, Lassar, Cripe,
Editors) Combining the number one individual tax text with
the number one corporations text, Comprehensive Volume,
2023 Edition is a true winner. An edited version of the first two
South-Western Federal Taxation textbooks, this book is ideal
for undergraduate or graduate levels. This text works for either
a one-semester course in which an instructor wants to integrate
coverage of individual and corporate taxation or for a twosemester sequence in which the use of only one book is desired.
(ISBN 978-0-357-71968-8)
Essentials of Taxation: Individuals and Business
Entities, 2023 Edition
(Nellen, Cuccia, Persellin, Young, Editors) emphasizes tax
planning and the multidisciplinary aspects of taxation. This
text is designed with the AICPA Model Tax Curriculum in
mind, presenting the introductory Federal taxation course from
a business entity perspective. Its Tax Planning Framework
helps users fit tax planning strategies into an innovative
pedagogical framework. The text is an ideal fit for programs
that offer only one course in taxation where users need to be
exposed to individual taxation, as well as corporate and other
business entity taxation. This text assumes no prior course in
taxation has been taken.
(ISBN 978-0-357-72010-3)
Federal Tax Research, 12E
(Sawyers and Gill) Federal Tax Research, Twelfth
Edition, offers hands-on tax research analysis and fully covers
computer-oriented tax research tools. Also included in this edition
is coverage on international tax research, a review of tax ethics,
and many new real-life cases to help foster a true understanding
of Federal tax law.
(ISBN 978-0-357-36638-7)
19688_fm_hr_i-xIii.indd 21
31/03/22 9:20 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xxii
Preface
About the Editors
James C. Young is the PwC
Annette Nellen, J.D., CPA,
Professor of Accountancy
at Northern Illinois University. A graduate of Ferris
State University (B.S.) and
Michigan State University
(M.B.A. and Ph.D.), Jim’s
research focuses on taxpayer
responses to the income
tax using archival data. His
dissertation received the
PricewaterhouseCoopers/
American Taxation Association Dissertation Award, and
his subsequent research has received funding from a
number of organizations, including the Ernst & Young
Foundation Tax Research Grant Program. His work has
been published in a variety of academic and professional
journals, including the National Tax Journal, The Journal
of the American Taxation Association, and Tax Notes. Jim
is a Northern Illinois University Distinguished Professor,
received the Illinois CPA Society Outstanding Accounting Educator Award in 2012, and has received university
teaching awards from Northern Illinois University, George
Mason University, and Michigan State University.
CGMA, directs San José State
University’s graduate tax
program (MST) and teaches
courses in tax research, tax
fundamentals, accounting
methods, property transactions, employment tax,
ethics, leadership, and tax
policy. Professor Nellen is
a graduate of CSU Northridge, Pepperdine (MBA),
and Loyola Law School. Prior to joining SJSU in 1990, she
was with a Big 4 firm and the IRS. At SJSU, Professor Nellen is a recipient of the Outstanding Professor and Distinguished Service Awards. Professor Nellen is an active
member of the tax sections of the AICPA and American
Bar Association. In 2013, she received the AICPA Arthur
J. Dixon Memorial Award, the highest award given by
the accounting profession in the area of taxation. Profes­
sor Nellen is the author of ­BloombergBNA Tax Portfolio,
Amortization of Intangibles. She has published numerous articles in the AICPA Tax Insider, Tax Adviser, Tax
Notes State, and The Journal of Accountancy. She has
testified before the House Ways & Means and Senate
Finance Committees and other committees on Federal
and state tax reform. Professor Nellen maintains the 21st
Century Taxation Website and blog (21stcenturytaxation
.com) as well as Websites on tax policy and reform,
­virtual currency, and state tax issues (sjsu.edu/­people/
annette.nellen/).
David M. Maloney, Ph.D.,
CPA, is the Carman G. Blough
Professor of Accounting
Emeritus at the University of
Virginia’s McIntire School of
Commerce. He completed
his undergraduate work at
the University of Richmond
and his graduate work at
the University of Illinois at
Urbana-Champaign. Upon
joining the Virginia faculty
in January 1984, Dr. Maloney taught Federal taxation
in the graduate and undergraduate programs and was
a recipient of major research grants from the Ernst &
Young and KPMG Foundations. Dr. Maloney has published work in numerous professional journals, including
Journal of Taxation, The Tax Adviser, Tax Notes, Corporate Taxation, Accounting Horizons, Journal of Taxation
of Investments, and Journal of Accountancy.
19688_fm_hr_i-xIii.indd 22
31/03/22 9:20 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Preface
xxiii
Mark B. Persellin, Ph.D.,
Sharon S. Lassar, Ph.D.,
CPA, CFP®, is the Ray and
Dorothy Berend ­Professor
of Accounting at St. Mary’s
University. He is a graduate of the University of
Arizona (B.S.), the University of Texas at Austin
(M.P.A. in Taxation), and
the University of Houston
(Ph.D.). He teaches Personal Income Tax, Business Income Tax, and Research in Federal Taxation. Prior
to joining St. Mary’s University in 1991, Professor Persellin
taught at Florida Atlantic University and Southwest Texas
University (Texas State University) and worked on the tax
staff of a Big 4 firm. His research has been published in
numerous academic and professional journals including
The Journal of the American Taxation Association, The
Accounting Educators’ Journal, The Tax Adviser, The CPA
Journal, Journal of Taxation, Corporate Taxation, The Tax
Executive, TAXES—The Tax Magazine, Journal of International Taxation, and Practical Tax Strategies. In 2003,
Professor Persellin established the St. Mary’s ­
University
Volunteer Income Tax Assistance (VITA) site, and he continues to serve as a trainer and reviewer at the site.
CPA (Florida), is the John
J. Gilbert Professor and
Director of the School
of Accountancy at The
University of Denver. Dr.
Lassar earned her Ph.D.
at the University of Southern California, her Master
of Taxation at Bentley
University, and her Bachelor’s in Accounting from
West Virginia University. Prior to joining the University
of Denver, Dr. Lassar was the Director of the School of
Accounting at Florida International University and previously served on the faculties of Florida Atlantic University
and the University of Arizona. She began her career with
a Big 4 firm. Dr. Lassar has served the profession in many
ways, most recently as a member of the AICPA Council.
Dr. Lassar is a past president of the Accounting Programs
Leadership Group and Past Chair of the Colorado Society
of CPAs. Dr. Lassar also served on the Accounting Accreditation Task Force of AACSB International whose work
resulted in new standards for accreditation, the hallmark
of them being fully engaging practitioners in the accreditation process.
Andrew D. Cuccia, Ph.D.,
Bradrick M. Cripe, Ph.D.,
CPA, is the Steed Professor of Accounting at the
University of Oklahoma.
He is a graduate of Loyola
University, New Orleans
(B.B.A.), and the University of Florida (Ph.D.).
Prior to entering academia,
Andy practiced as a CPA
with a Big 4 accounting
firm. Before joining the
University of Oklahoma, he was on the faculty at Louisiana State University and the University of Illinois. His
research focuses on taxpayer and tax professional judgment and decision making and has been published in
several journals including The Accounting Review, The
Journal of Accounting Research, The Journal of the American Taxation Association, and Tax Notes. He has taught
undergraduate and graduate courses in income tax fundamentals as well as graduate courses in corporate tax,
tax policy, and tax research. Andy is a past president of
the American Taxation Association and a member of the
­American Accounting Association and the AICPA.
CPA, is a Presidential
Teaching Professor and the
Donald E. Kieso Endowed
Chair of Accountancy at
Northern Illinois University. He is a graduate of
New Mexico State University (B.A., B.C.J., and
M.Acc.) and the University of Nebraska–Lincoln
(Ph.D.). Prior to receiving
his Ph.D. in 2006, he worked on the tax staff of a Big 4
accounting firm. Professor Cripe teaches courses in taxation and business strategy, corporate taxation, international taxation, and advanced issues in taxation. He has
published in The Accounting Review, Issues in Accounting
Education, Journal of Accountancy, Tax Notes, and other
academic and practitioner journals.
19688_fm_hr_i-xIii.indd 23
31/03/22 9:20 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Brief Contents
Part 1: Introduction and Basic Tax Model
Chapter 1An Introduction to Taxation and
Understanding the Federal Tax Law
1-1
Chapter 2
2-1
Working with the Tax Law
Chapter 3Tax Formula and Tax Determination;
An Overview of Property Transactions
3-1
Part 2: Gross Income
Chapter 4
Chapter 5
Gross Income: Concepts and Inclusions
Gross Income: Exclusions
4-1
5-1
Part 3: Deductions and Credits
Chapter 6
Deductions and Losses: In General
6-1
Chapter 7Deductions and Losses: Certain Business
Expenses and Losses
7-1
Chapter 8Depreciation, Cost Recovery, Amortization,
and Depletion
8-1
Chapter 9Deductions: Employee and Self-Employed-Related
Expenses
9-1
Chapter 10Deductions and Losses: Certain Itemized Deductions
10-1
Chapter 11
Investor Losses
11-1
Chapter 12
Tax Credits and Payments
12-1
Part 4: Property Transactions
Chapter 13Property Transactions: Determination of
Gain or Loss, Basis Considerations, and
Nontaxable Exchanges
13-1
Chapter 14Property Transactions: Capital Gains and
Losses, § 1231, and Recapture Provisions
14-1
xxiv
19688_fm_hr_i-xIii.indd 24
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Brief Contents
xxv
Part 5: Special Tax Computations and
Accounting Periods and Methods
Chapter 15The Deduction for Qualified Business
Income for Noncorporate Taxpayers
15-1
Chapter 16
16-1
Accounting Periods and Methods
Part 6: Corporations
Chapter 17Corporations: Introduction and
Operating Rules
17-1
Chapter 18Corporations: Organization and Capital
Structure
18-1
Chapter 19Corporations: Distributions Not in
Complete Liquidation
19-1
Chapter 20Corporations: Distributions in Complete
Liquidation and an Overview of
Reorganizations
20-1
Part 7: Flow-Through Entities
Chapter 21
Partnerships
21-1
Chapter 22
S Corporations
22-1
Part 8: Advanced Tax Practice Considerations
Chapter 23
Exempt Entities
23-1
Chapter 24
Multistate Corporate Taxation
24-1
Chapter 25
Taxation of International Transactions
25-1
Chapter 26
Tax Practice and Ethics
26-1
Part 9: Family Tax Planning
Chapter 27
The Federal Gift and Estate Taxes
27-1
Chapter 28
Income Taxation of Trusts and Estates
28-1
19688_fm_hr_i-xIii.indd 25
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
19688_fm_hr_i-xIii.indd 26
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
Part 1: Introduction and Basic
Tax Model
Chapter 1
An Introduction to Taxation
and Understanding the
Federal Tax Law
The Big Picture: Family and Taxes—A Typical Year
Statute of Limitations
Interest and Penalties
Global Tax Issues: Outsourcing of Tax Return Preparation
Tax Practice
Understanding the Federal Tax Law
1-1
1-1
Approaching the Study of Taxation
1-2
What Is Taxation?
Taxation in Our Lives
The Relevance of Taxation to Accounting
and Finance Professionals
How to Study Taxation
1-2
1-2
A Brief History of U.S. Taxation
1-5
1-3
1-5
Early Periods
1-5
Concept Summary: Individuals and Taxes
1-6
Revenue Acts
1-6
Trends1-7
Tax System Design
1-8
Legal Foundation
The Basic Tax Formula
Tax Principles
1-8
1-8
1-9
Major Types of Taxes
Property Taxes
Transaction Taxes
Ethics & Equity: Making Good Use of Out-of-State Relatives
Taxes on Transfers at Death
Gift Taxes
Income Taxes
Employment Taxes
Other U.S. Taxes
Concept Summary: Overview of Taxes in the United States
Proposed U.S. Taxes
Global Tax Issues: VAT in USA?
Tax Administration
Internal Revenue Service
The Audit Process
1-10
1-12
1-13
1-14
1-15
1-16
1-17
1-19
1-20
1-21
1-22
1-23
1-23
1-23
1-24
1-25
1-26
1-27
1-27
1-29
Revenue Needs
1-29
Economic Considerations
1-29
Social Considerations
1-30
Equity Considerations
1-31
Political Considerations
1-33
Influence of the Internal Revenue Service
1-34
Influence of the Courts
1-35
Summary1-36
Refocus on The Big Picture: Family and Taxes—A Typical Year
1-37
Chapter 2
Working with the Tax Law
The Big Picture: Importance of Tax Research
2-1
2-1
Tax Law Sources
2-2
Statutory Sources of the Tax Law
Administrative Sources of the Tax Law
Ethics & Equity: Reporting Tax Fraud
Judicial Sources of the Tax Law
Concept Summary: Federal Judicial System: Trial Courts
Concept Summary: Judicial Sources
Other Sources of the Tax Law
2-2
2-6
2-7
2-10
2-12
2-15
2-17
orking with the Tax Law—
W
Tax Research Tools
Commercial Tax Services
Using Electronic (Online) Tax Services
Noncommercial Electronic (Online) Tax Services
orking with the Tax Law—
W
Tax Research
Identifying the Problem
Refining the Problem
Locating the Appropriate Tax Law Sources
Assessing the Validity of Tax Law Sources
Arriving at the Solution or at Alternative Solutions
Financial Disclosure Insights: Where Does GAAP Come From?
Communicating Tax Research
2-18
2-18
2-19
2-19
2-20
2-21
2-22
2-22
2-23
2-25
2-26
2-26
xxvii
19688_fm_hr_i-xIii.indd 27
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xxviii
Contents
orking with the Tax Law—
W
Tax Planning
Nontax Considerations
Components of Tax Planning
Tax Avoidance and Tax Evasion
Follow-Up Procedures
Tax Planning
Taxation on the CPA Examination
2-28
2-29
2-29
2-30
2-30
2-31
2-31
The E-File Approach
When and Where to File
Modes of Payment
Gains and Losses from Property ­
Transactions—In General
3-41
Gains and Losses from Property ­
Transactions—Capital Gains and Losses
3-42
Preparation Blueprints
Regulation Section
2-31
2-31
Chapter 3
Tax Formula and Tax
Determination; An Overview
of Property Transactions
Definition of a Capital Asset
Determination of Net Capital Gain
Treatment of Net Capital Loss
Taxation of Net Capital Gain
Taxation of Virtual Currency
3-1
Tax Planning
The Big Picture: A Divided Household
Framework 1040: Tax Formula for Individuals
3-1
3-2
Tax Formula
3-2
Concept Summary: Tax Formula for Individuals
(Components Integrated into the Text)
Components of the Tax Formula
Tax Formula—Correlation with Form 1040
3-3
3-3
3-8
Standard Deduction
3-17
Basic and Additional Standard Deduction
3-17
Individuals Not Eligible for the Standard Deduction
3-18
Special Limitations on the Standard Deduction
for Dependents3-18
Exemptions3-19
Dependents3-19
Qualifying Child
Concept Summary: Tiebreaker Rules for Claiming Qualified Child
Qualifying Relative
Other Rules for Determining Dependents
Comparison of Dependent Categories
Concept Summary: Tests for Dependents
Ethics & Equity: Whose Qualifying Child Is He?
Child and Dependent Tax Credits
Filing Status and Filing Requirements
Filing Status
Global Tax Issues: Filing a Joint Return
Ethics & Equity: Abandoned Spouse?
Filing Requirements
Tax Determination
Tax Rates
Computation of Net Taxes Payable or Refund Due
Kiddie Tax—Unearned Income of Dependent Children
Tax Return Filing Procedures
Selecting the Proper Form
19688_fm_hr_i-xIii.indd 28
3-19
3-21
3-21
3-25
3-25
3-26
3-26
3-26
3-29
3-29
3-30
3-33
3-33
3-34
3-35
3-36
3-37
3-39
3-39
3-40
3-40
3-41
3-42
3-42
3-43
3-43
3-44
3-45
Maximizing the Use of the Standard Deduction
3-45
Dependents3-45
Taking Advantage of Tax Rate Differentials
3-46
Income of Certain Children
3-47
Refocus on The Big Picture: A Divided Household
3-47
Part 2: Gross Income
Chapter 4
Gross Income: Concepts
and Inclusions
The Big Picture: Calculation of Gross Income
Framework 1040: Tax Formula for Individuals
Gross Income
4-1
4-1
4-2
4-3
Definition4-3
Recovery of Capital Doctrine
4-3
Global Tax Issues: From “All Sources” Is a Broad Definition
4-3
Economic and Accounting Concepts of Income
4-4
Financial Accounting Income versus Taxable Income
4-5
Form of Receipt
4-6
Timing of Income Recognition
4-6
Taxable Year
Accounting Methods
Special Rules Applicable to Cash Basis Taxpayers
Ethics & Equity: Should the Tax Treatment of Government Bonds
and Corporate Bonds Be Different?
Special Rules Applicable to Accrual Basis Taxpayers
4-6
4-7
4-9
eneral Sources of Income and
G
to Whom They Are Taxed
Personal Services
Income from Property
Income from Partnerships, S Corporations, Trusts, and Estates
Concept Summary: Taxation of Income and Distributions
from Partnerships, S Corporations, Trusts, and Estates
Income in Community Property States
4-12
4-13
4-14
4-14
4-15
4-17
4-18
4-18
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
pecial Rules Related to Certain
S
Items Included in Gross Income
Alimony and Separate Maintenance Payments
Ethics & Equity: The Taxation of Alimony and the Alimony Tax Gap
Concept Summary: Tax Treatment of Payments and Transfers
Pursuant to Divorce Agreements and Decrees
Imputed Interest on Below-Market Loans
Concept Summary: Effect of Certain Below-Market Loans
on the Lender and Borrower
Concept Summary: Exceptions to the Imputed Interest
Rules for Below-Market Loans
Ethics & Equity: Taxing “Made-Up” Income
Income from Annuities
Prizes and Awards
Unemployment Compensation
Ethics & Equity: Tax Treatment of Unemployment Compensation
Social Security Benefits
Income Earned from Foreign Bank and Financial
Accounts and FBAR Rules
Tax Planning
4-20
4-20
4-22
4-23
4-23
Medical Reimbursement Plans
Long-Term Care Insurance Benefits
Meals and Lodging
4-26
4-26
4-26
4-29
4-29
4-30
4-30
4-31
4-32
4-32
4-32
4-34
4-35
Chapter 5
Gross Income: Exclusions
5-1
5-1
5-2
Income Exclusions
5-2
Exclusion Defined
Exclusions versus Non-Income Items
5-2
5-3
Gifts and Inheritances
5-3
Legislative Intent
Employer Payments to Employees
Employee Death Benefits
5-3
5-4
5-4
Life Insurance Proceeds
5-5
General Rule
Accelerated Death Benefits
Ethics & Equity: Should the Terminally Ill Pay Social Security Taxes?
Transfer for Valuable Consideration
5-5
5-5
5-6
5-6
Scholarships5-7
General Information
Timing Issues
5-7
5-8
Compensation for Injuries and Sickness
5-8
Damages5-8
Ethics & Equity: Tax Treatment of Damages Not Related
to Physical Personal Injury
5-9
Concept Summary: Taxation of Damages
5-9
Ethics & Equity: Classifying the Amount of the Claim
5-10
19688_fm_hr_i-xIii.indd 29
mployer-Sponsored Accident and
E
Health Plans
5-10
5-10
5-10
5-11
5-11
5-12
4-24
Minimize Income Included in Gross Income
Tax Deferral
Shifting Income to Other Taxpayers
Refocus on The Big Picture: Calculation of Gross Income
The Big Picture: Exclusions
Framework 1040: Tax Formula for Individuals
Wrongful Incarceration
Workers’ Compensation
Accident and Health Insurance Benefits
xxix
5-13
General Rules for the Exclusion
Other Housing Exclusions
5-13
5-14
Employee Fringe Benefits
5-14
Specific Benefits
Cafeteria Plans
Flexible Spending Plans
General Classes of Excluded Benefits
Ethics & Equity: Fringe Benefits
Group Term Life Insurance
Foreign Earned Income
Concept Summary: Employee Fringe Benefits
Global Tax Issues: Benefits of the Earned Income
Exclusion Are Questioned
5-15
5-15
5-16
5-16
5-20
5-20
5-21
5-22
5-22
I nterest on Certain State and Local
Government Obligations
5-23
Educational Savings Bonds
5-24
ducation Savings Programs (§ 529 and
E
§ 530 Plans)
5-25
Qualified Tuition Program
Coverdell Education Savings Account
5-26
5-26
Qualified ABLE Programs (§ 529A Plans)
5-26
Income from Discharge of Indebtedness
5-27
Tax Benefit Rule
5-28
Tax Planning
5-30
Life Insurance
5-30
Employee Fringe Benefits
5-30
Investment Income
5-31
Refocus on The Big Picture: Exclusions5-32
Part 3: Deductions and Credits
Chapter 6
Deductions and Losses:
In General
The Big Picture: Calculation of Deductible Expenses
Framework 1040: Tax Formula for Individuals
6-1
6-1
6-2
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xxx
Contents
Classification of Deductible Expenses
6-2
Bad Debts
7-2
Classifying Deductions
Authority for Deductions
Deduction Criteria for § 162 and § 212
Personal Expenses
Business and Nonbusiness Losses
Deduction for Qualified Business Income
Reporting Procedures
6-3
6-3
6-5
6-6
6-6
6-7
6-9
Specific Charge-Off Method
Concept Summary: The Tax Treatment of Bad Debts
Using the Specific Charge-Off Method
Business versus Nonbusiness Bad Debts
Loans between Related Parties
Concept Summary: Bad Debt Deductions
7-3
eductions and Losses—Timing
D
of Expense Recognition
Importance of Taxpayer’s Method of Accounting
Cash Method Requirements
Accrual Method Requirements
Prepaid Expenses—The “12-Month Rule”
Time Value of Tax Deductions
Disallowance Possibilities
6-10
6-10
6-10
6-10
6-12
6-12
6-13
Public Policy Limitation
6-13
Global Tax Issues: Overseas Gun Sales Result in Large Fines
6-14
Ethics & Equity: State Allowed Marijuana Activity: Do Regular
Business Deduction Rules Apply (or Those for Drug
Dealers)?6-15
Political Contributions and Lobbying Activities
6-15
Excessive Executive Compensation
6-16
Investigation of a Business
6-17
Concept Summary: Costs of Investigating a Business
6-18
Hobby Losses
6-18
Concept Summary: Common Questions from the
IRS Concerning Hobbies/Businesses with Losses
6-20
Rental of Vacation Homes
6-21
Concept Summary: Vacation/Rental Home
6-22
Expenditures Incurred for Taxpayer’s Benefit
or ­Taxpayer’s Obligation
6-25
Disallowance of Personal Expenditures
6-26
Ethics & Equity: Personal or Business Expenses?
6-26
Disallowance of Deductions for Capital Expenditures
6-26
Transactions between Related Parties
6-28
Substantiation Requirements
6-29
Expenses and Interest Relating to Tax-Exempt
Income6-29
Other Disallowances
6-30
Tax Planning
Vacation Homes
Concept Summary: Classification of Expenses
Hobby Losses
Do Deduction Limits Affect Executive Compensation?
Refocus on The Big Picture: Calculation of Deductible
Business Expenses and Tax Planning
6-30
6-30
6-31
6-32
6-33
6-33
Chapter 7
Deductions and Losses: ­Certain
Business Expenses and Losses
7-1
The Big Picture: Losses
Framework 1040: Tax Formula for Individuals
7-1
7-2
19688_fm_hr_i-xIii.indd 30
7-4
7-4
7-5
7-5
Worthless Securities and Small Business
Stock Losses
7-6
Worthless Securities
Small Business Stock (§ 1244 Stock) Losses
7-6
7-6
Losses of Individuals
7-7
Events That Are Not Casualties
Theft Losses
When to Deduct Casualty Losses
Measuring the Amount of Loss
Ethics & Equity: Is Policy Cancellation an Escape Hatch?
Personal Casualty Gains and Losses
Concept Summary: Casualty Gains and Losses
Statutory Framework for Deducting Losses
of Individuals
Concept Summary: Statutory Framework for Deducting
Losses of Individuals
7-7
7-8
7-8
7-9
7-10
7-12
7-14
Research and Experimental Expenditures
Expense Method
Deferral and Amortization Method
Excess Business Losses
Excess Business Loss Defined
Losses from Partnerships or S Corporations
Other Rules
Net Operating Losses
General Rules
Computation of the Net Operating Loss
Concept Summary: Computation of Net Operating Loss
Computation of Taxable Income for Year to Which
Net Operating Loss Is Carried
Calculation of the Remaining Net Operating Loss
Tax Planning
7-14
7-15
7-15
7-16
7-16
7-17
7-17
7-18
7-19
7-19
7-20
7-20
7-21
7-23
7-24
7-25
Small Business Stock (§ 1244 Stock) Losses
7-25
Casualty Losses
7-25
Refocus on The Big Picture: Losses7-25
Chapter 8
Depreciation, Cost Recovery,
Amortization, and Depletion
The Big Picture: Calculating Cost Recovery Deductions
Framework 1040: Tax Formula for Individuals
8-1
8-1
8-2
Depreciation and Cost Recovery
8-2
Nature of Property
8-2
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
Placed in Service Requirement
Cost Recovery Allowed or Allowable
Cost Recovery Basis for Personal Use Assets ­
Converted to Business or Income-Producing Use
odified Accelerated Cost Recovery ­System (MACRS):
M
General Rules
Concept Summary: MACRS: Class Lives, Methods,
and Conventions
Personalty (and Certain Realty): Recovery Periods
and Methods
Financial Disclosure Insights: Tax and Book Depreciation
Concept Summary: Straight-Line Cost Recovery
under MACRS (Personalty vs. Realty)
Realty: Recovery Periods and Methods
odified Accelerated Cost Recovery ­
M
System (MACRS): Special Rules
Election to Expense Assets (§ 179)
Ethics & Equity: Section 179 Limitation
Additional First-Year Depreciation (Bonus Depreciation)
Using § 179 and Bonus Depreciation Effectively
Concept Summary: Using § 179 and Bonus Depreciation in 2022
Business and Personal Use of Automobiles
and Other Listed Property
Alternative Depreciation System (ADS)
Reporting Procedures
8-3
8-3
Travel Expenses
9-9
8-4
Definition of Travel Expenses
Away-from-Home Requirement
Restrictions on Travel Expenses
Combined Business and Pleasure Travel
9-9
9-10
9-11
9-12
8-4
Education Expenses
8-4
8-5
8-6
8-9
8-9
8-10
8-10
8-14
8-14
8-15
8-17
8-18
8-23
8-24
Amortization8-25
Depletion8-28
Intangible Drilling and Development Costs (IDCs)
Depletion Methods
Tax Planning
8-29
8-29
8-31
Cost Recovery
8-31
Amortization8-32
Cost Recovery Tables
8-32
Refocus on The Big Picture: Calculating Cost Recovery Deductions 8-36
Chapter 9
Deductions: Employee and
­Self-Employed-Related Expenses
The Big Picture: The First Job
Framework 1040: Tax Formula for Individuals
Employee versus Independent Contractor
Concept Summary: Employee versus Independent Contractor
General Requirements
Legal Requirements to Keep a Job
Maintaining or Improving Existing Skills
Concept Summary: Conditions for Deducting Regular
Education Expenses
What Expenses Are Allowed?
Other Provisions Dealing with Education
Concept Summary: Tax Consequences of Provisions
Dealing with Education
Other Business Expenses
Office in the Home
Moving Expenses
Entertainment and Meal Expenses
Ethics & Equity: Your Turn or Mine?
Miscellaneous Employee Expenses
Contributions to Retirement Accounts
§ 401(k) Plans
Individual Retirement Accounts (IRAs)
General Rules
Taxation of Benefits
Rollovers and Conversions
Concept Summary: Comparison of IRAs
9-1
9-1
9-2
9-2
9-4
9-5
Transportation Expenses
9-5
Qualified Expenses
Computation of Automobile Expenses
9-5
9-6
9-14
9-14
9-14
9-15
9-15
9-15
9-16
9-16
9-17
9-17
9-21
9-21
9-23
9-24
9-25
9-25
9-26
9-26
9-29
9-30
9-30
etirement Plans for Self-Employed
R
Individuals9-31
Keogh (H.R. 10) Plans
9-31
Solo § 401(k) Plans
9-31
Savings Incentive Match Plan for Employees
(SIMPLE Plans)9-32
Simplified Employee Pension Plans (SEPs)
9-32
Classification of Employee Expenses
elf-Employed and Employee-Related
S
Expenses—In General
19688_fm_hr_i-xIii.indd 31
xxxi
Accountable Plans
Nonaccountable Plans
Limitations on Itemized Deductions
Miscellaneous Itemized Deductions Subject
to the 2%-of-AGI Floor
Miscellaneous Itemized Deductions Not Subject
to the 2%-of-AGI Floor
Tax Planning
Employment Status
Implications of Misclassifying Workers
Transportation and Travel Expenses
Refocus on The Big Picture: The First Job
9-32
9-33
9-34
9-34
9-34
9-35
9-35
9-35
9-36
9-36
9-37
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xxxii
Contents
Chapter 10
Deductions and Losses:
Certain Itemized Deductions
The Big Picture: Impact of Itemized Deductions
on Major Purchases
Framework 1040: Tax Formula for Individuals
Medical Expenses
10-1
10-1
10-2
The Big Picture: Investor Loss Limitations Affect the Viability
of Certain Investment Opportunities
Framework 1040: Tax Formula for Individuals
Taxes10-10
11-2
At-Risk Limits
11-4
10-10
10-11
10-13
Concept Summary: Calculation of At-Risk Amount
Passive Activity Loss Limits
Classification and Tax Treatment of Passive Activity
Income and Losses
Taxpayers Subject to the Passive Activity Loss Rules
Rules for Determining Passive Activities
Concept Summary: Tests to Determine Material Participation
Interaction of the At-Risk and Passive Activity Loss Limits
Special Passive Activity Rules for Real Estate Activities
Concept Summary: Treatment of Losses Subject to the
At-Risk and Passive Activity Loss Limitations
Ethics & Equity: Punching the Time Clock at Year-End
Dispositions of Passive Interests
Investment Interest Limitation
Allowed and Disallowed Items
Restrictions on Deductibility and Timing Considerations
Classification of Interest Expense
Concept Summary: Deductibility of Personal, Student Loan,
Mortgage, and Investment Interest
Limitation Imposed
Concept Summary: Passive Activity Loss Rules: Key
Issues and Answers
Computation of Allowable Deduction
Criteria for a Gift
Qualified Organizations
Ethics & Equity: An Indirect Route to a Contribution Deduction
Time of Deduction
Record-Keeping and Valuation Requirements
Concept Summary: Documentation and Substantiation
Requirements for Charitable Contributions
Global Tax Issues: Choose the Charity Wisely
Limitations on Charitable Contribution Deduction
Concept Summary: Determining the Deduction for
Contributions by Individuals
10-14
10-17
10-17
10-18
10-18
10-18
10-20
10-20
10-20
10-21
10-21
10-22
10-22
10-25
iming of Payments to Maximize
T
Deductions10-26
Other Itemized Deductions
10-27
Comprehensive Example of Schedule A
10-27
Tax Planning
10-29
Maximizing the Medical Deduction
Ensuring the Charitable Contribution Deduction
Planning to Avoid Nondeductible Treatment
Refocus on The Big Picture: Impact of Itemized Deductions
on Major Purchases
19688_fm_hr_i-xIii.indd 32
11-1
11-2
The Tax Shelter Problem
Interest10-14
Charitable Contributions
11-1
10-3
Medical Expenses Defined
10-3
Capital Expenditures for Medical Purposes
10-4
Medical Expenses Incurred for Spouse and Dependents
10-5
Transportation, Meal, and Lodging Expenses
for ­Medical Treatment
10-6
Amounts Paid for Medical Insurance Premiums
10-6
Year of Deduction
10-7
Reimbursements10-7
Health Savings Accounts
10-8
Affordable Care Act Provisions
10-10
Deductibility as a Tax
Property Taxes
State and Local Income Taxes and Sales Taxes
Chapter 11
Investor Losses
10-29
10-29
10-31
10-31
Other Investment Losses
Concept Summary: Common Investment Loss
Limitation Rules
Tax Planning
Minimizing the Impact of the Passive Activity Loss Limits
Maximizing the Investment Interest Deduction
Effect of the Additional Tax on Net Investment Income
Refocus on The Big Picture: Investor Loss Limitations Can
Affect Investment Returns
Chapter 12
Tax Credits and Payments
The Big Picture: Education Tax Credits
Framework 1040: Tax Formula for Individuals
11-5
11-5
11-5
11-9
11-10
11-14
11-15
11-16
11-17
11-18
11-20
11-21
11-21
11-22
11-23
11-23
11-24
11-24
11-24
11-26
11-26
11-27
12-1
12-1
12-2
Tax Policy Considerations
12-3
Overview and Priority of Credits
12-4
Refundable versus Nonrefundable Credits
General Business Credit
Treatment of Unused General Business Credits
Specific Business-Related Tax Credits
Tax Credit for Rehabilitation Expenditures
Work Opportunity Tax Credit
12-4
12-5
12-5
12-6
12-6
12-7
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
Research Activities Credit
Low-Income Housing Credit
Disabled Access Credit
Credit for Small Employer Pension Plan Startup Costs
Credit for Employer-Provided Child Care
Credit for Employer-Provided Family and Medical Leave
Other Tax Credits Earned Income Credit
Foreign Tax Credit
Child and Dependent Tax Credits
Credit for Child and Dependent Care Expenses
Ethics & Equity: Is This the Right Way to Use the Credit
for Child and Dependent Care Expenses?
Education Tax Credits
Energy Credits
Credit for Certain Retirement Plan Contributions
Concept Summary: Tax Credits
Payment Procedures
12-7
12-9
12-10
12-11
12-11
12-12
12-12
12-12
12-14
12-15
12-15
12-17
12-18
12-19
12-19
12-21
12-23
Employers12-23
Self-Employed Taxpayers
12-25
Additional Medicare Taxes on High-Income Individuals
12-29
Alternative Minimum Tax
12-31
Tax Planning
Credit for Child and Dependent Care Expenses
Adjustments to Increase Withholding
Adjustments to Avoid Overwithholding
Energy Credits
Refocus on The Big Picture: Education Tax Credits
12-33
12-33
12-34
12-35
12-35
12-35
Part 4: Property Transactions
Chapter 13
Property Transactions:
Determination of Gain or Loss,
Basis Considerations,
and Nontaxable Exchanges
The Big Picture: Sale or Gift of Inherited House and Other
Property Transactions
Framework 1040: Tax Formula for Individuals
Determination of Gain or Loss
Realized Gain or Loss
Concept Summary: Realized Gain or Loss
Recognized Gain or Loss
Concept Summary: Realized and Recognized
Gain or Loss
Nonrecognition of Gain or Loss
Inherited Property
Disallowed Losses
Concept Summary: Wash Sale Rules
Ethics & Equity: Washing a Loss Using an IRA
Property Converted from Personal Use to
Business or Income-Producing Use
Summary of Basis Adjustments
Concept Summary: Adjustments to Basis
13-1
13-2
13-2
13-3
13-3
13-8
13-8
13-8
13-14
13-16
13-18
13-19
13-19
13-20
13-21
Nontaxable Exchanges
13-22
Like-Kind Exchanges—§ 1031
13-22
Like-Kind Property
13-23
Exchange Requirement
13-24
Concept Summary: Delayed § 1031 Exchange
13-25
Boot13-25
Basis and Holding Period of Property Received
13-26
Reporting Considerations
13-29
Involuntary Conversions—§ 1033
Involuntary Conversion Defined
Computing the Amount Realized
Replacement Property
Concept Summary: Involuntary Conversions: Replacement
Property Tests
Time Limitation on Replacement
Nonrecognition of Gain
Reporting Considerations
Sale of a Residence—§ 121
Principal Residence
Requirements for Exclusion Treatment
Calculating the Exclusion
Exceptions to the Two-Year Rules
Tax Planning
13-1
xxxiii
Cost Identification and Documentation Considerations
Selection of Property for Making Gifts
Selection of Property to Pass at Death
Disallowed Losses
Like-Kind Exchanges
Involuntary Conversions
Sale of a Principal Residence
Refocus on The Big Picture: Sale or Gift of Inherited House
and Other Property Transactions
Chapter 14
Property Transactions: Capital
Gains and Losses, § 1231,
and Recapture Provisions
13-29
13-31
13-31
13-32
13-33
13-33
13-34
13-35
13-35
13-36
13-36
13-38
13-39
13-41
13-41
13-41
13-42
13-42
13-43
13-43
13-44
13-45
14-1
Basis Considerations
13-9
The Big Picture: Managing Capital Asset
Transactions14-1
Framework 1040: Tax Formula for Individuals
14-2
Determination of Cost Basis
Gift Basis
13-9
13-12
General Scheme of Taxation
19688_fm_hr_i-xIii.indd 33
14-3
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xxxiv
Contents
Capital Assets
Definition of a Capital Asset (§ 1221)
Ethics & Equity: Sculpture as a Capital Asset
Effect of Judicial Action
Statutory Expansions
Sale or Exchange
14-3
14-4
14-6
14-6
14-7
14-8
Worthless Securities and § 1244 Stock
14-8
Retirement of Corporate Obligations
14-9
Options14-9
Concept Summary: Options: Consequences to the
Grantor and Grantee
14-11
Patents14-11
Franchises, Trademarks, and Trade Names (§ 1253)
14-12
Concept Summary: Franchises: Consequences to the
Franchisor and Franchisee
14-14
Lease Cancellation Payments
14-14
Holding Period
General Rules
Special Holding Period Rules
Special Rules for Short Sales
Concept Summary: Short Sales of Securities
ax Treatment of Capital Gains
T
and Losses of Noncorporate Taxpayers
Capital Gain and Loss Netting Process
Qualified Dividend Income
Alternative Tax on Net Capital Gain and Qualified
Dividend Income
Concept Summary: Income Layers for Alternative
Tax on Capital Gain Computation
Treatment of Net Capital Losses
Concept Summary: Final Results of the Capital Gain
and Loss Netting Process and How They Are Taxed
14-15
14-15
14-15
14-16
14-18
14-19
14-19
14-22
14-22
14-24
14-26
14-27
ax Treatment of Capital Gains
T
and Losses of Corporate Taxpayers
14-27
Overview of § 1231 and the Recapture Provisions
14-28
Section 1231 Assets
14-28
Relationship to Capital Assets
Property Included
Property Excluded
Section 1231 Assets Disposed of by Casualty or Theft
Concept Summary: Section 1231 Netting Procedure
(Discussed in text Section 14-8e)
General Procedure for § 1231 Computation
Section 1245 Recapture
Section 1245 Property
Observations on § 1245
14-28
14-29
14-30
14-30
14-31
14-32
14-35
14-37
14-38
Concept Summary: Comparison of § 1245
and § 1250 Depreciation Recapture
Unrecaptured § 1250 Gain (Real Estate 25% Gain)
Ethics & Equity: The Sale of a “Cost-Segregated” Building
Considerations Common
to §§ 1245 and 1250
Section 1250 Recapture Situations
19688_fm_hr_i-xIii.indd 34
14-38
14-39
14-41
Exceptions14-41
Global Tax Issues: Depreciation Recapture in
Other Countries
14-42
Other Applications
14-43
Concept Summary: Depreciation Recapture
and § 1231 Netting Procedure
14-44
Special Recapture Provisions
Special Recapture for Corporations
Gain from Sale of Depreciable Property
between Certain Related Parties
Intangible Drilling Costs
Reporting Procedures
Ethics & Equity: Incorrect Depreciation and Recognized Gain
Tax Planning
Importance of Capital Asset Status
Planning for Capital Asset Status
Global Tax Issues: Capital Gain Treatment in the United
States and Other Countries
Effect of Capital Asset Status in Transactions
Other Than Sales
Stock Sales
Maximizing Benefits
Year-End Planning
Timing of § 1231 Gain
Timing of Recapture
Postponing and Shifting Recapture
Avoiding Recapture
Refocus on The Big Picture: Managing Capital
Asset Transactions
14-44
14-44
14-45
14-45
14-45
14-45
14-46
14-46
14-46
14-47
14-47
14-48
14-48
14-48
14-48
14-49
14-49
14-50
14-50
Part 5: Special Tax
Computations and
Accounting Periods and
Methods
Chapter 15
The Deduction for ­Qualified
Business Income for
Noncorporate Taxpayers
15-1
The Big Picture: Entrepreneurial Pursuits
15-1
Tax Treatment of Various Business Forms
Section 1250 Recapture
14-39
14-39
14-41
15-2
Sole Proprietorships
15-2
Partnerships15-3
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
Corporations15-3
Concept Summary: Tax Treatment of Business
Forms Compared
15-6
Global Tax Issues: U.S. Corporate Taxes and International
Business Competitiveness
15-7
Limited Liability Companies
15-7
The Challenges of Taxing Business Activities:
Entity Tax Rates
Challenges of Lowering Tax Rates
Lowering Tax Rates for Different Business Forms
15-8
15-8
15-9
Concept Summary: Accruals Under the Economic
Performance Test (Reg. § 1.461–4)
16-14
Financial Disclosure Insights: Tax Deferrals from
Reserves16-16
Hybrid Method
16-16
Change of Method
16-17
Ethics & Equity: Change in Accounting Method
16-19
Special Accounting Methods
Installment Method
Long-Term Contracts
The Deduction for Qualified Business Income
15-10
General Rule
The Overall Limitation: Modified Taxable Income
Definition of Qualified Business Income
Definition of a Qualified Trade or Business
Limitations on the QBI Deduction
Limitation Based on Wages and Capital Investment
Concept Summary: An Overview of the 2022 Qualified
Business Income Deduction
Limitation for “Specified Services” Businesses
Reporting the Qualified Business Income Deduction
Aggregation of Qualified Trades and Businesses
Under the § 199A Regulations
Treatment of Losses
Coordination with Other Rules
Considerations for Partnerships and S Corporations
Other Items in the § 199A Regulations
15-10
15-10
15-11
15-11
15-14
15-14
Determining Inventory Cost
Ethics & Equity: Preserving the LIFO Reserve
The LIFO Election
Special Inventory Methods Relating to Farming
and Ranching
Inventory of Small Taxpayers
15-15
15-18
15-26
Tax Planning
Tax Planning
15-27
15-32
15-34
15-35
15-35
15-36
Corporate versus Noncorporate Forms of Business
Organization15-36
Optimizing the Deduction for Qualified Business Income
15-37
Refocus on The Big Picture: Entrepreneurial Pursuits
15-37
Chapter 16
Accounting Periods and Methods
The Big Picture: Accounting Period and Method
Framework 1040: Tax Formula for Individuals
Accounting Periods
Specific Provisions for Partnerships, S Corporations,
and Personal Service Corporations
Ethics & Equity: Who Benefits from the Change
in Tax Year?
Selecting the Tax Year
Changes in the Accounting Period
Taxable Periods of Less Than One Year
Mitigation of the Annual Accounting Period Concept
Ethics & Equity: Special Tax Relief
Accounting Methods
Permissible Methods
Cash Receipts and Disbursements Method
Accrual Method
19688_fm_hr_i-xIii.indd 35
16-1
16-1
16-2
16-2
16-3
16-5
16-6
16-6
16-7
16-8
16-10
16-10
16-10
16-11
16-13
xxxv
16-19
16-19
16-25
Inventories16-28
16-29
16-33
16-33
16-34
16-34
16-35
Taxable Year
16-35
Cash Method of Accounting
16-35
Installment Method
16-35
Inventories16-36
Refocus on The Big Picture: Accounting Period
and Method
16-36
Part 6: Corporations
Chapter 17
Corporations: Introduction
and Operating Rules
17-1
The Big Picture: A Half-Baked Idea?
17-1
n Introduction to the Income
A
Taxation of Corporations
17-2
An Overview of Corporate versus Individual Income
Tax Treatment
17-2
Specific Provisions Compared
17-3
Accounting Periods and Methods
17-4
Capital Gains and Losses
17-5
Recapture of Depreciation
17-6
Business Interest Expense Limitation
17-6
Passive Activity Losses
17-8
Concept Summary: Special Rules Applicable to Personal
Service Corporations (PSCs)
17-9
Charitable Contributions
17-9
Excessive Executive Compensation
17-11
Net Operating Losses
17-12
Deductions Available Only to Corporations
17-12
Ethics & Equity: Pushing the Envelope on Year-End
Planning17-15
Concept Summary: Income Taxation of Individuals
and Corporations Compared
17-17
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xxxvi
Contents
etermining the Corporate Income
D
Tax Liability
Corporate Income Tax Rates
Alternative Minimum Tax
Restrictions on Corporate Accumulations
Consolidated Returns
Financial Disclosure Insights: GAAP and Tax Treatment
of Consolidations
Procedural Matters
Filing Requirements for Corporations
Estimated Tax Payments
Schedule M–1—Reconciliation of Income
(Loss) per Books with Income per Return
Schedule M–2—Analysis of Unappropriated Retained
Earnings per Books
Concept Summary: Conceptual Diagram of
Schedule M–1 (Form 1120)
Schedule M–3—Net Income (Loss) Reconciliation for
Corporations with Total Assets of $10 Million or More
Income Taxes in the Financial Statements
Tax Planning
Investor Losses
17-18
17-18
17-19
17-19
17-20
17-22
17-23
17-23
17-24
17-24
17-25
17-26
17-26
17-28
17-34
Corporate versus Noncorporate Forms of Business
Organization17-34
Operating the Corporation
17-35
Refocus on The Big Picture: Cooked to Perfection
17-37
Chapter 18
Corporations: Organization
and Capital Structure
The Big Picture: The Vehicle for Business Growth Is
the Corporate Form
rganization of and Transfers
O
to ­Controlled Corporations
18-1
18-1
18-2
Section 351 Rationale and General Rules
18-2
Global Tax Issues: Tax Reform Adds a New Wrinkle to the
Choice of Organizational Form When Operating Overseas
18-3
Concept Summary: Shareholder Consequences: Taxable
Corporate Formation versus Tax-Deferred § 351
Transaction18-5
Property Defined
18-5
Stock Transferred
18-6
Control of the Corporation
18-6
Basis Determination and Related Issues
18-10
Concept Summary: Tax Consequences to the Shareholders
and Corporation: With and Without the Application of
§ 351 (Based on the Facts of Example 16)
18-11
Assumption of Liabilities—§ 357
18-14
Concept Summary: Tax Consequences of
Liability Assumption
18-17
Capital Structure of a Corporation
Capital Contributions
Debt in the Capital Structure
19688_fm_hr_i-xIii.indd 36
18-18
18-18
18-18
18-21
Stock and Security Losses
18-21
Ethics & Equity: Can a Loss Produce a Double
Benefit?18-21
Business versus Nonbusiness Bad Debts
18-21
Section 1244 Stock
18-23
Gain from Qualified Small
Business Stock
18-24
Tax Planning
18-24
Working with § 351
Selecting Assets to Transfer
Debt in the Capital Structure
Investor Losses
Corporations versus Flow-Through Entities
Refocus on The Big Picture: The Vehicle for Business Growth
Is the Corporate Form
Chapter 19
Corporations: Distributions
Not in Complete Liquidation
The Big Picture: Taxing Corporate Distributions
18-24
18-26
18-26
18-27
18-28
18-29
19-1
19-1
Corporate Distributions—Overview
19-2
Earnings and Profits (E & P)—§ 312
19-3
Computation of E & P
Summary of E & P Adjustments
Concept Summary: E & P Adjustments
Current versus Accumulated E & P
Allocating E & P to Distributions
Concept Summary: Allocating E & P to Distributions
Ethics & Equity: Shifting E & P
19-3
19-6
19-7
19-8
19-8
19-9
19-12
Dividends19-12
Rationale for Reduced Tax Rates on Dividends
Qualified Dividends
Property Dividends
Concept Summary: Noncash Property Distributions
Constructive Dividends
Stock Dividends and Stock Rights
Stock Redemptions
19-12
19-13
19-14
19-16
19-16
19-19
19-21
Overview19-21
Global Tax Issues: Foreign Shareholders Prefer Sale
or Exchange Treatment in Stock Redemptions
19-23
Historical Background
19-24
Concept Summary: Summary of the Qualifying Stock
Redemption Rules
19-25
Stock Attribution Rules
19-25
Concept Summary: Tax Consequences of Stock Redemptions
to Shareholders
19-27
Not Essentially Equivalent Redemptions
19-27
Disproportionate Redemptions
19-28
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
Complete Termination Redemptions
Partial Liquidations
Redemptions to Pay Death Taxes
19-29
19-29
19-30
tock Redemptions—Effect on
S
the Corporation
19-31
Recognition of Gain or Loss
Effect on Earnings and Profits
Redemption Expenditures
19-31
19-32
19-32
Other Corporate Distributions
19-32
Tax Planning
19-32
Corporate Distributions
Planning for Qualified Dividends
Constructive Dividends
Stock Redemptions
Refocus on The Big Picture: Taxing Corporate Distributions
Chapter 20
Corporations: Distributions
in Complete Liquidation and
an Overview of Reorganizations
The Big Picture: The Options for Transitioning to Retirement
Liquidations—In General
The Liquidation Process
Liquidating and Nonliquidating Distributions Compared
iquidations—Effect on the
L
Distributing Corporation
The General Rule
Antistuffing Rules
Concept Summary: Summary of Antistuffing Loss
Disallowance Rules
19-32
19-34
19-35
19-37
19-38
20-1
20-2
20-2
20-2
20-3
20-3
20-4
20-8
Liquidations—Effect on the
Shareholder20-8
Ethics & Equity: Transferee Liability for Tax Deficiency
of Liquidated Corporation
20-9
Liquidations—Parent-Subsidiary
Situations20-9
Minority Shareholder Interests
20-10
Indebtedness of the Subsidiary to the Parent
20-10
Global Tax Issues: Basis Rules for Liquidations of Foreign
Subsidiaries20-11
Basis of Property Received by the Parent ­
Corporation—The General Rule
20-11
Basis of Property Received by the Parent ­
Corporation—§ 338 Election
20-12
Concept Summary: Summary of Liquidation Rules
20-13
Corporate Reorganizations
In General
Different Types of Reorganizations
19688_fm_hr_i-xIii.indd 37
Tax Consequences in a Tax-Free Reorganization
20-15
Concept Summary: Gain and Basis Rules for Nontaxable
Exchanges20-16
Financial Disclosure Insights: Blank Check Companies
20-17
Concept Summary: Basis to Acquiring Corporation
of Property Received
20-18
Tax Planning
Effect of a Liquidating Distribution on the Corporation
Effect of a Liquidating Distribution on the Shareholder
Parent-Subsidiary Liquidations
Asset Purchase versus Stock Purchase
Refocus on The Big Picture: The Transition to Retirement
Is Subject to Double Taxation
20-14
20-15
20-15
20-19
20-19
20-19
20-20
20-20
20-21
Part 7: Flow-Through Entities
Chapter 21
Partnerships21-1
The Big Picture: Why Use a Partnership, Anyway?
20-1
xxxvii
Overview of Partnership Taxation
What Is a Partnership?
Concept Summary: Comparison of Partnership Types
Key Concepts in Taxation of Partnership Income
Formation of a Partnership: Tax Effects
Contributions to the Partnership
Exceptions to the General Rule of § 721
Other Issues Related to Contributed Property
Concept Summary: Partnership Formation and Initial
Basis Computations
Tax Accounting Elections
Initial Costs of a Partnership
Method of Accounting
Taxable Year of the Partnership
Partnership Operations and Reporting
21-1
21-2
21-2
21-3
21-4
21-6
21-6
21-7
21-9
21-11
21-11
21-12
21-12
21-13
21-15
Partnership Reporting
21-15
Measuring Partnership Income
21-16
Form 1065 Example
21-18
Financial Disclosure Insights: Financial Reporting for
Partnerships21-24
Partner Calculations and Reporting
Partner Reporting of Partnership Income
Partner Allocations
Schedule K–1 Example
Concept Summary: Tax Reporting of
Partnership Items
Partner’s Basis
Effect of Partnership Liabilities
Partner’s Capital Account
Concept Summary: Comparing a Partner’s Tax Basis
and Capital Account
21-24
21-24
21-26
21-28
21-30
21-31
21-31
21-35
21-36
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xxxviii
Contents
Loss Limitations
Global Tax Issues: Withholding Requirements for
non-U.S. Partners
Other Taxes on Partnership Income
Self-Employment Tax
Net Investment Income Tax
21-36
21-38
21-39
21-39
21-40
Distributions from the Partnership
21-40
Distributions in General
Proportionate Current Distributions
Proportionate Liquidating Distributions
Concept Summary: Proportionate Current
Distributions (General Rules)
21-40
21-41
21-44
Sale of a Partnership Interest
General Rules
Hot Assets and Carried Interests
21-45
21-47
21-47
21-48
Limited Liability Entities
21-49
Limited Liability Companies
Limited Liability Partnerships
21-49
21-50
Tax Planning
Choosing Partnership Taxation
Formation and Operation of a Partnership
Basis Considerations and Loss Deduction Limitations
Concept Summary: Major Advantages and Disadvantages
of the Partnership Form
Partners’ Capital Considerations
Transactions between Partners and Partnerships
Drafting the Partnership Agreement
Refocus on The Big Picture: Why Use a Partnership, Anyway?
Chapter 22
S Corporations
The Big Picture: Deductibility of Losses and the Choice
of Business Entity
21-50
21-50
21-51
21-51
21-52
21-52
21-53
21-53
21-53
22-1
Concept Summary: Consequences of Noncash
Distributions22-18
Shareholder’s Basis in S Stock
22-19
Treatment of Losses
22-21
Tax on Pre-Election Built-In Gain
22-22
LIFO Recapture Tax
22-23
Passive Investment Income Penalty Tax
22-23
Other Operational Rules
22-24
Tax Planning
When the Election Is Advisable
Concept Summary: Making an S Election
Making a Proper Election
Operation of the S Corporation
Overall Comparison of Forms of
Doing Business
Concept Summary: Tax Attributes of Different Forms of Business
(Assume That Partners and Shareholders Are All Individuals)
Refocus on The Big Picture: Using a Pass-Through Entity
to Achieve Deductibility of Losses
An Overview of S Corporations
22-2
22-3
22-3
22-5
22-6
22-7
Chapter 23
Exempt Entities
The Big Picture: Effect of a For-Profit Business on a
Tax-Exempt Entity
22-28
22-31
23-1
23-1
Types of Exempt Organizations
23-3
Characteristics of Exempt Entities
23-3
Serving the Common Good
Not-for-Profit Entity
Use of Net Earnings
Concept Summary: Consequences of Exempt Status
Taxable Transactions
Feeder Organizations
23-3
23-3
23-4
23-5
22-9
Taxable Income
Qualified Business Income Deduction
Allocation of Income and Loss
Distributions to Shareholders
Concept Summary: Classification Procedures for
Distributions from an S Corporation
Noncash Property Distributions
22-9
22-12
22-12
22-13
22-14
22-18
23-5
23-5
23-8
Private Foundations and Public Charities
23-8
Tax Consequences of Private Foundation Status
Concept Summary: Exempt Organizations: Classification
Taxes Imposed on Private Foundations
23-8
23-10
23-11
Unrelated Business Income Tax
Operational Rules
19688_fm_hr_i-xIii.indd 38
22-27
Part 8: Advanced Tax Practice
Considerations
Taxes on Exempt Entities
22-2
Defining an S Corporation
Making the Election
Shareholder Consent
Loss of the Election
22-25
22-25
22-26
22-26
22-1
Choice of Business Entity
Qualifying for S Corporation Status
22-25
Unrelated Trade or Business
Unrelated Business Taxable Income
Concept Summary: Unrelated Business Income Tax
Reporting Requirements
Obtaining Exempt Organization Status
Annual Filing Requirements
Disclosure Requirements
23-12
23-13
23-16
23-18
23-19
23-19
23-19
23-20
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
Tax Planning
Choosing an Exempt Classification
Maintaining Exempt Status
Private Foundations
Unrelated Business Income Tax
Refocus on The Big Picture: Effect of a For-Profit Business
on a Tax-Exempt Entity
Chapter 24
Multistate Corporate Taxation
The Big Picture: Making a Multistate Location Decision
Corporate State Income Taxation
Computing State Income Tax
State Modifications
The UDITPA and the Multistate Tax Commission
Jurisdiction to Impose Tax:
Nexus and Public Law 86–272
Nexus in Today’s Economy
Concept Summary: Multistate Taxation
pportionment and Allocation
A
of Income
The Apportionment Procedure
Apportionable Income
Apportionment Factors: Elements and Planning
Concept Summary: Apportionable Income
The Sales Factor
The Payroll Factor
The Property Factor
Financial Disclosure Insights: State/Local Taxes
and the Tax Expense
The Unitary Theory
What Is a Unitary Business?
Tax Effects of the Unitary Theory
Consolidated and Combined Returns
Global Tax Issues: Water’s Edge Is Not a Day at the Beach
Concept Summary: Using Apportionment Formulas
Taxation of S Corporations
23-21
23-21
23-21
23-22
23-22
23-23
24-1
24-1
24-2
Chapter 25
Taxation of International
Transactions25-1
The Big Picture: Going International
25-1
Tax Treaties
25-5
24-6
24-7
24-8
Sourcing of Income and Deductions
25-6
Income Sourcing Rules
Allocation and Apportionment of Deductions
Concept Summary: The Sourcing Rules
Transfer Pricing
Ethics & Equity: The Costs of Good Tax Planning
25-6
25-9
25-10
25-10
25-11
24-8
24-9
24-9
24-11
24-12
24-13
24-14
24-16
24-17
24-18
24-19
24-19
24-21
24-21
24-22
24-22
Other State and Local Taxes
24-23
19688_fm_hr_i-xIii.indd 39
24-33
25-3
24-23
Selecting the Optimal State in Which to Operate
Restructuring Corporate Entities
24-31
24-32
24-32
24-33
24-33
Overview of International Taxation
Taxation of Partnerships and LLCs
Tax Planning
Ethics & Equity: Can You Be a Nowhere Adviser?
Planning with Apportionment Factors
Sales/Use Tax Compliance
Capital Stock Taxation
Refocus on The Big Picture: Making a Multistate
Location Decision
24-2
24-3
24-3
Eligibility24-22
State Tax Filing Requirements
24-22
State and Local Sales and Use Taxes
Local Property Taxes
Other Taxes
Ethics & Equity: Encouraging Economic Development
through Tax Concessions
Subjecting the Corporation’s Income to Apportionment
xxxix
24-23
24-25
24-26
24-27
24-28
24-28
24-29
Foreign Currency Gain/Loss
25-14
U.S. Persons with Offshore Income
25-15
Export Property, Licenses, Foreign Branches
Financial Disclosure Insights: Overseas Operations
and Book-Tax Differences
Concept Summary: The Foreign Tax Credit
Tax Havens
Offshore (Foreign) Corporations Controlled by
U.S. Persons
Concept Summary: Subpart F Income and a CFC
Concept Summary: Components of Subpart F Income
Movement Toward a More Territorial System
Global Intangible Low-Taxed Income (GILTI)
Concept Summary: The Components of Global Intangible
Low-Taxed Income (GILTI)
Global Tax Issues: Agreement on Global Minimum Corporate
Tax Rate Reached
.S. Taxation of Nonresident Aliens
U
and Foreign Corporations
Nonresident Alien Individuals
Foreign Corporations
Foreign Investment in Real Property Tax Act
Expatriation to Avoid U.S. Taxation
25-15
25-17
25-17
25-18
25-19
25-21
25-23
25-23
25-24
25-24
25-27
25-27
25-28
25-29
25-30
25-30
Reporting Requirements
25-31
Tax Planning
25-31
The Foreign Tax Credit Limitation and Sourcing Provisions
Transfer Pricing
Refocus on The Big Picture: Going International
25-31
25-32
25-33
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
xl
Contents
Chapter 26
Tax Practice and Ethics
The Big Picture: A Tax Adviser’s Dilemma
Tax Administration
The Federal Gift Tax
26-1
26-1
26-2
Organizational Structure of the IRS
26-3
IRS Procedure—Letter Rulings
26-4
IRS Procedure—Other Issuances
26-4
Ethics & Equity: Tax Compliance Costs
26-5
Administrative Powers of the IRS
26-5
The Audit Process
26-6
Ethics & Equity: Can the IRS Pretend to Be Your Friend?
26-7
The Taxpayer Appeal Process
26-9
Offers in Compromise and Closing Agreements
26-10
Ethics & Equity: Our Taxing System of Self-Assessment
26-11
Interest26-12
Concept Summary: Working with the IRS
26-13
Taxpayer Penalties
26-13
Ethics & Equity: First-Time Tax Violators Can Get Off
with Just a Warning
26-18
Statute of Limitations
26-21
The Tax Profession and Tax Ethics
The Tax Professional
Regulating Tax Preparers
IRS Rules Governing Tax Practice
Preparer Penalties
Privileged Communications
AICPA Statements on Standards for Tax Services
Concept Summary: Tax Profession and Ethics
Tax Planning
26-22
26-22
26-23
26-23
26-24
26-26
26-27
26-30
26-30
Strategies in Seeking a Letter Ruling
26-30
Considerations in Handling an IRS Audit
26-30
Statute of Limitations
26-31
Litigation Considerations
26-32
Penalties26-32
Ethics in the Tax Practice
26-32
Privileged Communications
26-33
Refocus on The Big Picture: A Tax Adviser’s Dilemma
26-33
Part 9: Family Tax Planning
Chapter 27
The Federal Gift and Estate Taxes
The Big Picture: An Eventful and Final Year
Transfer Taxes—In General
Nature of the Taxes
Global Tax Issues: U.S. Transfer Taxes and NRAs
Concept Summary: Gift Tax Formula
Concept Summary: Estate Tax Formula
Valuation Issues
Key Property Concepts
19688_fm_hr_i-xIii.indd 40
27-7
General Considerations
27-7
Ethics & Equity: It’s the Thought That Counts
27-7
Transfers Subject to the Gift Tax
27-9
Annual Gift Tax Exclusion
27-10
Deductions27-11
Computing the Federal Gift Tax
27-11
Procedural Matters
27-12
Concept Summary: Federal Gift Tax Provisions
27-13
The Federal Estate Tax
Gross Estate
Concept Summary: Federal Estate Tax Provisions—Gross Estate
Taxable Estate
Estate Tax Credits
Global Tax Issues: Treaty Relief Is Not Abundant!
Procedural Matters
Concept Summary: Federal Estate Tax Provisions—Taxable
Estate and Procedural Matters
The Generation-Skipping Transfer Tax
Inter-Generational Transfers
The Tax on Generation-Skipping Transfers
Tax Planning
The Federal Gift Tax
The Federal Estate Tax
Refocus on The Big Picture: An Eventful and Final Year
Chapter 28
Income Taxation of
Trusts and Estates
The Big Picture: Setting Up a Trust to Protect a Family
Fiduciary Income Taxation
What Is a Trust?
What Is an Estate?
Nature of Trust and Estate Taxation
Concept Summary: Tax Characteristics of Major
Pass-Through Entities
Tax Accounting Periods and Methods
Tax Rates and Personal Exemption
Alternative Minimum Tax
Additional Tax on Net Investment Income
27-13
27-13
27-18
27-19
27-22
27-23
27-23
27-24
27-24
27-24
27-24
27-25
27-25
27-26
27-28
28-1
28-1
28-2
28-2
28-5
28-5
28-6
28-6
28-6
28-7
28-8
27-1
Taxable Income of Trusts and Estates
28-8
27-1
Entity Accounting Income
Gross Income
Ethics & Equity: To Whom Can I Trust My Pet?
Ordinary Deductions
Deductions for Losses
Charitable Contributions
Deduction for Distributions to Beneficiaries
Concept Summary: Uses of the DNI Amount
Tax Credits
28-8
28-11
28-13
28-13
28-15
28-15
28-16
28-17
28-19
27-2
27-2
27-3
27-3
27-4
27-5
27-6
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Get Complete eBook Download link Below for Instant Download:
https://browsegrades.net/documents/286751/ebook-payment-link-forinstant-download-after-payment
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Contents
Concept Summary: Principles of Fiduciary
Income Taxation
Taxation of Beneficiaries
Distributions by Simple Trusts
Distributions by Estates and Complex Trusts
Character of Income
xli
28-20
28-20
28-20
28-20
28-22
Table of Code Sections Cited
D-1
Present Value and Future Value Tables
E-1
F-1
Grantor Trusts
28-23
Practice Set Assignments—
Comprehensive Tax Return Problems
Procedural Matters
28-25
IndexI-1
Tax Planning
28-25
A Trust or an Estate as an Income-Shifting Device
Income Tax Planning for Estates
Distributions of In-Kind Property
Ethics & Equity: Who Should Be a Trustee?
Deductibility of Administrative Expenses
Duties of an Executor
Additional Taxes on Capital Gains and Net
Investment Income
Refocus on The Big Picture: Setting Up a Trust to
Protect a Family
28-25
28-26
28-27
28-27
28-27
28-28
28-28
Online Appendices
Depreciation and the Accelerated
Cost Recovery System (ACRS)
Affordable Care ACT Provisions
28-29
Appendices
Tax Formulas, Tax Rate Schedules,
and Tables
A-1
Tax Forms
B-1
GlossaryC-1
19688_fm_hr_i-xIii.indd 41
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
19688_fm_hr_i-xIii.indd 42
31/03/22 9:21 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1
Part
Introduction and
Basic Tax Model
Chapter
1
An Introduction to Taxation and Understanding the Federal Tax Law
Chapter
2
Working with the Tax Law
Chapter
3
Tax Formula and Tax Determination; An Overview of Property
Transactions
Part 1 provides an introduction to taxation in the United States. Although this text focuses on income
­taxation, other types of taxes also are briefly discussed. The purposes of the Federal tax law are examined,
and the legislative, administrative, and judicial sources of Federal tax law, including their application to the
tax research process, are analyzed. Part 1 concludes by introducing the basic tax model for the individual
­taxpayer (the tax formula), discussing tax determination, and providing an overview of property transactions.
19688_pt01_hr.indd 1
29/03/22 7:01 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1
C h ap ter
An Introduction to Taxation
and Understanding the
Federal Tax Law
L e a r n i n g O b j e c t i v e s : After completing Chapter 1, you should be able to:
LO.1
Explain the importance of taxation and apply
­methods for studying this topic.
LO.5
Explain the administration of the tax law, including
the audit process utilized by the IRS.
LO.2
Describe some of the history and trends of the
Federal income tax.
LO.6
Evaluate some of the ethical guidelines involved in
tax practice.
LO.3
Describe and apply principles and terminology
relevant to the design of a tax system.
LO.7
LO.4
Identify the different taxes imposed in the United
States at the Federal, state, and local levels.
LO.8
Classify tax rules based on their possible economic,
social, equity, and political reasons for inclusion in a
particular tax system.
Explain the role played by the IRS and the courts in
the evolution of the Federal tax system.
Chapter Outline
1-1 Approaching the Study of Taxation, 1-2
1-1a What Is Taxation? 1-2
1-1b Taxation in Our Lives, 1-2
1-1cThe Relevance of Taxation to Accounting and
Finance Professionals, 1-3
1-1d How to Study Taxation, 1-5
1-2 A Brief History of U.S. Taxation, 1-5
1-2a Early Periods, 1-5
1-2b Revenue Acts, 1-6
1-2c Trends, 1-7
1-3 Tax System Design, 1-8
1-3a Legal Foundation, 1-8
1-3b The Basic Tax Formula, 1-8
1-3c Tax Principles, 1-9
1-4 Major Types of Taxes, 1-10
1-4a Property Taxes, 1-12
1-4b Transaction Taxes, 1-13
1-4c Taxes on Transfers at Death, 1-15
1-4d Gift Taxes, 1-16
19688_ch01_hr_002-043.indd 2
1-4e
1-4 f
1-4g
1-4h
Income Taxes, 1-17
Employment Taxes, 1-19
Other U.S. Taxes, 1-20
Proposed U.S. Taxes, 1-22
1-5 Tax Administration, 1-23
1-5a Internal Revenue Service, 1-23
1-5b The Audit Process, 1-24
1-5c Statute of Limitations, 1-25
1-5d Interest and Penalties, 1-26
1-5e Tax Practice, 1-27
1-6 Understanding the Federal Tax Law, 1-29
1-6a Revenue Needs, 1-29
1-6b Economic Considerations, 1-29
1-6c Social Considerations, 1-30
1-6d Equity Considerations, 1-31
1-6e Political Considerations, 1-33
1-6 f Influence of the Internal Revenue Service, 1-34
1-6g Influence of the Courts, 1-35
1-6h Summary, 1-36
29/03/22 4:06 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
The Big Picture
TETRA IMAGES/GETTY
CORBIS/SUPERSTOCK
IMAGES
Family and Taxes—A Typical Year
Travis and Amy Carter are married and live in a state that imposes both a sales tax and an income tax.
They have two children, April (age 17) and Martin (age 18). Travis is a mining engineer who specializes in
land reclamation. After several years with a mining corporation, Travis established a consulting practice that
involves a considerable amount of travel due to work he performs in other states. Amy is a registered nurse
who, until recently, was a homemaker. In November of this year, she decided to reenter the job market and
accepted a position with a medical clinic. The Carters live only a few blocks from Ernest and Mary Walker,
Amy Carter’s parents. The Walkers are retired and live on interest, dividends, and Social Security benefits.
Activities during the year with possible tax ramifications are summarized below.
• The ad valorem property taxes on the Carters’ residence are increased, whereas those on the Walkers’
residence are lowered.
• When Travis registers an automobile purchased last year in another state, he is required to pay a sales
tax to his home state.
• As an anniversary present, the Carters gave the Walkers a recreational vehicle (RV).
• Travis employs his children to draft blueprints and prepare scale models for use in his work. Both April
and Martin have had training in drafting and topography.
• Early in the year, the Carters are audited by the state on an income tax return filed a few years ago. Later
in the year, they are audited by the IRS on a Form 1040 they filed for the same year. In each case, a tax
deficiency and interest were assessed.
• The Walkers are audited by the IRS. Unlike the Carters, they did not have to deal with an agent, but
settled the matter by mail.
Explain these developments, and resolve the issues raised.
Read the chapter and formulate your response.
1-1
19688_ch01_hr_002-043.indd 1
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-2
Part 1
Introduction and Basic Tax Model
T
his chapter provides an introduction to our Federal tax system to set a foundation
for what you’ll learn in subsequent chapters. Among the topics discussed are:
•
•
•
•
•
•
LO.1
Explain the importance
of taxation and apply
methods for studying
this topic.
The importance and relevance of taxation and how to study taxation.
A brief history of the Federal income tax.
The types of taxes imposed at the Federal, state, and local levels.
Some highlights of tax law administration.
Tax concepts that help explain the reasons for various tax provisions.
The influence the Internal Revenue Service (IRS) and the courts have had in
the evolution of current tax law.
1-1 Approaching the Study of Taxation
1-1a What Is Taxation?
“Taxes are what we pay for civilized society.”
This is a famous quote from U.S. Supreme Court Justice Oliver Wendell Holmes, Jr.
(1841 to 1935).1 It is engraved on the government building at 1111 Constitution Avenue
in Washington, D.C.—headquarters of the Internal Revenue Service (IRS). This quote
eloquently sums up the primary purpose of taxation—to raise revenue for government
operations. Governments at all levels—national, state, and local—require funds for
defense, protection (police and fire), education, roads, the court system, social services,
and more. Various types of taxes provide the resources to pay for government services.
In addition, taxation is often used as a tool to influence the behavior of individ­uals
and businesses. For example, an income tax credit (which reduces a taxpayer’s tax
bill) may be designed to encourage people to purchase a fuel-efficient car. A tobacco
excise tax may discourage individuals from smoking by increasing the cost of tobacco
products. The tax system can also be used to provide direct benefits to ­taxpayers (e.g.,
to help pay for health insurance) and indirect benefits (in the form of exclusions, deductions, and credits that reduce a taxpayer’s tax liability).
1-1b Taxation in Our Lives
“Nothing is certain, except death and taxes.”
Most people attribute this quote to Benjamin Franklin (1706–1790). Taxes per­meate
our society. Various types of taxes, such as income, sales, property, and excise taxes
(discussed in text Section 1-4), come into play in many of the activities of individuals,
businesses, nonprofit entities (e.g., charitable organizations), and even governments.
Most directly, individuals are affected by taxes by paying them. Taxes may be paid
directly or indirectly. A direct tax is paid to the government by the person who pays
the tax. Examples include the personal income tax, which is paid by filing a personal
income tax return (Form 1040 at the Federal level), and property taxes on one’s home
(paid to the local government). Individuals also pay many taxes indirectly. For example,
most states impose sales tax on the purchase of tangible goods such as clothes. While
this tax is collected and remitted to the government by the seller, the buyer is charged
the tax along with the purchase price of the goods or services. Taxes also can be
imposed indirectly when embedded in the prices charged by the seller. For example,
when you buy gasoline for your car, the price you pay likely includes some of the
income taxes and the gasoline excise taxes owed by the oil company. And a renter
indirectly pays property taxes assessed on the landlord (who will consider that cost
when determining how much rent to charge).
1
Compania General De Tabacos De Filipinas v. Collector of Internal R
­ evenue,
275 U.S. 87, 100 (1927), dissenting opinion.
19688_ch01_hr_002-043.indd 2
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-3
Ultimately, all taxes are paid by individuals. The corporate income tax, for example,
is paid directly by the corporation but is really paid indirectly by individuals in their
capacity as customers, investors (owners), or employees. Economists and others often
study this topic to estimate the percentage of the corporate income tax borne by individuals in these different capacities. It is not easy to measure, but it is known that taxes
are passed along to individuals through higher prices, lower dividends, and/or lower
wages.
Taxes also affect the lives of individuals via the ballot box. Federal, state, and local
elections often include initiatives that deal with taxation, such as whether state income
taxes should be raised (or lowered), whether a new tax should be imposed on soda,
or whether the sales tax rate should be changed. Candidates running for office often
have positions on tax changes they would like to make if elected.
Given the pervasiveness of taxation—in our roles as both direct and indirect ­payers
of taxes as well as citizens/voters—it is important that we understand how the tax
system operates.
1-1c The Relevance of Taxation to Accounting
and Finance Professionals
The U.S. corporate income tax rate is 21 percent. State income taxes can easily constitute, on average, an additional 5 percent. So a large corporation such as a Fortune
500 company may have to devote 26 percent or more of its net income to pay income
taxes. In addition, businesses are subject to employment taxes, property taxes, sales
taxes, and various excise taxes. Corporations with international operations are subject
to taxation in other countries. Small businesses are also subject to a variety of taxes that
affect profits and cash flows.
Given its significance, taxation is a crucial topic for accounting and finance professionals. They must understand the various types of business taxes to assist effectively
with the following:
• Compliance: Ensure that the business files all tax returns and makes all tax payments
on time. Mistakes and missed due dates will lead to penalties and interest expense.
• Planning: Help a business apply favorable tax rules, such as income deferral and
tax credits, to minimize tax liability (and maximize owner wealth). The time value
of money concept is also important here, as is coordinating tax planning with
other business goals to maximize earnings per share.2
• Financial reporting: Financial statements include a variety of tax information,
including income tax expense on the income statement and deferred tax assets
and liabilities on the balance sheet. Footnotes to the financial statements report
various tax details, including the company’s effective tax rate. Computation and
proper reporting of this information require knowledge of both tax and f­inancial
reporting rules [including the Financial Accounting Standards Board’s Accounting
Standards Codification (ASC) 740, Income Taxes].
• Environmental, Social, and Governance (ESG) reporting: A growing trend in corporate reporting is to address various business sustainability and responsibility
matters and to report environmental, social, and governance activities and impact.
Standard frameworks might be used that include tax metrics such as the Global
Reporting Initiative (GRI) Standards or ones generated by the World Economic
Forum.3 This reporting can include taxes paid in each country (part of “countryby-country reporting”), reconciliation between taxes paid and the statutory tax
2
corporate tax director or vice president of tax is typically involved in the
A
strategic planning and growth of the company due to the significance of tax
liabilities and planning opportunities to the business. For example, a 2021
position announcement for a Tax Director at Roblox stated that the director
would lead initiatives to support global growth of the company.
19688_ch01_hr_002-043.indd 3
3
or example, see World Economic Forum, Toward Common Metrics and
F
Consistent Reporting of Sustainable Value Creation, Jan. 2020; www3
.weforum.org/docs/WEF_IBC_ESG_Metrics_Discussion_Paper.pdf.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-4
Part 1
Introduction and Basic Tax Model
•
•
•
•
rate on financial statement profits, financial assistance received from governments
via tax deductions and credits, and an explanation of the corporation’s tax policy
and strategy.4
Controversy: This term refers to interaction a taxpayer may have with a tax agency
such as the IRS. The IRS and state and local tax agencies regularly audit tax returns
that have been filed to verify that taxes were properly computed and paid.
Cash management: Taxes must be paid on time to avoid penalties and interest.
Income and self-employment taxes must be estimated and paid quarterly and
reconciled on the annual return. Other taxes may be due weekly, monthly, or
semiannually. Businesses must be sure they have the funds ready when the taxes
are due and have procedures to track due dates.
Data analysis: With a majority, if not all, of a company’s records maintained in
digital form, there are opportunities to use this information to enhance profits,
better understand the customer base, and improve and understand the information from a tax perspective. Tax practitioners often need skills in data analysis and
visualization to identify samples for both internal and external audits, find ways
to identify the products and services subject to sales tax in different states, and
extract tax data to help inform other business functions such as where to locate
a new sales office.
Tax advocacy: Taxpayers and tax practitioners can add tremendous value to the
improvement and evolution of our tax laws by sharing their knowledge, experiences, and ideas with lawmakers and tax agencies. Some of this work is performed
by professional organizations such as the American Institute of CPAs (AICPA),
industry associations, and various policy organizations. This input might take the
form of comment letters, testimony before legislative committees (delivered in
person or submitted for the record), or individual correspondence and meetings.5
These tasks are also relevant to professionals such as CPAs who advise business and
individual clients.
The level and depth of tax knowledge needed for any accounting or tax professional
depends on the specific job. The vice president of tax for a company clearly needs
thorough knowledge in all areas of taxation; the same is true of a partner in a CPA firm.
In contrast, the corporate treasurer likely focuses more on cash management, while
working closely with the company’s tax advisers.
Ultimately, much of taxation is transaction-based. How a transaction is structured
(e.g., as a sale or a lease) has varying tax consequences that must be considered. Even
the purchase of a home can result in significant change—the new mortgage interest and
property tax deductions may mean that an individual itemizes her deductions (using
Schedule A of Form 1040) rather than using the standard deduction. And life events such
as marriage (and divorce) will change an individual’s tax situation. Similar “life events”
can also affect a corporation (e.g., acquiring a corporation or spinning off a subsidiary).
It is essential in working with taxation to maintain a balanced perspective. A corporation that is deciding where to locate a new factory does not automatically select the city
or state that offers the most generous tax benefits. Nor does the person who is retiring
to a warmer climate pick Belize over Arizona because the former has no income tax but
the latter does. Tax considerations should not control decisions, but they remain one of
many factors to be considered (and often one of the most significant).
4
or examples, see Intel’s 2020–21 Corporate Responsibility Report; csrre­
F
portbuilder.intel.com/pdfbuilder/pdfs/CSR-2020-21-Full-Report
.pdf; and The Walt Disney Company’s 2020 Corporate Social Responsibility
Report; thewaltdisneycompany.com/app/uploads/2021/02/2020-CSRReport.pdf.
5
For examples of such advocacy, see formal letters submitted by the AICPA
(aicpa.org/advocacy/tax.html); testimony delivered at tax reform
hearings in Congress (sjsu.edu/people/annette.nellen/website/
19688_ch01_hr_002-043.indd 4
117th-hearings.htm); and tax policy activities and reports of various
industry and policy organizations such as the U.S. Chamber of Commerce
(uschamber.com/taxes) and the Center on Budget and Policy Priorities
(cbpp.org/research/topics/federal-tax).
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-5
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-1d How to Study Taxation
The goal of studying taxation is to be able to recognize issues (or transactions) that
have tax implications and, when possible, try to understand the justification for them.
Suppose, for example, that you come upon a situation that involves a discharge of
indebtedness. If you know that forgiveness of debt results in income but that there are
exceptions to this rule, you’re doing well. The issue has been identified, and the outcome (i.e., when an exception applies) can be resolved through research. A variety of
commercial and free tools and resources are available to help you research and reach
a conclusion.
You may have heard that tax is a difficult subject because of the many rules, exceptions, and definitions, as well as frequent changes to tax rules. You even may have
heard that taxation is boring. Taxation is a challenging topic, but it is certainly not boring. Taxation is an important and exciting topic due to constant change by the three
branches of our Federal government (as well as changes by state and local governments), the significance of taxes to the bottom line of a company and an individual’s
finances, and the impact on our economy and society.
Tax professionals tend to find enjoyment in their chosen field due to the intellectual
challenge of dealing with tax rules for compliance and planning purposes, the opportunity to interact with colleagues or clients to help them understand the effect of taxes,
and the knowledge that their work affects the financial well-being of individuals and
businesses.
In studying taxation, focus on understanding the rules and the why(s) behind them
(rather than memorizing the many rules and terms). The rules become more meaningful by thinking about why they exist for the particular type of tax. For example, why
does the Federal income tax allow for a casualty loss deduction in certain situations?
Why is tax depreciation different from that used for financial reporting? Also consider
how the rules apply to different types of taxpayers (like employees, sole proprietors,
corporations, investors, children, and retirees). Also think about how the rules apply
to taxpayers of varying income levels and sophistication of transactions (a homeowner
versus someone who owns assets in several countries). Aiming for understanding rather
than memorization will make your journey into the world of taxation interesting and
meaningful and will prepare you well for dealing with taxation in your accounting or
finance career.
For tax professionals, the study of taxation is an ongoing and intriguing process.
When Congress changes the tax law, tax professionals must review the new rules in
order to understand how they affect clients or their employer. In addition, decisions
rendered by the courts in tax disputes and guidance issued by the Treasury Department
and Internal Revenue Service must be understood to ensure correct compliance with
the law as well as identification of updated and proper tax planning ideas.
Concept Summary 1.1 illustrates the various ways that individuals deal with, and are
affected by, taxes.
1-2 A Brief History of U.S. Taxation
1-2a Early Periods
An income tax was first enacted in 1634 by the English colonists in the Massachusetts
Bay Colony, but the Federal government did not adopt an income tax until 1861. In fact,
both the Federal Union and the Confederate States of America used the income tax to
raise funds to finance the Civil War.
When the Civil War ended, the need for additional revenue disappeared and the
income tax was repealed. Once again the Federal government was able to finance its
operations almost exclusively from customs duties (tariffs).
When a new Federal income tax on individuals was enacted in 1894, its opponents
were prepared to successfully challenge its constitutionality. In Pollock v. Farmers’ Loan
19688_ch01_hr_002-043.indd 5
LO.2
Describe some of the history
and trends of the Federal
income tax.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-6
Part 1
Introduction and Basic Tax Model
Concept Summary 1.1
Individual
In
ve
sto
r
s
ic tie
i
Civ sibil
s
on
es
sp
sin
Re
Bu
Fin
Lit anci
era al
cy
Co
mp
g
n in
Ta
x
lan
xP
Ta
ee
oy
pl
Personal
Responsibilities
Em
The diagram to the right illustrates the many ways individuals
interact with taxes. For example, as shown in the outer circle,
­individuals pay taxes and file tax returns (tax compliance). They
also engage in tax planning as part of their desire to maximize
after-tax wealth. If their tax return is audited or they do not pay
their taxes, taxpayers will deal with the IRS or their state tax
agency (tax controversy). Individuals deal with tax rules and
planning in their roles as consumers, employees, investors, and
business ­owners. Tax law is designed around these various taxpayer activities. Finally, as shown by the inner circle, individuals
have a personal responsibility to comply with tax laws and pay
any taxes due. I­ ndividuals also have a civic responsibility to understand taxes in their role as citizens and voters. And individuals
need to understand how taxes affect their personal cash flows,
­consumption, and savings.
Use this diagram as you study the materials in this text, considering where in the circle various rules fit.
lia
nc
e
Pe
Co rso
ns na
um l/
er
Individuals and Taxes
Tax Controversy
and Trust Co., the U.S. Supreme Court found that taxes on the income of real and personal property were the legal equivalent of a tax on the property involved and, therefore, required apportionment based on the population of the United States, as required
by Article I, Section 8 of the Constitution.6
A Federal corporate income tax, enacted by Congress in 1909, fared better in the
judicial system. The U.S. Supreme Court found this tax to be constitutional because it
was treated as an excise tax.7 In essence, it was a tax on the right to do business in the
corporate form. So it was viewed as a form of the franchise tax.8 Since the corporate
form of doing business had been developed in the late nineteenth century, it was
unknown to the framers of the U.S. Constitution. Because a corporation is an entity
created under law, jurisdictions possess the right to tax its creation and operation. Using
this rationale, many states still impose franchise taxes on corporations.
The ratification of the Sixteenth Amendment to the U.S. Constitution in 1913 sanctioned both the Federal individual and corporate income taxes and, as a consequence,
neutralized the continuing effect of the Pollock decision.
1-2b Revenue Acts
After the Sixteenth Amendment was ratified by the states, Congress enacted the Revenue
Act of 1913. Under this Act, the first Form 1040 was due on March 1, 1914. The law
allowed various deductions and personal exemptions of $3,000 for a single individual
and $4,000 for married taxpayers. These large exemptions excluded all but the more
wealthy taxpayers from the new income tax.9 Rates ranged from a low of 1 percent to
a high of 6 percent. The 6 percent rate applied only to taxable income in excess of
$500,000.10
6
3 AFTR 2602, 15 S.Ct. 912 (USSC, 1895). See Chapter 2 for an explanation
of the citations of judicial decisions.
7
Flint v. Stone Tracy Co., 3 AFTR 2834, 31 S.Ct. 342 (USSC, 1911).
8
See the discussion of state franchise taxes later in text Section 1-4g.
19688_ch01_hr_002-043.indd 6
9
$3,000 exemption in 1913 would be about $82,000 today, while a $4,000
A
exemption would be about $109,000.
10
his should be contrasted with the highest 2022 tax rate of 37%, which
T
applies once taxable income exceeds $539,900 for single taxpayers and
$647,850 for married taxpayers filing a joint return.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-7
Various revenue acts were passed between 1913 and 1939. In 1939, all of these
revenue laws were codified (arranged in a systematic manner) into the Internal Revenue Code of 1939. In 1954, a similar codification took place. The Internal Revenue
Code of 1986, which largely carries over the provisions of the 1954 Code, is our current law. Tax law changes occur almost every year (how this happens is discussed
in Chapter 2).
1-2c Trends
The income tax is a major source of revenue for the Federal government. Exhibit 1.1
shows the tax revenue sources11 and the importance of the income tax. Income tax
collections from individuals and corporations amount to 61 percent of the total receipts.
One revenue source missing from the Exhibit 1.1 pie chart is borrowing to cover the
deficit, which in recent years has represented between 10 to 40 percent of total government revenues.
The need for revenues to finance the war effort during World War II converted the
income tax from one that applied mostly to high-income individuals to a mass tax. In
1939, less than 6 percent of the U.S. population was subject to the Federal income
tax. By 1945, more than 74 percent of the population was subject to the Federal
income tax.12
Certain tax law changes are important to understand. In 1943, Congress passed the
Current Tax Payment Act, which provided for a pay-as-you-go tax system. A pay-asyou-go income tax system requires employers to withhold a specified portion of an
employee’s wages and remit them to the government to cover the worker’s income
taxes. Persons with income from other than wages may have to make quarterly payments to the IRS for estimated taxes due for the year.
The increasing complexity of the Federal income tax laws causes concern among
many, including lawmakers, taxpayers, and tax practitioners. Congress has added to this
complexity by frequently changing the tax laws (e.g., by adding or deleting deductions
or tax credits). This complexity forces many taxpayers to seek assistance in preparing
their income tax returns. According to estimates, more than one-half of individual taxpayers who file a return pay a preparer and most of these returns are prepared using
E x h i b i t 1.1
Federal Tax Revenues (Estimated) in 2022
2%
2%
1%
Individual Income Taxes
Corporate Income Taxes
Payroll Taxes
33%
55%
Excise Taxes
Customs Duties
7%
11
evenue data can be found at irs.gov/statistics, cbo.gov, and white­
R
house.gov/omb. The instruction booklet for Form 1040 includes a revenue pie chart that includes borrowing to cover the deficit, as well as a pie
chart that shows government spending in broad categories.
19688_ch01_hr_002-043.indd 7
Estate and Gift Taxes
12
Richard Goode, The Individual Income Tax (Washington, D.C.: The
Brookings Institution, 1964), pp. 2–4.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-8
Part 1
Introduction and Basic Tax Model
tax software.13 The IRS estimates that the average time spent by individuals to prepare
and file their tax return and engage in necessary recordkeeping is 12 hours
New ways of doing business and living often require changes and/or clarifications to
the tax law. For example, increased longevity requires a need for more revenues from
Social Security taxes (and/or an increase in retirement age). Increased global business
activity means modifying a country’s tax system to be more in line with other countries
to make sure businesses are not impeded when entering the global marketplace. New
types of digital assets [e.g., virtual currency (or cryptocurrency) and non-fungible tokens
(NFTs)] often require lawmakers or the IRS to clarify how existing tax rules apply to
the new assets and related transactions. Ideally, lawmakers should review tax systems
periodically to ensure that they continue to be efficient in light of changes in how businesses and individuals function.
LO.3
1-3 Tax System Design
Describe and apply principles
and terminology relevant to
the design of a tax system.
1-3a Legal Foundation
Article I, Section 8 of the U.S. Constitution states in part: “The Congress shall have power
to lay and collect taxes.” The Constitution also provided some limits on this taxing
power, which led to the enactment of the Sixteenth Amendment to allow for an income
tax (discussed in text Section 1-2a). This history lesson is important for a legislature or
an electorate that wants to change a tax system. The jurisdiction’s underlying governing
documents (whether a country, state, or city) must be reviewed to determine whether
they impose any restrictions relevant to taxation.
For example, the California Constitution (Article 13A) states that the maximum tax
rate for real property taxation is 1 percent. The Florida Constitution (Section 5) specifies limits on the imposition of income taxes on natural persons. Also, state law may
impose limitations on the types or amounts of taxes that cities and counties can impose.
Thus, the governing documents of a jurisdiction must be considered as part of
any effort to modify that jurisdiction’s tax system to make sure the change is permissible. If a change is not permissible but desired, then the governing document must
be amended, as was done with the addition of the Sixteenth Amendment to the U.S.
Constitution.
1-3b The Basic Tax Formula
The basic formula for any tax is:
Tax base
X
Tax rate
=
Tax liability
Tax Base
A tax base is the amount to which the tax rate is applied. In the case of the Federal
income tax, the tax base is taxable income. As noted later in the chapter (Exhibit 1.3),
taxable income is gross income reduced by certain deductions (both business and
personal).
Tax Rates
Tax rates are applied to the tax base to determine a taxpayer’s liability. Some taxes,
like the sales tax and the gasoline excise tax, apply a fixed tax rate to all transactions.
13
ost IRS instructions for forms and schedules include an estimate of the
M
time needed to prepare the form or schedule.
19688_ch01_hr_002-043.indd 8
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
Kansas applies a sales tax rate of 6.5% to all taxable items. In contrast, Illinois applies a sales tax rate
of 6.25% for most taxable items but applies a rate of 1% when the tax base consists of food or prescription drugs.
1-9
Example
1
Alternatively, for some taxes, tax rates may vary depending on the details of the tax
base. Income taxes tend to use a progressive tax rate structure where a higher rate of
tax applies as the tax base increases.
Bill and Chris, a married couple filing jointly, have taxable income of $15,000. Their Federal income tax
rate for 2022 is 10%, which is the rate that applies to the first $20,550 of taxable income for a married
couple filing jointly. Their tax liability is $1,500.
If, however, their taxable income is $85,000, their Federal income tax rates progress from 10% to
12% to 22% as their taxable income increases. In this case, their 2022 Federal income tax liability is
$9,934. The Federal income tax uses a progressive rate structure that applies higher rates to taxable
income (the tax base) as that income increases (see Appendix A to confirm these calculations, and
note how progressivity is built into the rate structure of the Federal income tax).
Example
2
The basic tax formula (shown above) is relevant for both computing taxes and planning, as well as for reforming a tax system. For example, if a legislator wants to lower
tax rates but generate the same amount of tax revenues, the tax base must be increased.
However, if she wants to increase tax revenues, the tax base can be increased or tax
rates can be increased (or both can be increased). Changes to the tax base will depend
on how it is constructed. For example, the income tax base is taxable income (income
minus income exclusions minus deductions). To increase this tax base, income exclusions or deductions could be limited or eliminated. The details of the income tax base
are discussed in later chapters. Tax system changes also involve canons (or principles)
of taxation, discussed next.
1-3c Tax Principles
In the late 1700s, Adam Smith identified the following canons (or principles) of taxation,
which are still considered today when evaluating a particular tax structure:14
• Equity. Each taxpayer enjoys fair or equitable treatment by paying taxes in proportion to his or her income level. Ability to pay a tax is one of the measures of how
equitably a tax is distributed among taxpayers.
• Certainty. A tax should be certain rather than arbitrary. Taxpayers need to be able
to understand how tax rules work so that they understand the effect of the rules
on various transactions and can comply.
• Convenience of payment. Taxes should be imposed in a manner that involves a
convenient time for payment. An advantage of the existing withholding system
(pay-as-you-go) is its convenience for taxpayers.
• Economy in collection. A good tax system involves only nominal collection
costs by the government and minimal compliance costs on the part of the
taxpayer.
14
The Wealth of Nations (New York: Dutton, 1910), Book V, Chapter II, Part II.
19688_ch01_hr_002-043.indd 9
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-10
Part 1
Introduction and Basic Tax Model
The American Institute of Certified Public Accountants (AICPA) has issued suggestions to guide tax reform and policy activities. Titled Guiding Principles of Good
Tax Policy: A Framework for Evaluating Tax Proposals, the monograph identifies
12 principles that are commonly used as indicators of desirable tax policy. The first
four principles are adapted from Adam Smith’s The Wealth of Nations. The complete
list follows:15
1. Equity and Fairness. Similarly situated taxpayers should be taxed in a similar
manner.
2. Certainty. Taxpayers should have certainty rather than ambiguity as to when and
how a tax is paid as well as how to calculate it.
3. Convenience of Payment. A tax should be due at a time and manner that is most
convenient for the taxpayer.
4. Effective Tax Administration. Tax compliance and administrative costs should be
kept to a minimum.
5. Information Security. Taxpayer information must be protected from improper
disclosure.
6. Simplicity. Tax rules should be simple so that taxpayers understand them and can
follow them in a cost-efficient manner.
7. Neutrality. The effect of tax rules on taxpayer decision making should be kept
to a minimum.
8. Economic Growth and Efficiency. The tax system should not harm economic
growth or distort economic effects among different activities and investments.
9. Transparency and Visibility. Taxpayers should know that a tax exists and how
and when it applies to them.
10. Minimum Tax Gap. A tax should be structured to minimize noncompliance.
11. Accountability to Taxpayers. Taxpayers should have access to information on taxes
as well as proposed law changes and their rationale.
12. Appropriate Government Revenues. Tax rules should enable the government to
predict the amount and timing of revenue production.
Exhibit 1.2 provides an application of these principles to a proposed tax law
change.
1-4 Major Types of Taxes
LO.4
Identify the different taxes
imposed in the United States
at the Federal, state, and local
levels.
Example
3
15
Why does a text devoted primarily to the Federal income tax discuss state and local
taxes? A simple illustration demonstrates the importance of non-Federal taxes.
Rick is employed by Flamingo Corporation in San Antonio, Texas, at a salary of $74,000. Rick’s
employer offers him a chance to transfer to its New York City office at a salary of $94,000.
Although Rick must consider many nontax factors before he decides on a job change, he should
also evaluate the tax climate. How do state and local taxes compare? For example, neither Texas nor
San Antonio imposes an income tax, but New York State and New York City do. A quick computation indicates that the additional income taxes (Federal, state, and local) involve approximately
$12,000.
continued
AICPA, Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals, 2017. Similarly, see GAO, Understanding the Tax
Reform Debate: Background, Criteria, & Questions, 2005. As “long-standing
19688_ch01_hr_002-043.indd 10
criteria,” the GAO lists “equity; economic efficiency; and a combination of
simplicity, transparency, and administrability.”
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-11
Consequently, what appears to be a $20,000 pay increase is actually only about $8,000 when the
additional $12,000 of income taxes are taken into account. Other taxes and costs (e.g., sales taxes,
property taxes, food, utilities, transportation) will also have to be factored into a decision.
E x h i b i t 1.2
Application of the Guiding Principles of Good Tax Policy
The Guiding Principles of Good Tax Policy can be applied to evaluate an existing tax rule or a proposed change. Here is an example of how
the principles apply to a state’s proposal to exempt college textbooks from sales tax.
Principle
Equity and fairness
Application
Although all college students would pay no sales tax on their textbooks, the effect varies
among students based on their ability to pay. This proposal provides tax savings not
only to lower-income students but also to higher-income students who may not need
the tax break to cover school costs. Also, higher-income students might buy full-price
new books rather than lower-cost used books, resulting in larger tax savings.
Certainty
College textbooks can be identified, such as by looking at what is listed on a course syllabus.
Convenience of
A sales tax exemption generally means that the tax is not owed at the time of purchase.
payment
If, instead, the exemption is structured for the student to pay the sales tax and apply
for a refund later, convenience of payment would not be met.
Effective tax
Sellers will have additional record keeping and reporting requirements to separate tax­-exempt
administration
textbook sales from taxable sales. Some type of system is needed to prove that the buyer
is a student purchasing a book for a college class. The state tax agency will incur additional time
and costs in writing rules, modifying tax forms, and auditing compliance with the new rule.
Information security
If obtaining the exemption requires that students show proof to retailers that they are a student,
there should be no need to provide a Social Security number. If students are required to claim
the exemption with the state tax agency after purchasing the textbooks, the agency might
request a student’s Social Security number, which could increase the risk of identity theft.
Simplicity
“Textbook” needs to be defined. The intent of the exemption is to benefit students. The
seller needs to verify that the book is for use by a student for a class. For example, both
students and nonstudents might buy a copy of Romeo and Juliet. Only the student
purchasing it for a college class is entitled to the sales tax exemption. Complexity exists
in the procedures needed to ensure that the exemption is used properly.
Neutrality
Students purchase textbooks because they are needed for class. The exemption is
unlikely to change a student’s behavior.
Economic growth
The exemption will reduce costs of attending college by a small amount. As a result, the
and efficiency
change is unlikely to result in a greater number of college graduates (which might
­benefit the ­economy). Savings from not paying sales tax might be spent on other
­consumables. The impact on the economy is likely minor.
Transparency and
Students and textbook sellers are likely to be aware of the exemption because colleges
visibility
will ­promote it as a reduction in the cost of attending college.
Minimum tax gap
Students may abuse the rule by using the exemption for books that are not for class use.
­Nonstudents may abuse this rule by claiming they are college students.
Accountability to
Were students and universities, particularly those funded by the state, aware of the
­textbook sales tax exemption proposal? Students and universities could provide
taxpayers
information to ­legislators on whether there is a need for a sales tax exemption or if
other financial ­support would be more helpful. Bookstores would want an opportunity
to provide ­information on the compliance costs and challenges of the exemption.
Appropriate government Existing data on how many textbooks are purchased enable the government to estimate how
revenue
much tax revenues will decrease due to the new exemption.
Result
Not fully met
Met
Met
Not met
Likely met
Not met
Met
Met
Met
Not met
More
­information
needed
Met
Conclusion: Although the majority of the principles are met, the ones that are not met (effective tax administration, simplicity, and minimum
tax gap) are significant. If lawmakers believe this tax exemption is necessary to help lower costs for college students, they should consider
alternative means of achieving the goal that are less complex. For example, grants could be offered or increased for college students in
need of financial assistance.
19688_ch01_hr_002-043.indd 11
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-12
Part 1
Introduction and Basic Tax Model
1-4a Property Taxes
Correctly referred to as ad valorem taxes because they are based on value, property
taxes are a tax on wealth, or capital. As a result, they have much in common with estate
taxes and gift taxes discussed later in the chapter. Although property taxes do not tax
income, the income actually derived from the property (or the potential for any income)
may be relevant if it affects the value of the property being taxed.
Property taxes fall into two categories: those imposed on real property (land and
buildings) and those imposed on personal property (assets other than land and buildings). Both have added importance because they often generate a deduction for Federal
income tax purposes (see Chapter 10).
Ad Valorem Taxes on Real Property
Property taxes on real property are used exclusively by states and their local subdivisions (such as cities, counties, and school districts). They represent a major source of
revenue for local governments (and school districts).
How real property is defined can have an important bearing on which assets are subject
to tax. This is especially true in jurisdictions that do not impose ad valorem taxes on personal property. Real property, or realty , generally includes real estate and any fixtures. A
fixture is something so permanently attached to the real estate that its removal will cause
irreparable damage. A built-in bookcase is likely a fixture, whereas a movable bookcase
is not. Electrical wiring and plumbing become realty when they are installed in a building.
Here are some of the characteristics of ad valorem taxes on real property:
• Property owned by the Federal government is exempt from tax. In general, the
same is true for property owned by state and local governments and by charitable
organizations.
• Some states provide for lower valuations on property used for agriculture or other
special uses (e.g., wildlife sanctuaries).
• States may have a homestead exemption, which makes some portion of the value
of a personal residence exempt from tax.
• Lower taxes may apply to a residence owned by a taxpayer aged 65 or older.
• When non-income-producing property (e.g., a personal residence) is converted
to income-producing property (e.g., a rental house), the appraised value may be
increased.
The Big Picture
Example
4
Return to the facts of The Big Picture on p. 1-1. Why did the Walkers’ property taxes decrease but those
of the Carters increase?
A likely explanation is that one (or both) of the Walkers achieved senior citizen status, ­leading to
a reduction of their property taxes. In the case of the Carters, the assessed value of their property
might have increased due to property values increasing in their location. Or perhaps they made
significant home improvements (e.g., kitchen/bathroom renovation or addition of a deck) that
increased the value (tax base) of the home.
Ad Valorem Taxes on Personal Property
Personal property, or personalty , can be defined as all property that is not realty. There
is a difference between how property is classified (realty or personalty) and how it is
used. Both realty and personalty can be either business use or personal use property.
Examples include a residence (realty that is personal use), an office building (realty
that is business use), surgical instruments (personalty that is business use), and home
furniture (personalty that is personal use).16
16
he distinction, important for ad valorem and for Federal income tax purT
poses, often becomes confusing when personalty is referred to as “personal”
property to distinguish it from “real” property. This designation does not
19688_ch01_hr_002-043.indd 12
give a complete picture of what is involved. The description “personal” residence, however, is clearer, because a residence can be identified as being
realty. What is meant in this case is realty that is personal use property.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-13
Personal property can also be classified as tangible property or intangible property.
For ad valorem tax purposes, intangible personalty includes stocks, bonds, and various
other securities (e.g., bank shares).
Here are some general rules related to ad valorem taxes on personal property:
• Generally, for individuals, vehicles (e.g., cars and boats) are the only non-realty
personal use assets subject to property tax. The value of a vehicle is typically
established by a schedule based on its age and make/model (a high-priced car
versus a low-priced car). Usually, any vehicle property tax is assessed and collected along with vehicle license or registration fees.
• Generally, businesses are assessed property taxes on equipment and other tangible
property, although many states do not tax inventory.
• A few states levy an ad valorem tax on intangibles such as stocks and bonds.
1-4b Transaction Taxes
Transaction taxes, imposed at the manufacturer’s, wholesaler’s, or retailer’s level, cover a
wide range of transfers. Transaction taxes can be assessed by any taxing authority (Federal, state, or local government). As the description implies, these taxes cover transfers
of property and normally are determined by multiplying the value by a percentage rate.
Federal Excise Taxes
In general, Federal excise taxes cover fewer items than in the past. Congress has focused
(and substantially increased) the Federal excise taxes on items such as tobacco products,
fuel and gasoline sales, and air travel. Other Federal excise taxes include:
• Manufacturers’ excise taxes on trucks, trailers, tires, firearms, sporting equipment,
and coal and the gas guzzler tax on automobiles.17
• Alcohol taxes.
• Miscellaneous taxes (e.g., the tax on wagering and the tax on investment income
of certain private colleges and universities).
When reviewing the list of both Federal and state excise taxes, recognize that these
taxes may be trying to influence social behavior. For example, the gas guzzler tax is
intended as an incentive for an individual to buy (and for the automobile companies
to build) fuel-efficient cars.
State and Local Excise Taxes
Many state and local excise taxes parallel the Federal version. For example, all states tax
the sale of gasoline, liquor, and tobacco products. However, the rates vary significantly.
For gasoline products, for example, compare the 58.7 cents per gallon imposed by the
Commonwealth of Pennsylvania with the 19.0 cents per gallon levied by the state of
Arizona. For tobacco sales, contrast the 17.0 cents per pack of 20 cigarettes in effect in
Missouri with the $4.35 per pack in the state of New York.
Other excise taxes found at some state and local levels include those on admission to
amusement facilities, on the sale of playing cards, and on prepared foods. Some counties impose a transaction tax on the transfer of property that requires the recording of
documents (e.g., real estate sales).
Over the last few years, two types of excise taxes imposed at the local level have
become increasingly popular: the hotel occupancy tax and the rental car “surcharge.”
The hotel occupancy tax is called a transient occupancy tax (TOT) in some areas. This
tax also can apply to short-term rentals of one’s home or a room in the home (such as
via Airbnb). Because they tax the visitor who cannot vote, they are a political windfall
and are often used to finance special projects that generate civic pride (e.g., convention
centers and state-of-the-art sports arenas). These levies can be significant, as demonstrated by Houston’s hotel tax of 17 percent [6 percent (state) 1 7 percent (city) 1 2
percent (county) 1 2 percent (sports authority)].
17
he gas guzzler tax is imposed on the manufacturers of automobiles
T
(both domestic and foreign) with fuel economy under 22.5 miles per gallon (mpg). For example, a 2021 Rolls-Royce Dawn gets about 14 mpg in
19688_ch01_hr_002-043.indd 13
combined city/highway driving and costs about $360,000. The gas guzzler
tax on this vehicle is $5,400. The highest gas guzzler tax is $7,700, and the
lowest is $1,000. § 4064.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-14
Part 1
Introduction and Basic Tax Model
General Sales Taxes
The distinction between an excise tax and a general sales tax is easy to make. One is
restricted to a particular transaction (e.g., the 18.4 cents per gallon Federal excise tax
on the sale of gasoline), whereas the other covers a multitude of transactions (e.g., a
5 percent tax on all retail sales). In actual practice, however, the distinction is not always
that clear. Some states exempt certain items from the general sales taxes (e.g., groceries,
medicines, and drugs). Also, sales tax rates can vary. Many states, for example, allow
lower rates for the sale of agricultural equipment or prescription drugs or apply different
rates (either higher or lower than the general rate) to the sale of automobiles.
A use tax is a complement to the sales tax and is assessed at the same rate as the
sales tax. A use tax is owed on property purchased outside the state but used in the state.
The purpose of a use tax is to prevent the avoidance of a sales tax. For example, if you
purchase clothes online and are not charged sales tax but clothes are subject to sales tax
in your state, you owe use tax on the purchase. State rules vary on how use tax is collected. Many states allow individuals to pay it along with their state income tax. Alaska,
Delaware, Montana, New Hampshire, and Oregon do not impose sales or use taxes. There
is no Federal general sales or use tax.
The Big Picture
Example
5
Return to the facts of The Big Picture on p. 1-1. The payment Travis made when he registered the
car is probably a use tax.
When the car was purchased in another state, likely no (or a lesser) sales tax was levied. The
current payment makes up for the amount of sales tax he would have paid had the car been purchased in his home state.
Ethics & Equity
Making Good Use of Out-of-State Relatives
Marcus, a resident of Austin, Texas, has found
the ideal gift for his spouse in celebration of their upcoming
wedding anniversary—a $22,000 gold watch. However, Marcus is appalled at the prospect of paying the state and local
sales tax of $1,815 (combined rate of 8.25 ­percent). So, he asks
his aunt, a resident of Montana, to purchase the watch. The
jewelry store lists the aunt as the buyer and ships the watch
to her, with no sales tax owed on the transaction. Prior to the
anniversary, Marcus receives the watch from his aunt. Is Marcus able to save $1,815 on the present for his spouse? What
can go wrong?
Local general sales taxes, over and above state sales taxes, are common. It is not
unusual to find taxpayers living in the same state but paying different general sales taxes
due to the location of their residence.
Example
6
Pete and Sam both live in a state that has a general sales tax of 3%. Sam, however, resides in a city
that imposes an additional general sales tax of 2%. Even though Pete and Sam live in the same
state, one is subject to a rate of 3%, whereas the other pays a tax of 5%.
For various reasons, some jurisdictions will suspend the application of a general
sales tax for a specified, brief time period. For example, a state may have a “sales tax
holiday” in late summer for back-to-school clothing and supplies. Some states use sales
tax holidays to encourage the purchase of energy-conserving appliances and hurricane
preparedness items.
Severance Taxes
Severance taxes are transaction taxes that are based on the notion that the state has
an interest in its natural resources (e.g., oil, gas, iron ore, or coal). Therefore, a tax is
imposed when the natural resources are extracted. For some states, severance taxes can
be a significant source of revenue.
19688_ch01_hr_002-043.indd 14
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-15
1-4c Taxes on Transfers at Death
The right to transfer property or to receive property upon the death of the owner may
be subject to estate and/or inheritance taxes. Consequently, such taxes fall into the
category of excise taxes. An estate tax is levied on the estate of the decedent (it is a
tax on the right to pass property at death). An inheritance tax is levied on the person
receiving the property (the heir). The value of the property transferred provides the
base for determining the amount of the tax.
The Federal government imposes only an estate tax. Some state governments, however, levy inheritance taxes, estate taxes, or both. Some states (e.g., Florida and Texas)
levy neither tax.
At the time of her death, Cari lived in a state that imposes an inheritance tax but not an estate
tax. Amy, one of Cari’s heirs, lives in the same state. Cari’s estate is subject to the Federal estate
tax, and Amy is subject to the state inheritance tax.
Example
7
The Federal Estate Tax
The Revenue Act of 1916 incorporated the estate tax into the tax law. The tax was
originally intended to prevent large concentrations of wealth from being kept in a family for many generations. Whether this objective has been accomplished is debatable.
Like the income tax, estate taxes can be reduced through various planning procedures.
The gross estate includes property the decedent owned at the time of death.18 It also
includes property interests, such as life insurance proceeds paid to the estate. All property included in the gross estate is valued as of the date of death or, if the alternate valuation date is elected, six months later.19
Deductions from the gross estate in arriving at the taxable estate include funeral and
administration expenses; certain taxes; debts of the decedent; casualty losses20 incurred
during the administration of the estate; transfers to charitable organizations; and, in
some cases, the marital deduction. The marital deduction is available for amounts actually passing to a surviving spouse (a widow or widower).
Once the taxable estate has been determined and certain taxable gifts made by
the decedent during life have been added to it, the estate tax can be computed. From
this amount, various credits are subtracted to arrive at the tax, if any, that is due.21
The most significant credit is the unified transfer tax credit. The main reason for this
credit is to eliminate or reduce the estate tax liability for certain estates. For 2022,
the credit exempts a tax base of up to $12,060,000, meaning that the vast majority of
estates pass tax-free to the heirs.
Jason made no taxable gifts before his death in 2022. If Jason’s taxable estate amounts to
$12,060,000 or less, no Federal estate tax is due because of the application of the unified transfer
tax credit.
Example
8
State Taxes on Transfers at Death
As noted earlier, some states levy an inheritance tax, an estate tax, or both. Typically, a
state inheritance tax divides the heirs into classes based on their relationship to the decedent. The more closely related the heir, the lower the rates imposed and/or the greater
the exemption allowed. Some states allow amounts passing to a surviving spouse to
escape taxation.
18
or further information on these matters, see Chapter 27.
F
See the discussion of the alternate valuation date in Chapter 13.
20
For a definition of casualty losses, see the Glossary in Appendix C.
21
For tax purposes, it is crucial to appreciate the difference between a deduction and a credit. A credit is a dollar-for-dollar reduction of tax liability. A
deduction, however, provides a benefit only to the extent of the taxpayer’s
19
19688_ch01_hr_002-043.indd 15
tax bracket. A taxpayer in a 50% tax bracket, for example, would need
$2 of deductions to eliminate $1 of tax liability. In contrast, $1 of credit
eliminates $1 of tax liability.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-16
Part 1
Introduction and Basic Tax Model
1-4d Gift Taxes
Like taxes on transfers at death, a gift tax is an excise tax levied on property transfers
made during the owner’s life and not at death. If the recipient pays the donor for the
property (but at an amount less than its fair market value), the difference is a gift.
Example
9
Carl sells property worth $50,000 to his daughter for $1,000. Although property worth $50,000 has
been transferred, only $49,000 represents a gift because this is the portion that was not paid for.
The Federal Gift Tax
First enacted in 1932, the Federal gift tax was intended to complement the estate tax. If
lifetime transfers by gift were not taxed, it would be possible to avoid the estate tax and
escape taxation entirely.
Only taxable gifts are subject to the gift tax. For this purpose, a taxable gift is measured by the fair market value of the property on the date of transfer less the annual
exclusion per donee and, in some cases, less the marital deduction, which allows taxfree transfers between spouses. In 2022, each donor is allowed an annual exclusion of
$16,000 for each donee ($15,000 in 2021).22
Example
10
On December 31, 2022, Yasmin (a widow) gives $16,000 to each of her four married children, their
spouses, and her eight grandchildren. On January 2, 2023, she repeats the procedure.
Due to the annual exclusion, Yasmin has not made a taxable gift, although she transferred
$256,000 [$16,000 (annual exclusion) 3 16 (donees)] in 2022 and another $256,000 in 2023, for
a total of $512,000 ($256,000 1 $256,000).
A married couple may make a special election that allows one-half of the gift made
by the donor-spouse to a third party to be treated as being made by the non-donorspouse. This gift splitting effectively allows the annual exclusion to double.
The Big Picture
Example
11
Return to the facts of The Big Picture on p. 1-1. Although the value of the RV is not stated, it is
likely to exceed the annual exclusion allowed of $60,000 [$15,000 (annual exclusion) 3 two
donees (the Walkers) 3 two donors (the Carters)].
As a result, a taxable gift results, and a Form 709 (Gift Tax Return) must be filed. Whether any
gift tax is due depends on what past taxable gifts the Carters have made and how much of their
unified transfer tax credit (see the following discussion) is still available.
The gift tax and estate tax rate schedules are the same. The schedule is commonly
referred to as the unified transfer tax rate schedule.
The Federal gift tax is cumulative in effect. What this means is that the tax base for
current taxable gifts includes past taxable gifts. Although a credit is allowed for prior
gift taxes, the result of adding past taxable gifts to current taxable gifts could force the
donor into a higher tax bracket.23 Like the Federal estate tax rates, the Federal gift tax
rates are progressive (see Example 2 earlier in this chapter).
The unified transfer tax credit is available for all taxable gifts. As was the case with
the Federal estate tax, the credit for 2022 is $4,769,800 (which covers taxable gifts up
to $12,060,000) and for 2021 is $4,625,800 (which covers taxable gifts up to $11,700,000).
There is, however, only one unified transfer tax credit, and it applies to both taxable
22
he purpose of the annual exclusion is to avoid the need to report and
T
pay a tax on modest gifts. Without the exclusion, the IRS could face a real
problem of taxpayer noncompliance. The annual exclusion is indexed as
the level of inflation warrants. The exclusion was $15,000 from 2018 to
2021, $14,000 from 2013 to 2017, and $13,000 from 2009 through 2012.
19688_ch01_hr_002-043.indd 16
23
For further information on the Federal gift tax, see Chapter 27.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-17
gifts and the Federal estate tax. Once the unified transfer tax credit has been used up for
Federal gift tax purposes, any transfers at death will be subject to the Federal estate tax.
Making lifetime gifts of property carries several tax advantages over passing the
property at death. If income-producing property is involved (e.g., marketable securities
and rental real estate), a gift may shift subsequent income to donees in a lower income
tax bracket. If the gift involves property that is expected to appreciate in value (e.g., life
insurance policies, real estate, and artwork), future increases in value will be assigned
to the donee and will not be included in the donor’s estate. And due to the annual
exclusion ($16,000 per donee in 2022; $15,000 per donee in 2021), some of the gift can
escape tax (with gift splitting, married donors can double the annual exclusion).
Neither the actual receipt of a gift nor an inheritance will cause income tax consequences to the donee or heir.
1-4e Income Taxes
Income taxes are levied by the Federal government, most states, and some local governments. Income taxes generally are imposed on individuals, corporations, and certain
fiduciaries (estates and trusts). Most jurisdictions attempt to ensure the collection of
income taxes by requiring pay-as-you-go procedures, including withholding requirements for employees and estimated tax payments for all taxpayers.
Federal Income Taxes
Exhibit 1.3 illustrates the formula for the Federal income tax imposed on individuals.
This formula provides a framework for part of the text. Beginning with Chapter 3, each
component of the formula is illustrated and explained.
Unlike its individual counterpart, the Federal corporate income tax is not progressive,
but instead uses a flat tax rate of 21 percent. Also, it does not include the computation of
adjusted gross income (AGI) and does not provide for the standard deduction or the
deduction for qualified business income. As a result, a corporation’s taxable income is the
E x h i b i t 1.3
Formula for Federal Income Tax on Individuals
Income (broadly defined)
$xx,xxx
Less: Exclusions (income that is not subject to tax)
Gross income (income that is subject to tax)
(x,xxx)
$xx,xxx
Less: Certain deductions (usually referred to as deductions for adjusted gross
income)
Adjusted gross income
(x,xxx)
$xx,xxx
Less: The greater of:
Certain personal and investment deductions (referred to as itemized
deductions)
or
The standard deduction (including any additional standard deduction)
(x,xxx)
Less: Personal and dependency exemptions*
Deduction for qualified business income**
(x,xxx)
(x,xxx)
Taxable income
$xx,xxx
Tax on taxable income (see the Tax Tables and Tax Rate Schedules in
Appendix A)
$ x,xxx
Less: Tax credits (including Federal income tax withheld and other
prepayments of Federal income taxes)
Tax due (or refund)
(xxx)
$
xxx
*Exemption deductions are not allowed from 2018 through 2025.
**Only applies from 2018 through 2025.
19688_ch01_hr_002-043.indd 17
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-18
Part 1
Introduction and Basic Tax Model
difference between gross income and deductions. Chapter 17 discusses the rules relating
to the determination of the Federal income tax on corporations.24
State Income Taxes
Almost all states impose an income tax on individuals.25
Here are some of the characteristics of state income taxes:
• With few exceptions, all states require some form of withholding procedures.
• Most states use as the tax base the income determination made for Federal
income tax purposes. This is often referred to as the piggyback approach to
state income taxation. Although the term piggyback does not lend itself to a
precise definition, in this context, it means making use, for state income tax
purposes, of what was done for Federal income tax purposes.
• Some states “decouple” from selected Federal tax changes passed by Congress.
The purpose of the decoupling is to retain state revenue that would otherwise
be lost. For example, some states do not allow “bonus depreciation” allowed for
Federal tax purposes.
• Because of the tie-ins to the Federal return, a state may be notified of any changes
made by the IRS upon audit of a Federal return (or vice versa).
• Most states allow a deduction for personal and dependency exemptions. Some
states substitute a tax credit for a deduction.
• Many state income tax returns provide checkoff boxes for donations to various causes.
Many are dedicated to medical research and wildlife programs, but special projects
are not uncommon. For example, Wisconsin uses one for maintenance and operating
costs of Lambeau Field (home of the Green Bay Packers). These checkoff boxes have
been criticized as adding complexity to the returns and misleading taxpayers.26
• The objective of most states is to tax the income of residents and those who conduct business in the state (e.g., employees sent to the state to help a client or a
professional athlete playing a game in the state).
• Most states allow their residents some form of tax credit for income taxes paid to
other states.
The Big Picture
Example
12
Return to the facts of The Big Picture on p. 1-1. Travis will need to review the state income tax
laws in each state he has clients to determine if he is subject to that state’s tax on his consulting
income earned in that state. If the income is subject to tax in another state as well as his home
state, the home state might provide a credit to negate the double taxation.
• The due date for filing generally is the same as for the Federal income tax (for
individuals, the fifteenth day of the fourth month following the close of the tax
year; usually April 15 for calendar year taxpayers).
• Some states have occasionally instituted amnesty programs that allow taxpayers
to pay back taxes (and interest) on unreported income with no (or reduced) penalty. In many cases, the tax amnesty has generated enough revenue to warrant the
authorization of follow-up programs covering future years.27 Amnesties usually
include other taxes as well (e.g., sales, franchise, and severance).
24
or an in-depth treatment of the Federal income tax as it affects corporaF
tions, partnerships, estates, and trusts, and owners or beneficiaries of these
entities as well as sole proprietors, see Chapters 17 through 22 and 28.
See Chapters 6, 9, and 15 for additional discussion of the deduction for
qualified business income.
25
Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and
Wyoming do not have an individual income tax. New Hampshire imposes
an individual income tax only on interest and dividends.
19688_ch01_hr_002-043.indd 18
26
any taxpayers do not realize they are paying for the checkoff donation
M
(usually with some of their income tax refund). Unlike the presidential
election campaign fund available for Federal income tax purposes ($3 in
this case), the contribution is not made by the government.
27
Although the suggestion has been made, no comparable amnesty program
has been offered for the Federal income tax. The IRS has, however, offered
exemption from certain penalties for taxpayers who disclose offshore bank
accounts and participation in certain tax shelters.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-19
• Because many consumers do not pay state and local sales taxes on out-of-state
purchases, state income tax returns in some states include a separate line for
reporting any use tax that is due. As a result, the income tax return serves as a
means of collecting use taxes.
Nearly all states have an income tax applicable to corporations. Other states have
a franchise tax (discussed later in the chapter) that can be based in part on corporate
income.
Local Income Taxes
Cities imposing an income tax include Baltimore, Cincinnati, Cleveland, Detroit, Kansas
City (Missouri), New York, Philadelphia, and St. Louis. The application of a city income
tax is not limited to local residents.
1-4f Employment Taxes
Employment taxes are a type of income tax imposed on employers and employees.
We concentrate on the two major employment taxes: FICA (Federal Insurance Contributions Act—commonly referred to as the Social Security tax) and FUTA (Federal
Unemployment Tax Act). Both taxes can be justified by social and public welfare
considerations: FICA offers some measure of retirement security, and FUTA provides a
modest source of income in the event of loss of employment.
These employment taxes come into play for employees (not self-employed individ­
uals) if the particular work is covered under FICA or FUTA or both.28
FICA Taxes
The FICA tax rates and wage base have increased steadily over the years. It is difficult
to imagine that the initial rate in 1937 was only 1 percent of the first $3,000 of covered
wages. Thus, the maximum tax due was only $30.
The FICA tax has two components: Social Security tax (old age, survivors, and disability insurance) and Medicare tax (hospital insurance). The Social Security tax rate
is 6.2 percent and generally does not change. The base amount usually increases each
year. For 2022, the base amount is $147,000 ($142,800 for 2021).
The Medicare portion of FICA is applied at a rate of 1.45 percent and, unlike Social
Security, is not subject to any dollar limitation. The Affordable Care Act (ObamaCare)
imposes an additional 0.9 percent tax on earned income (including self-employment
income) above $200,000 (single filers) or $250,000 (married filing jointly). Unlike the
Social Security tax of 6.2 percent and the regular Medicare portion of 1.45 percent, an
employer does not have to match the employees’ 0.9 percent tax.
A spouse employed by another spouse is subject to FICA. However, children under
the age of 18 who are employed in a parent’s unincorporated trade or business are
exempted.
The Big Picture
Return to the facts of The Big Picture on p. 1-1. Presuming that April and Martin perform meaningful services for Travis (which the facts seem to imply), they are legitimate employees. April is not
subject to Social Security tax because she is under the age of 18. However, Martin is 18 and needs
to be covered. Furthermore, recall that Amy Carter is now working at a medical clinic and will
likewise be subject to Social Security tax. Travis, as an independent contractor, is subject to selfemployment tax.
28
Example
13
hapter 12 includes additional coverage of employment taxes for employC
ees, employers, and self-employed persons. See also Circular E, Employer’s
Tax Guide, issued by the IRS as Publication 15.
19688_ch01_hr_002-043.indd 19
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-20
Part 1
Introduction and Basic Tax Model
Taxpayers who are not employees (e.g., sole proprietors and independent contractors)
may also be subject to Social Security taxes. Known as the self-employment tax, the rates
are 12.4 percent for Social Security and 2.9 percent for Medicare, or twice that applicable
to an employee. The additional 0.9 percent Medicare tax also covers situations involving
high net income from self-employment. The Social Security tax is imposed on net selfemployment income up to the annual base amount ($147,000 for 2022; $142,800 for 2021).
The Medicare portion of the self-employment tax is not subject to any dollar limitation.
To help cover the government’s cost of medical care, Congress enacted a special tax on
investment income.29 For this purpose, “investment income” is often referred to as “unearned
income” because it is not generated by the performance of services. A tax of 3.8 percent
is imposed on net investment income when a taxpayer’s modified adjusted gross income
(MAGI) exceeds certain threshold amounts.30 The threshold amounts are $250,000 for married taxpayers and $200,000 for single taxpayers. Investment income generally includes
passive-type income (e.g., rents, taxable interest, dividends, and capital gains). For further
discussion, see Chapter 12 and the online appendix on the Affordable Care Act.
FUTA Taxes
The purpose of the FUTA tax is to provide funds the states can use to administer
unemployment benefits. This leads to the somewhat unusual situation of one tax being
handled by both Federal and state governments. This joint administration means that
the employer must observe two sets of rules. State and Federal returns must be filed
and payments made to both governmental units.
In 2022, FUTA is 6 percent on the first $7,000 of covered wages paid during the year
to each employee. The Federal government allows a credit for FUTA paid (or allowed
under a merit rating system) to the state. The credit cannot exceed 5.4 percent of the
covered wages. Thus, the amount required to be paid to the Federal government could
be as low as 0.6 percent (6.0% 2 5.4%).
States reduce the unemployment tax on employers who experience stable employment, since the state pays less unemployment benefits. Thus, an employer with little or
no employee turnover might find that the state rate drops to as low as 0.1 percent or,
in some states, even to zero.
FUTA, unlike FICA, is paid entirely by the employer. A few states, however, levy a
special tax on employees to provide either disability benefits or supplemental unemployment compensation or both.
1-4g Other U.S. Taxes
To complete the overview of the U.S. tax system, some missing links need to be covered
that do not fit into the classifications discussed elsewhere in this chapter.
Federal Customs Duties
The tariff on imported goods,31 also known as customs duties, together with excise
taxes, provided most of the revenues needed by the Federal government during the
nineteenth century. In view of present times, it is remarkable that tariffs and excise taxes
alone paid off the national debt in 1835 and enabled the U.S. Treasury to pay a surplus
of $28 million to the states.
In recent years, tariffs have served both as an instrument for carrying out protectionist policies and for generating revenue. By imposing customs duties on the importation
of foreign goods that can be sold at lower prices, protectionists contend that the tariff
thereby neutralizes the competitive edge held by the producer of the foreign goods.
However, history shows that tariffs often lead to retaliatory action on the part of the
nation or nations affected.
29
nacted as part of the Health Care and Education Reconciliation Act of
E
2010.
30
AGI is adjusted gross income (see Exhibit 1.3 and page 1 of Form 1040)
M
plus any foreign income or excluded foreign housing costs. An online
19688_ch01_hr_002-043.indd 20
appendix covers the net investment income tax (NIIT) and other Affordable
Care Act tax provisions.
31
Less-developed countries that rely principally on one or more major commodities (e.g., oil or coffee) are prone to favor export duties.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-21
Miscellaneous State and Local Taxes
Most states impose a franchise tax on corporations for the right to do business in the
state.32 The tax base used varies from state to state but most often is based on the capitalization of the corporation (either with or without certain long-term indebtedness).
Similar to the franchise tax are occupational fees that apply to various trades or businesses (e.g., a liquor store license; a taxicab permit; or a fee to practice a profession
such as law, medicine, or accounting). Most of these are not significant revenue producers, and the fees are used to fund the costs of regulating the business or profession in
the interest of the public good.
The Big Picture
Return to the facts of The Big Picture on p. 1-1. Although the facts do not mention the matter,
both Travis and Amy might owe occupation or license fees—Travis for engineering and Amy for
nursing.
Example
14
Concept Summary 1.2 provides an overview of the major taxes existing in the United
States and specifies which political jurisdiction imposes them.
Concept Summary 1.2
Overview of Taxes in the United States
Imposed by Jurisdiction
Type of Tax
Federal
State
Local
Property taxes:
Ad valorem on realty
No
Yes
Yes
Ad valorem on personalty
No
Yes
Yes
Yes
Yes
Few*
Transaction taxes:
Excise
General sales
No
Most
Some
Severance
Yes**
Most
No
Estate
Yes
Some
No
Inheritance
No
Some
No
Gift
Yes
Few
No
Corporations
Yes
Most
Few
Individuals
Yes
Most
Few
FICA
Yes
No
No
FUTA
Income taxes:
Employment taxes:
Yes
Yes
No
Customs duties
Yes
No
No
Franchise taxes
No
Yes
No
Occupational taxes or fees***
Yes
Yes
Yes
* An example of a local excise tax is a tax on hotel occupancy, typically referred to as a transient occupancy tax (TOT).
** For Federal public lands and continental-shelf areas.
*** An example is a fee to operate a beauty salon or barbershop.
32
nly five states do not impose a franchise tax (Michigan, Nevada, South
O
Dakota, Washington, and Wyoming).
19688_ch01_hr_002-043.indd 21
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-22
Part 1
Introduction and Basic Tax Model
1-4h Proposed U.S. Taxes
The last two major reforms to the U.S. tax system were in 2017 [the Tax Cuts and Jobs
Act (TCJA) of 2017] and in 1986 (the Tax Reform Act of 1986). Tax reform discussions
over the past few decades also have included use of a consumption tax to replace all or
a portion of the income tax or as a new additional tax. Consumption taxes considered
include the flat tax, a national sales tax, and a value added tax. Federal tax reform discussions have also included adding a carbon tax or a financial transactions tax. A brief
description of these types of taxes follows.
Flat Tax
The flat tax , as introduced in 1981 by economists Robert Hall and Alvin Rabushka of
the Hoover Institution, is a form of a consumption tax. Their proposal achieves some
of the administrative advantages of a value added tax (VAT) relative to a sales tax while
also partially addressing concerns that consumption taxes impose a relatively heavier
tax burden on lower-income taxpayers. It assesses a “flat” 19 percent tax on all businesses (corporate or otherwise)—identical to the VAT, except that wages, pension
contributions, materials costs, and capital investments are deducted from the tax base.
Individuals (or households) are assessed a 19 percent flat-rate tax on wages and pension benefits above an exemption of $25,500 for a family of four. No other income is
taxable, and no other deductions are allowed. Over the past 35 years, the Hall-Rabushka
proposal has served as the blueprint for a number of proposals to reform the Federal
tax system.33
National Sales Tax
A national sales tax would operate similarly to most state sales taxes although the tax
base would be larger. The rate would also be higher to generate the revenues needed
to replace the Federal income tax.
A frequent proposal for a national sales tax, called the “Fair Tax,” would tax all
purchases, including food and medicine, real property, and many types of services, at
approximately 23 percent. Exempt items include business expenses, used goods, and
the costs of education. The Fair Tax would replace the income tax (both individual and
corporate), payroll taxes (including the self-employment tax), and the gift and estate
taxes. To help address the regressivity of the tax, many individuals would receive a
monthly rebate to offset a portion of sales tax paid.
Value Added Tax
A value added tax (VAT) is imposed on the value added by each party in a production
cycle. For example, a furniture maker is charged VAT on wood purchased to make the
furniture. Customers are charged VAT when they buy the furniture. A system of credits
results in the VAT ultimately only being paid by the final consumer. This form of VAT—
a credit invoice VAT—is similar to a sales tax. It is viewed as more efficient than a sales
tax because assessment throughout the production process better ensures collection of
the tax. The credit invoice VAT is widely used throughout the world.
A VAT has been considered in the United States various times since the 1960s. In
1984, the Treasury Department released a three-volume tax reform report, with one
volume devoted to the VAT.34 In 2016, Congressman James Renacci (R-OH) introduced
a proposal to replace the corporate income tax with a credit invoice VAT as part of his
Simplifying America’s Tax System (SATS) proposal.35
33
sually, the tax bill carries the number H.R. 1040. See R. E. Hall and
U
A. Rabushka, The Flat Tax, Hoover Institution (2007).
35
Tax Foundation, Details and Analysis of Rep. Jim Renacci’s Tax Reform
­Proposal, July 14, 2016.
34
U.S. Treasury Department, Tax Reform for Fairness, Simplicity, and
­Economic Growth: The Treasury Department Report to the President,
­Volume 3, 1984.
19688_ch01_hr_002-043.indd 22
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
Global Tax Issues
1-23
VAT in USA?
The United States is the only country in
the OECD (Organization of Economic Cooperation and
Development) that does not have a value added tax (VAT).
Over 140 countries around the world use a VAT, with rates
ranging from 5 percent to 27 percent.
Is the United States out of sync with most other countries by not having a VAT? One advantage of a VAT is that
it provides a significant revenue source, allowing for lower
individual and corporate income tax rates. Also, unlike the
income tax, a VAT is “border-adjustable,” meaning that a
country can impose it on imports but not exports. These are
some considerations for U.S. lawmakers in evaluating the economic effects of the U.S. tax system and tax reform options in
a global perspective.
One challenge of implementing a VAT in the United States is that it is a regressive tax
(it has a greater impact on lower-income taxpayers relative to higher-income taxpayers).
As a result, adjustments need to be implemented to protect lower-income taxpayers
(e.g., expanding the earned income tax credit and/or child tax credit; both occur in the
SATS proposal). Another challenge is that the Treasury Department (and IRS) will have
to learn how to implement and enforce the VAT.
Carbon Tax
A carbon tax aims to help reduce carbon emissions (i.e., greenhouse gases). The tax
could be applied to fossil fuels based on their level of greenhouse gas emissions.
Because a significant fossil fuel is gasoline, some people suggest a higher gasoline
excise tax as a simple form of a carbon tax.
Financial Transaction Tax
A financial transaction tax can take many forms. For example, it could be imposed on the
value of financial instruments purchased (e.g., stocks and bonds). It could be restricted
in some way (e.g., only applying to high-frequency trading). It could be imposed on
the value of bank assets. Because the tax base is quite large, the tax rate would likely
be low, perhaps even less than 1 percent. The primary concern with this type of tax is
the possible adverse effects on financial markets.
Space Flight Excise Tax
With the growth of commercial space flight activity and Sir Richard Branson and Jeff
Bezos riding on rockets their companies (Virgin Galactic and Blue Origin, respectively)
recently launched into space, Congress is evaluating whether to assess specific taxes
on these commercial ventures. Just as there is already an excise tax on airline tickets,
many think the same should apply to tickets for space flights. In 2021, Congressman
Blumenauer (D-OR) announced the Securing Protections Against Carbon Emissions
(SPACE) Tax Act proposal. This tax is also intended to help address the externalities of
the emissions resulting from rocket launches.
1-5 Tax Administration
1-5a Internal Revenue Service
The responsibility for administering the Federal tax laws rests with the Treasury Department. The IRS is part of the Department of the Treasury and is responsible for enforcing
the tax laws. The Commissioner of Internal Revenue is appointed by the President with the
advice and consent of the Senate. The Commissioner is responsible for establishing policy
and supervising the activities of the IRS. Here is the mission statement of the IRS:
LO.5
Explain the administration
of the tax law, including
the audit process utilized
by the IRS.
Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.
19688_ch01_hr_002-043.indd 23
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-24
Part 1
Introduction and Basic Tax Model
1-5b The Audit Process
Selection of Returns for Audit
Only a small number of tax returns are audited each year. The overall audit rate for
individuals is 0.2 percent. The audit rate for corporations is 0.3 percent. Keep in mind,
however, that the probability for audit increases for higher-income taxpayers.36
Tax returns are selected for audit in different ways. A common technique for
­individuals is called information matching. For example, the IRS compares information
returns it receives (e.g., a Form 1099 interest income statement from a bank related to
an individual) to an individual’s tax return. If the information is not reported correctly,
the IRS sends a notice to the taxpayer indicating the problem and the additional tax
owed. Another approach is done through computer scoring. This approach uses mathematical formulas and statistical sampling techniques to select tax returns that are most
likely to contain errors and to provide significant amounts of additional tax revenues
when audited. The mathematical formula produces what is called a ­Discriminant Function (DIF) score. It is the DIF score given to a particular return that may lead to its selection for audit. Periodically, the IRS updates the DIF components by auditing a random
cross section of returns to determine the most likely areas of taxpayer noncompliance.
Although the IRS does not openly disclose the details of all of its audit selection
techniques, here are some general comments about audit selection:
• Certain groups of taxpayers are subject to audit much more frequently than others.
These groups include individuals with large amounts of gross income, self-employed
individuals with substantial deductions, and taxpayers with prior tax deficiencies. The
same is true for businesses that receive a large proportion of their receipts in cash (e.g.,
cafés and small service businesses) and thus have a high potential for tax avoidance.
Example
15
Jack owns and operates a liquor store on a cash-and-carry basis. Because all of Jack’s sales are for
cash, he might be a prime candidate for an audit by the IRS. Cash transactions are easier to conceal
than those made on credit.
• If information returns (e.g., Form 1099 or Form W–2) are not in substantial agreement with reported income, an audit can be anticipated.
• If an individual’s itemized deductions are in excess of averages established for
various income levels, the probability of an audit is increased.
• Filing of a refund claim by the taxpayer may prompt an audit of the return.
• Information obtained from other sources (e.g., informants and news items) may
lead to an audit.
The IRS pays rewards to persons who provide information leading to the discovery and punishment of those who violate the tax laws. The rewards may not exceed
30 percent of the taxes, fines, and penalties recovered.
Information Leading to an IRS Audit
Example
16
36
After 15 years of service, Rita is discharged by her employer, Dr. Benjamin Smith. Shortly thereafter,
the IRS receives an anonymous letter stating that Dr. Smith keeps two separate sets of books and
that the one used for tax reporting substantially understates his cash receipts.
Internal Revenue Service, Data Book 2020, Table 17. Examination
Coverage and Recommended Additional Tax After Examination, by Type
and Size of Return, Tax Year 2018.
19688_ch01_hr_002-043.indd 24
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-25
Information Leading to an IRS Audit
During a divorce proceeding, it is revealed that Leo, a public official, kept large amounts of cash in
a shoe box at home. This information is widely disseminated by the news media and comes to the
attention of the IRS. Needless to say, the IRS is interested in knowing whether these funds originated
from a taxable source and, if so, whether they were reported on Leo’s income tax returns.
Example
17
Types of Audits
Once a return is selected for audit, the taxpayer is notified by mail. If the issue involved
is minor, the matter often can be resolved simply by correspondence (a correspondence
audit ) between the IRS and the taxpayer. For fiscal year 2020, approximately 73 percent
of audits were handled via correspondence.37
Other examinations are generally classified as either office audits or field audits.
An office audit usually is restricted in scope and is conducted in IRS offices. In contrast,
a field audit involves an examination of numerous items reported on the return and is
conducted at the taxpayer’s location (or that of the taxpayer’s representative).
The Big Picture
Return to the facts of The Big Picture on p. 1-1. The audit of the Walkers by the IRS obviously was
a correspondence type. The reason for the audit was probably triggered by a minor oversight by
the Walkers, such as the omission of some interest or dividend income. The audit of the Carters,
however, was more serious—probably a field or office type. Because the Federal audit followed a
state audit that was productive (i.e., led to the assessment of a deficiency), there may have been
an exchange of information between the two taxing authorities—see p. 1-16 in this chapter.
Example
18
At the end of an audit, the examining agent issues a Revenue Agent’s Report (RAR) that
summarizes the findings. The RAR will result in a refund (the tax was overpaid), a deficiency (the tax was underpaid), or a no change (the tax was correct) finding. If during the
course of an audit a special agent accompanies (or takes over from) the regular auditor,
the IRS suspects fraud. In this case, the taxpayer should retain competent legal counsel.
Settlement Procedures
If an audit results in an assessment of additional tax and no settlement is reached
with the IRS agent, the taxpayer may request an appeal within the IRS. The Independent Office of Appeals of the IRS is authorized to settle all disputes based on the
hazards of litigation (the probability of favorable resolution of the disputed issue
or issues if litigated). In some cases, a taxpayer may be able to obtain an overall
­reduction of the assessment or a favorable settlement of one or more disputed issues.
If a satisfactory settlement is not reached within the IRS, the taxpayer can litigate
the case in the Tax Court, a Federal District Court, or the Court of Federal Claims.
However, litigation is normally discouraged because of the legal costs involved and
the uncertainty of the final outcome. Tax litigation considerations are discussed more
fully in Chapter 2.
1-5c Statute of Limitations
A statute of limitations is a provision that requires any lawsuit to be brought within a
reasonable period of time. Found at the state and Federal levels, such statutes cover a
multitude of suits, both civil and criminal.
For the Federal income tax, two categories are involved, which cover time limits on
the assessment of additional tax deficiencies by the IRS and time limits related to refund
claims by taxpayers.
37
Internal Revenue Service, Data Book, 2020, p. 34.
19688_ch01_hr_002-043.indd 25
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-26
Part 1
Introduction and Basic Tax Model
Assessment by the IRS
In general, the IRS may assess an additional tax liability against a taxpayer within three
years of the filing of the income tax return. If the return is filed early, the three-year
period begins to run from the due date of the return (usually April 15 for a calendar
year individual taxpayer). If the taxpayer files the return late (i.e., beyond the due date),
the three-year period begins to run on the date filed.
If a taxpayer omits an amount of gross income in excess of 25 percent of the gross
income reported on the return, the statute of limitations is increased to six years.
Example
19
For 2022, Amin, a calendar year taxpayer, reported gross income of $400,000 on a timely filed
income tax return. If Amin omitted more than $100,000 (25% 3 $400,000), the six-year statute of
limitations would apply to the 2022 tax year.
The six-year provision on assessments by the IRS applies only to the omission of
income; it does not cover other factors that might lead to an understatement of tax
liability, such as overstatement of deductions and credits.
There is no statute of limitations on assessments of tax if no return is filed or if a
fraudulent return is filed.
Limitations on Refunds
If a taxpayer believes that an overpayment of Federal income tax was made, a claim for
refund should be filed with the IRS. A claim for refund is a request to the IRS that it
return a tax overpayment to the taxpayer.38
A claim for refund generally must be filed within three years from the date the return
was filed or within two years from the date the tax was paid, whichever is later. Income tax
returns that are filed early are deemed to have been filed on the date the return was due.
1-5d Interest and Penalties
Interest rates are determined quarterly by the IRS based on the existing Federal short-term
rate. Currently, the rates for tax refunds (overpayments) for individual taxpayers are the same
as those applicable to assessments (underpayments). For the first quarter ­(January
1–March 31) of 2022, the rates were 3 percent for refunds and assessments.39
For assessments of additional taxes, the interest begins running on the unextended
due date of the return. With refunds, however, no interest is allowed if the overpayment is refunded to the taxpayer within 45 days of the date the return is filed. For this
purpose, returns filed early are deemed to have been filed on the due date.
In addition to interest, the tax law provides various penalties for lack of compliance
by taxpayers. Some of these penalties are summarized as follows:
• For failure to file a tax return by the due date (including extension—see Chapter 3),
a penalty of 5 percent per month up to a maximum of 25 percent is imposed on
the amount of tax shown as due on the return. Any fraction of a month counts
as a full month.
• A penalty for failure to pay the tax due as shown on the return is imposed in the
amount of 0.5 percent per month up to a maximum of 25 percent. Again, any
fraction of a month counts as a full month. During any month in which both the
failure to file penalty and the failure to pay penalty apply, the failure to file penalty
is reduced by the amount of the failure to pay penalty.
38
Generally, an individual filing a claim for refund should use Form 1040X.
19688_ch01_hr_002-043.indd 26
39
ev.Rul. 2021–24; the rates for the remainder of 2022 were not available
R
when the text went to press.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
Global Tax Issues
1-27
Outsourcing of Tax Return Preparation
The use of foreign nationals to carry out
c­ ertain job assignments for U.S. businesses is an increasingly
­popular practice. Outsourcing activities such as telemarketing to India, for example, can produce the same satisfactory
result as ­having the work done in the United States but at a
lower cost.
Outsourcing is also being applied to the preparation of
tax returns. This practice not only can be expected to continue but also is likely to increase in volume. Outsourcing
tax return preparation does not violate Federal law and is
compatible with accounting ethical guidelines as long as
three safeguards are followed: First, the practitioner must
make sure client confidentiality is maintained. Second, the
practitioner must verify the accuracy of the work that has
been outsourced. Third, the practitioner must inform clients,
preferably in writing, when any third-party contractor is used
to provide professional services.
Practitioners justify outsourcing as a means of conserving
time and effort that can be applied toward more meaningful
tax planning on behalf of their clients.
Adam files his tax return 18 days after the due date of the return. Along with the return, he remits
a check for $1,000, which is the balance of the tax he owed. Disregarding the interest element,
Adam’s total penalties are as follows:
Failure to pay penalty (0.5% 3 $1,000)
Plus:
Failure to file penalty (5% 3 $1,000)
Less failure to pay penalty for the same period
Failure to file penalty
Total penalties
Example
20
$ 5
$50
(5)
45
$50
Note that the penalties for one full month are imposed even though Adam was delinquent by
only 18 days. Unlike the method used to compute interest, any part of a month is treated as a
whole month.
• A negligence penalty of 20 percent is imposed if any of the underpayment was
for intentional disregard of rules and Regulations without intent to defraud. The
penalty applies to just that portion attributable to the negligence.
Cindy underpaid her taxes in the amount of $20,000, of which $15,000 is attributable to negligence. Cindy’s negligence penalty is $3,000 (20% 3 $15,000).
Example
21
• Various penalties may be imposed in the case of fraud. Fraud involves specific
intent on the part of the taxpayer to evade a tax. In the case of civil fraud, the
penalty is 75 percent of the underpayment attributable to fraud. In the case of
criminal fraud, the penalties can include large fines as well as prison sentences.
The difference between civil and criminal fraud is one of degree. Criminal fraud
involves the presence of willfulness on the part of the taxpayer. Also, the burden
of proof, which is on the IRS in both situations, is more stringent for criminal fraud
than for civil fraud. The negligence penalty is not imposed when the fraud penalty
applies. For possible fraud situations, refer to Examples 16 and 17.
1-5e Tax Practice
A practitioner who is a member of a profession (e.g., public accounting or law) must
abide by certain ethical standards. Furthermore, the Internal Revenue Code imposes
penalties on Federal tax return preparers who violate identified acts and procedures.
19688_ch01_hr_002-043.indd 27
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-28
Part 1
Introduction and Basic Tax Model
Ethical Guidelines
LO.6
Evaluate some of the ethical
guidelines involved in tax
practice.
The American Institute of CPAs has issued its “Statements on Standards for Tax Services”
(SSTS), dealing with CPAs engaged in tax practice. These pronouncements are enforceable as
part of its Code of Professional Conduct. They include the following summarized provisions:
• Do not take questionable positions on a client’s tax return in the hope the return
will not be selected for audit by the IRS. Any positions taken should be supported
by a good-faith belief that they have a realistic possibility of being sustained if
challenged. The client should be fully advised of the risks involved and of the
penalties that will result if the position taken is not successful.
• A practitioner can use a client’s estimates if they are reasonable under the circumstances.
If the tax law requires receipts or other verification, the client should be so advised. In
no event should an estimate be given the appearance of greater accuracy than is the
case. For example, an estimate of $1,000 should not be deducted on a return as $999.
• Every effort should be made to answer questions appearing on tax returns. A question need not be answered if the information requested is not readily available,
the answer is voluminous, or the question’s meaning is uncertain. The failure to
answer a question on a return cannot be justified on the grounds that the answer
could prove disadvantageous to the taxpayer.
• Upon learning of an error on a past tax return, advise the client to correct it. Do
not, however, inform the IRS of the error. If the error is material and the client
refuses to correct it, consider withdrawing from the engagement. This will be
necessary if the error has a carryover effect and prevents the current year’s tax
liability from being determined correctly.
Statutory Penalties Imposed on Tax Return Preparers
In addition to ethical constraints, a tax return preparer may be subject to specific penalties, including the following:
• Penalty for understatement of a tax liability based on a position that lacks substantial authority. If the position has a reasonable basis, the penalty can be avoided
by disclosing it on the return.
• Penalty for any willful attempt to understate taxes. This usually results when a preparer disregards or makes no effort to obtain pertinent information from a client.
• Penalty for failure to exercise due diligence in determining eligibility for, or the
amount of, an earned income tax credit, the child tax credit, or the American
opportunity tax credit.
• Various penalties involving procedural matters. Examples include failing to furnish
the taxpayer with a copy of the return, endorsing a taxpayer’s refund check, failing
to sign the return as a preparer, failing to furnish one’s identification number, and
failing to keep copies of returns or maintain a client list. The identification number
required of preparers of most Federal tax returns is the Preparer Tax Identification
Number (PTIN) . A PTIN is required by all persons who are paid for preparing or
assisting in preparing all or substantially all of a Federal tax return.40
Example
22
40
In a few months, Jaden, an accounting major at State University, will start an internship at Nguyen &
Associates, CPAs. He will assist other employees by organizing and analyzing client data for completeness, entering client information into the tax preparation software program used by the firm, and
comparing results to the prior year’s return. Jaden will not sign any tax returns.
Jaden will need to obtain a PTIN from the IRS because he is assisting in the preparation of the
returns. If, instead, Jaden were only entering data provided by his colleagues and making copies, and
not exercising any discretion or independent judgment regarding client tax information, he would
not need a PTIN.41
§ 6109(a)(4). Also see IRS website on PTINs that includes an online tool
to obtain or annually renew a PTIN (rpr.irs.gov/datamart/mainMen­
uUSIRS.do).
19688_ch01_hr_002-043.indd 28
41
§ 6109(a)(4) and Reg. §§ 1.6109–2(d) and (g).
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-6 Understanding the Federal Tax Law
The Federal tax law reflects the three branches of our Federal government. It is a
mixture of laws passed by Congress, explanations provided by the Treasury Department and the Internal Revenue Service (IRS), and interpretation of the law by the
courts. Anyone who has attempted to work with this vast amount of information is
familiar with its complexity. For the person who has to sift through this information to find the solution to a tax problem, it is good to know that there are reasons
behind the law. Knowing these reasons is the first step toward understanding the
Federal tax law.
The primary objective of any tax system is to raise the revenue needed to fund government operations. Although the fiscal needs of the government are important, other
considerations (economic, social, equity, and political factors) also play a significant
role. The Treasury Department, the IRS, and the courts also have significant impacts on
the evolution of Federal tax law. The remainder of the chapter focuses on these topics.
While the discussion focuses on the Federal tax system, it also applies to any level of
government that imposes taxes.
1-29
LO.7
Classify tax rules based on
their possible economic, social,
equity, and political reasons
for inclusion in a particular tax
system.
1-6a Revenue Needs
Raising revenues to fund the cost of government operations is the key factor in structuring a tax system. In a perfect world, taxes raised by the government would equal the
expenses incurred by government operations. However, this goal is rarely achieved by
the U.S. government, but is typically achieved by state and local governments that may
face restrictions on borrowing.
When enacting tax legislation, a deficit-conscious Congress often has been guided
by the concept of revenue neutrality so that changes neither increase nor decrease the
net revenues received by the government. With revenue-neutral legislation, there are
likely to be both “winners” (taxpayers who see a reduction in taxes paid) and “losers”
(taxpayers who see an increase in taxes paid).
In addition to making revenue-neutral changes in the tax law, several other procedures can be taken to mitigate any revenue loss. When tax reductions are involved, the
full impact of the legislation can be phased in over a period of years. Or as an alternative, the tax reduction can be limited to a period of years. When the period expires,
the prior law is reinstated through a sunset provision . For example, at times, Congress
has allowed more rapid depreciation treatment for a specified number of years. These
sunset (or temporary) provisions move legislation toward revenue neutrality (even
though it is not achieved).
1-6b Economic Considerations
Sometimes tax legislation is designed to help control the economy or encourage certain
activities and businesses.
Control of the Economy
Congress has used the tax depreciation rules as a means of controlling the economy.
Theoretically, shorter asset lives and accelerated methods should encourage additional
investment in depreciable property acquired for business use. On the other hand, longer asset lives and use of straight-line depreciation should discourage capital outlays.
Congress also uses incentives such as bonus depreciation to stimulate the economy
when needed.
A change in tax rates has a more immediate impact on the economy. With lower tax
rates, taxpayers retain money that can be used for other purposes (e.g., purchases or
savings). If, however, Congress is using the concept of revenue neutrality, these rate
reductions may be offset by a reduction or elimination of deductions or credits. As a
result, lower tax rates do not always mean lower taxes.
19688_ch01_hr_002-043.indd 29
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-30
Part 1
Introduction and Basic Tax Model
Encouragement of Certain Activities
Congress uses the tax law to encourage certain types of economic activity or segments of
the economy. For example, certain research and development expenditures may generate a
tax credit that reduces the taxpayer’s tax liability. Inventions are also encouraged by tax law.
Under certain conditions, the sale of a patent results in long-term capital gain treatment.
Part of the tax law addresses the nation’s energy policy—in terms of both our reliance
on carbon-based fuels and the need to ease the problem of climate change. For example, a tax credit is available for installation of solar and small wind energy equipment.
Residential energy credits are available for home improvements that conserve energy or
make its use more efficient (e.g., solar water heaters). Ecological considerations explain
why pollution control facilities can be amortized over 60 months (rather than over the
39-year period for most buildings).
Is saving desirable for the economy? Saving can lead to capital formation, making funds
available to finance home construction and industrial expansion. The tax law encourages
saving by giving private retirement plans preferential treatment. Besides contributions to
certain Individual Retirement Accounts (IRAs) and Keogh (H.R. 10) plans being deductible, income from the contributions accumulates tax-free until it is withdrawn.
Encouragement of Certain Industries
Historically, agricultural activities have been favored under Federal tax law. Among the
benefits are the election to expense rather than capitalize certain soil and water conservation expenditures and fertilizers and the election to defer the recognition of gain
on the receipt of crop insurance proceeds.
The tax law favors the development of natural resources by permitting the use of
percentage depletion and a write-off (rather than a capitalization) of certain exploration costs. The railroad and banking industries also receive special tax treatment under
Federal tax law.
Encouragement of Small Business
Small business development is also encouraged under the tax law. For example, the shareholders of a small business corporation can make an election that allows the profits (or
losses) of the corporation to flow through to its shareholders, avoiding the corporate
income tax.42 Another provision allows non-corporate shareholders of certain small corporations to exclude from income their gain from the sale of the stock if held over five years.
1-6c Social Considerations
Some provisions of the Federal tax law, particularly those dealing with individuals, can
be explained by social considerations. Here are some notable examples:
• Certain benefits provided to employees through accident and health plans financed
by employers are nontaxable to employees. It is socially desirable to encourage
these plans because they provide medical benefits in the event of an employee’s
illness or injury. In addition, insurance companies are paying for these benefits
(rather than the government).
• Most premiums paid by an employer for group term insurance covering the life
of the employee are nontaxable to the employee. Life insurance proceeds (which
are also nontaxable) provide funds to help the family unit adjust to the loss of
wages caused by the employee’s death.
• A contribution made by an employer to a qualified pension or profit sharing plan
for an employee may receive special treatment. The contribution and any income it
generates are not taxed to the employee until the funds are distributed. This arrangement also benefits the employer by allowing a tax deduction for the contribution to
the qualified plan. Private retirement plans are encouraged to supplement any Social
Security payments.43
42
Known as the S election, it is discussed in Chapter 22.
19688_ch01_hr_002-043.indd 30
43
he same rationale explains the availability of similar arrangements for
T
self-employed persons (e.g., the H.R. 10, or Keogh, plan).
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-31
• A deduction is allowed for contributions to qualified charities. The deduction shifts
some of the financial and administrative burden of socially desirable programs
from the public (the government) to the private sector.
• A tax credit is allowed for amounts spent to furnish care for dependents to
enable the taxpayer to work. A credit for employers who incur certain child care
expenses assists employees indirectly.
• To encourage taxpayers to join the workforce even though their wages may be
low, an earned income tax credit can be claimed. The credit varies depending on
the number of qualifying children and the level of wages earned.
• Certain credits are made available to individuals aged 65 and older and those with
disabilities. Credits also are allowed to businesses that incur expenditures to make
their facilities more accessible to the disabled.
• Various tax credits, deductions, and exclusions are designed to encourage taxpayers to obtain additional education.44
• A tax deduction is not allowed for certain expenses deemed to be contrary to ­public
policy. Expenses not allowed include fines, penalties, illegal kickbacks, bribes to
government officials, and gambling losses in excess of gains. In addition, any business expense (including attorney fees) related to sexual harassment or abuse is not
deductible if the settlement or payment is subject to a nondisclosure agreement.
1-6d Equity Considerations
The concept of equity (or fairness) is relative. One measure of equity is whether a tax
is regressive or progressive. The determination is made by calculating the percentage of
a taxpayer’s income that is used to pay a tax. As noted earlier, the Federal income tax
is progressive. In contrast, the gasoline excise tax is regressive.
Hanna and Lori are single taxpayers living in the same state. Hanna has income of $100,000, and Lori
has income of $10,000. Assume that Hanna pays $5,000 in state income taxes while Lori pays only
$100. The state income tax represents 5% of Hanna’s income but only 1% of Lori’s income. Because the
higher-income taxpayer (Hanna) devotes a larger percentage of her income to pay the tax relative to
a lower-income taxpayer (Lori), this state income tax is progressive in its effect on taxpayers.
Alternatively, assume that Hanna and Lori each purchase the same quantity of gasoline during the
year and each pays gasoline excise tax of $200. This tax represents less than 0.1% of Hanna’s income
but 2% of Lori’s income. Because the lower-income taxpayer (Lori) devotes a larger percentage of her
income to pay the tax relative to a higher-income taxpayer (Hanna), the gasoline excise tax is regressive in its effect on taxpayers.
Example
23
Lawmakers and others often consider whether a tax change is progressive or regressive
to understand its impact on taxpayers and whether the change should be made. If a tax
represents the same percentage of the income of all taxpayers, it is a proportional tax.
Eduardo and Sanjay are single taxpayers living in the same state. Eduardo has income of $50,000 and
pays $1,500 in state taxes. Sanjay has income of $20,000 and pays $600 in state taxes. In this case,
Eduardo and Sanjay are devoting the same percentage of their income to the state tax (3%), making
the tax proportional in terms of the effect it has on taxpayers.
Example
24
The concept of equity also appears in tax provisions that alleviate the effect of multiple taxation and postpone the recognition of gain when the taxpayer lacks the ability
or wherewithal to pay the tax. Provisions that mitigate the effect of the application of
the annual accounting period concept and help taxpayers cope with the eroding results
of inflation also reflect equity considerations.
44
hese provisions can also be justified under the category of economic
T
considerations because a better-educated workforce carries a positive economic impact.
19688_ch01_hr_002-043.indd 31
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-32
Part 1
Introduction and Basic Tax Model
Alleviating the Effect of Multiple Taxation
Equity considerations can explain the Federal tax treatment of certain income from foreign sources. Because double taxation results when the same income is subject to both
foreign and U.S. income taxes, the tax law permits the taxpayer to choose between a
credit and a deduction for the foreign taxes paid.
The Wherewithal to Pay Concept
The wherewithal to pay concept recognizes the inequity of taxing a transaction when the
taxpayer lacks the means (i.e., funds) to pay the tax. This concept is typically applied
to transactions where the taxpayer’s economic position has not changed significantly.
An illustration of the wherewithal to pay concept is the tax treatment of an involuntary conversion. An involuntary conversion occurs when property is destroyed by a
casualty (e.g., a fire or hurricane) or taken by a public authority through condemnation
(e.g., taking land to build a new road). If gain results from the conversion, it is deferred
if the taxpayer replaces the property within a specified period of time.
Example
25
Some of the pasture land belonging to Ron, a rancher, is condemned by the state for use as a
game preserve. The condemned pasture land cost Ron $120,000, but the state pays him $150,000
(its fair market value). Shortly thereafter, Ron buys more pasture land for $150,000.
In Example 25, Ron has a realized gain of $30,000 [$150,000 (condemnation award) 2
$120,000 (cost of land)]. It would be inequitable to force Ron to pay a tax on this gain
for two reasons. First, without selling the property acquired (the new land), Ron does
not have the funds to pay the tax. Second, his economic position has not changed
(i.e., he still owns pasture land worth $150,000). If, however, the taxpayer’s economic
position changes in any way, tax consequences may result.
Example
26
Assume the same facts as in Example 25, except that Ron reinvests only $140,000 of the award in
new pasture land. Now Ron has a taxable gain of $10,000. Instead of ending up with only replacement property, Ron has $10,000 in cash.
Mitigating the Effect of the Annual Accounting Period Concept
All taxpayers must report their taxable income to the Federal government at regular
intervals. The accounting period used to report taxable income (and settle any tax
liability) is one year. Referred to as the annual accounting period concept, its effect is
to divide each taxpayer’s life, for tax purposes, into equal annual intervals.
The annual accounting period concept can lead to different tax treatment for taxpayers who are in the same economic position. Consider the following example.
Example
José and Alicia, both sole proprietors, showed the following results during the past three years:
27
Profit (or Loss)
Year
José
Alicia
2020
2021
2022
$50,000
60,000
60,000
$150,000
60,000
(40,000)
Although José and Alicia have the same total profit of $170,000 over the three-year period, the
annual accounting period concept places Alicia at a definite disadvantage for tax purposes. The
net operating loss (NOL) deduction offers Alicia some relief by allowing her to carry forward (but
not back) some or all of her 2022 loss to future years. With a net operating loss carryforward, Alicia
may apply her 2022 loss to future years’ profits (with certain limitations; see Chapter 7).
19688_ch01_hr_002-043.indd 32
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-33
The reasoning used to support the net operating loss deduction also can explain the
special treatment the tax law accords to excess capital losses and excess charitable
contributions.45 Carryback and carryover procedures help mitigate the effect of limiting
a loss or a deduction to the accounting period in which it was realized. Using these
procedures, a taxpayer can salvage a loss or a deduction that might otherwise be lost.
The installment method of recognizing gain on the sale of property allows a taxpayer to spread tax consequences over the payout period.46 The installment method is
supported by the wherewithal to pay concept; recognition of gain corresponds to the
collection of the cash received from the sale of the property. The tax consequences
match the seller’s ability to pay the tax.
Coping with Inflation
Because of the progressive nature of the income tax, a wage adjustment to compensate for inflation could place the employee in a higher income tax bracket. Known as
bracket creep, its overall impact is an erosion of purchasing power. Congress recognizes this problem and adjusts various income tax components, such as tax brackets,
standard deduction amounts, and a wide variety of other items, through an indexation
procedure. Indexation is based on the change in the chained consumer price index
over the prior year.
1-6e Political Considerations
A large segment of the Federal tax law is made up of statutory provisions. Because
these statutes are enacted by Congress, political considerations often influence tax law.
The effect of political considerations on the tax law includes special interest legislation,
political expediency situations, and state and local government influences.
Special Interest Legislation
There is no doubt that certain provisions of the tax law can largely be explained by the
political influence some groups have had on Congress. For example, prepaid subscription and dues income is not taxed until earned, whereas prepaid rents are taxed to the
landlord in the year received. This exception was created because certain organizations
(e.g., the American Automobile Association) convinced Congress that special tax treatment was needed for multi-year dues and subscriptions.
Another provision, sponsored by a senator from Georgia, suspended the import
duties on ceiling fans. The nation’s largest seller of ceiling fans is Atlanta-based Home
Depot.
Although some special interest legislation can be justified on economic or social
grounds, in most cases, it cannot. It is, however, an inevitable product of our political
system.
Political Expediency Situations
Various tax changes can be tied to the shifting moods of the American public. That Congress is sensitive to popular feelings is an accepted fact. As a result, certain provisions
of the tax law can be explained by the political climate at the time they were enacted.
Measures that deter more affluent taxpayers from obtaining so-called preferential tax
treatment have always had popular appeal and, consequently, the support of Congress.
Tax provisions like the imputed interest rules and the limitations on the deductibility of
interest on investment indebtedness affect affluent taxpayers directly. More subtle are
provisions that phase out tax breaks as income rises. These phaseouts are often called
stealth taxes because the effects are indirect (and the taxpayer might not be aware of
45
46
The tax treatment of these items is discussed in Chapters 7, 10, and 14.
Under the installment method, each payment received by the seller represents both a recovery of capital (the nontaxable portion) and profit from
19688_ch01_hr_002-043.indd 33
the sale (the taxable portion). The tax rules governing the installment
method are discussed in Chapter 16.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-34
Part 1
Introduction and Basic Tax Model
them). The tax law contains several of these phaseout rules. Examples include the
phaseout of the child tax credit and education tax credits.
State and Local Government Influences
Political considerations played a major role in the nontaxability of interest received on
state and local obligations. Somewhat less apparent has been the influence state law
has had in shaping our present Federal tax law. Such was the case with community
property systems. The nine states with community property systems are Arizona,
California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
The rest of the states are common law jurisdictions.47 The difference between common
law and community property systems centers around the property rights possessed by
married persons. In a common law system, each spouse owns whatever each earns.
Under a community property system, one-half of the earnings of each spouse is considered owned by the other spouse.
Example
28
Adam and Fran are married, and their only income is the $80,000 annual salary Adam receives. If
they live in New Jersey (a common law state), the $80,000 salary belongs to Adam. If, however, they
live in A
­ rizona (a community property state), the $80,000 is divided equally, in terms of ownership,
between Adam and Fran.
At one time, the tax position of the residents of community property states was so
advantageous that many common law states adopted community property systems.
Needless to say, the political pressure placed on Congress to correct the disparity in tax
treatment was considerable. To a large extent, this was accomplished in the Revenue Act
of 1948, which extended many of the community property tax advantages to residents
of common law jurisdictions.
Congress accomplished this by allowing married taxpayers to file joint returns and
compute their tax liability as if one-half of the income had been earned by each spouse.
This result is automatic in a community property state because half of the income
earned by one spouse belongs to the other spouse. The income-splitting benefits of a
joint return are now incorporated as part of the tax rates applicable to married taxpayers. See Chapter 3.
LO.8
Explain the role played
by the IRS and the courts
in the evolution of the
Federal tax system.
1-6f Influence of the Internal Revenue Service
The IRS has exerted its influence in many areas of the tax law. As the protector of the
national revenue, the IRS has been instrumental in securing the passage of legislation
designed to curtail aggressive tax avoidance practices (i.e., closing tax loopholes). In
addition, the IRS has sought and obtained law changes to make its job easier (to attain
administrative feasibility).
The IRS as Protector of the Revenue
Many provisions in the tax law resulted from the direct efforts of the IRS to prevent
taxpayers from exploiting a tax loophole. Working within the letter of existing laws,
ingenious taxpayers and their advisers devise techniques that accomplish indirectly
what cannot be accomplished directly. As a result, Congress passes laws to close the
loopholes that taxpayers have located and exploited.
In addition, Congress has passed laws that enable the IRS to make adjustments based
on the substance of a transaction (rather than the form chosen by the taxpayer). For
example, the IRS can make adjustments to a taxpayer’s method of accounting when the
method used by the taxpayer does not clearly reflect income.48
47
I n Alaska, spouses can choose to have the community property rules apply.
Otherwise, property rights are determined under common law rules.
19688_ch01_hr_002-043.indd 34
48
See Chapter 16.
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
Tran owns and operates a clothing distribution business with over $26,000,000 of annual gross
receipts. The merchandise acquired is charged to the purchases account and written off (expensed) for
tax purposes in the year of acquisition. Since this procedure does not clearly reflect income, it would
be appropriate for the IRS to require that Tran establish and maintain an ending inventory account.
1-35
Example
29
Administrative Feasibility
Some tax laws are created to simplify the task of the IRS in collecting the revenue and
administering the law. As to collecting revenue, the IRS long ago realized the importance of placing taxpayers on a pay-as-you-go basis. Withholding procedures apply to
wages, but the tax on other types of income may have to be paid via quarterly estimated
payments. The IRS has been instrumental in convincing the courts that accrual basis
taxpayers should, in most cases, pay taxes on prepaid income in the year received and
not when earned. The approach may be contrary to generally accepted accounting
principles, but prepayment is consistent with the wherewithal to pay concept.
To help the IRS collect revenues when due, Congress has passed many provisions that
impose interest and penalties on taxpayers if they don’t comply with the tax law. Provisions such as the penalties for failure to pay a tax or to file a return that is due, the negligence penalty for intentional disregard of rules and Regulations, and various penalties for
civil and criminal fraud are intended to encourage taxpayers to comply with the tax law.
The audit process conducted by the IRS is key to an effective administration of our
tax system. To carry out this function, the IRS is aided by provisions that reduce the
chance of taxpayer error or manipulation, thus simplifying the audit effort. For example,
by increasing the standard deduction amount, the audit function is simplified because
fewer returns with itemized deductions need to be checked.49
1-6g Influence of the Courts
In addition to interpreting statutory provisions and the administrative pronouncements
issued by the Treasury Department and the IRS, the Federal courts have influenced tax
law in two other ways.50 First, the courts have developed a number of judicial concepts
and doctrines that help guide how tax provisions are applied. Second, certain key decisions have led to changes in the Internal Revenue Code.
Judicial Concepts and Doctrines Relating to Tax
A leading tax concept developed by the courts deals with the interpretation of statutory
tax provisions that operate to benefit taxpayers. The courts have decided that these relief
provisions are exceptions to general tax rules so they should be applied narrowly. If a
taxpayer wants a relief provision to apply, the taxpayer has the responsibility to meet
the provision’s requirements (i.e., no exceptions).
The arm’s length concept is applied in dealings between related parties. Transactions may be tested by asking this question: Would unrelated parties have handled the
transaction in the same way?
Matt, the sole shareholder of Silver Corporation, leases property to the corporation for a yearly rent
of $60,000. To test whether the corporation should be allowed a rent deduction for this amount,
the IRS and the courts will apply the arm’s length concept. Would Silver Corporation have
paid $60,000 a year in rent if it had leased the same property from an unrelated party (rather than
from Matt)?
Example
30
continued
49
or a discussion of the standard deduction, see Chapter 3. The same jusF
tification was given by the IRS when it proposed to Congress the $100
limitation on personal casualty and theft losses. Imposition of the limitation
eliminated many casualty and theft loss deductions and, as a consequence,
saved the IRS considerable audit time. Later legislation, in addition to
retaining the $100 feature, generally limits deductible losses to those in
19688_ch01_hr_002-043.indd 35
Federally declared disaster areas. In addition, only losses in excess of 10%
of a taxpayer’s adjusted gross income are allowed. See Chapter 7.
50
A great deal of case law is devoted to ascertaining congressional intent.
The courts, in effect, ask: What did Congress have in mind when it enacted
a particular tax provision?
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-36
Part 1
Introduction and Basic Tax Model
Suppose it is determined that an unrelated third party would have charged an annual rent for
the property of only $50,000. Under these circumstances, Silver Corporation will be allowed a
deduction of only $50,000. The other $10,000 it paid for the use of the property represents a nondeductible dividend. Accordingly, Matt will be treated as having received rent income of $50,000
and dividend income of $10,000.
A judicial doctrine that must be considered in some transactions is the substance over
form doctrine. Here, no matter how a transaction is structured, the actual substance of
how the transaction is carried out controls.
Example
31
Gold Corporation hired Adam to work as its bookkeeper for six months while the regular bookkeeper is
on sick leave. This is a full-time position, and Adam reports to Gold’s CFO who directs his assignments.
Gold gave Adam a contract that states he is not an employee of Gold, but is instead an independent
contractor. Despite the form saying Adam is not an employee, the substance of what he does and the
relationship between Gold and Adam will control Adam’s employment designation for tax purposes.
Judicial Influence on Statutory Provisions
Some court decisions have been so important that Congress incorporated them into the
Internal Revenue Code. For example, many years ago the courts found that stock dividends
distributed to the shareholders of a corporation were not taxable as income. This result was
largely accepted by Congress, and the Code was modified to reflect the court’s position.
On occasion, however, Congress reacts negatively to judicial interpretations of the tax law.
Example
32
Nora leases unimproved real estate to Wade for 20 years. At a cost of $400,000, Wade erects a
building on the land. The building is worth $150,000 when the lease terminates and Nora takes
­possession of the property.
Does Nora have any income either when the improvements are made or when the lease termi­
nates? In a landmark decision, a court held that Nora must recognize income of $150,000 upon
the termination of the lease.
Congress believed that the result reached in Example 32 was not consistent with the
wherewithal to pay concept. As a result, the tax law was changed to provide that a
landlord does not recognize any income either when the improvements are made
(unless made in lieu of rent) or when the lease terminates.51
1-6h Summary
In addition to raising revenues, other factors have influenced the development of Federal tax law:
• Economic considerations. Congress uses the tax law to help regulate the economy
and encourage certain activities and types of businesses.
• Social considerations. The tax law has been used to encourage (or discourage)
certain socially desirable (or undesirable) practices.
• Equity considerations. The tax law can be designed to alleviate the effect of multiple taxation, recognize the wherewithal to pay concept, mitigate the effect of the
annual accounting period concept, and recognize the eroding effect of inflation.
• Political considerations. Some tax law represents special interest legislation,
reflects political expediency, or illustrates the effect of state and local law.
• Influence of the IRS. Laws are enacted to aid the IRS in the collection of revenue
and the administration of the tax law.
• Influence of the courts. Court decisions have established a body of judicial concepts relating to tax law and have, on occasion, led Congress to enact laws to
either clarify or negate their effect.
These factors help us understand how tax law develops (and why some provisions
exist). We also must learn to work with the tax law, which is the subject of Chapter 2.
51
M.E. Blatt Co. v. U.S., 305 U.S. 267 (1938) and § 109.
19688_ch01_hr_002-043.indd 36
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-37
Refocus on The Big Picture
Family and Taxes—A Typical Year
CORBIS/SUPERSTOCK
The explanation given for the difference in the ad valorem property taxes—the Carters’
increase and the Walkers’ decrease—seems reasonable (see Example 4). It is not likely
that the Carters’ increase was solely due to a general upward assessment in valuation,
because the Walkers’ taxes on their residence (located nearby) dropped. More business
use of the Carters’ residence (presuming that Travis conducts his consulting practice
from his home) might be responsible for the increase, but capital improvements appear
to be a more likely cause.
The imposition of the use tax when Travis registered the new automobile illustrates
one of the means by which a state can preclude the avoidance of its sales tax (see
Example 5).
When gifts between family members are material in amount (e.g., an RV) and
exceed the annual exclusion, a gift tax return needs to be filed (see Example 11). Even
though no gift tax may be due because of the availability of the unified transfer tax
credit, the filing of a return starts the running of the statute of limitations.
The Carters must recognize that some of their income is subject to income taxes in
more than one state and take advantage of whatever relief is available to mitigate the
result of double taxation (see Example 12).
Employment within and by the family group (e.g., children, other relatives, and
domestics) has become a priority item in the enforcement of Social Security tax and
income tax withholdings. Thus, the Carters must be aware of the need to cover their
son, Martin (see Example 13).
Because of the double audit (i.e., both state and Federal) and the deficiency
assessed, the Carters need to make sure that future returns do not contain similar
errors (see Example 18). As the text suggests, taxpayers with prior deficiencies are
among those whose returns may be selected for audit.
Key Terms
Ad valorem taxes, 1-12
FUTA tax, 1-20
Revenue neutrality, 1-29
Carbon tax, 1-23
Gift tax, 1-16
Sales tax, 1-14
Correspondence audit, 1-25
Indexation, 1-33
Severance taxes, 1-14
Employment taxes, 1-19
Inheritance tax, 1-15
Statute of limitations, 1-25
Estate tax, 1-15
National sales tax, 1-22
Sunset provision, 1-29
Excise taxes, 1-13
Occupational fees, 1-21
Use tax, 1-14
FICA tax, 1-19
Office audit, 1-25
Value added tax (VAT), 1-22
Field audit, 1-25
Personalty, 1-12
Wherewithal to pay, 1-32
Financial transaction tax, 1-23
Flat tax, 1-22
Preparer tax identification number
(PTIN), 1-28
Franchise tax, 1-21
Realty, 1-12
Discussion Questions
1.
LO.1 This textbook includes many features beyond the text materials in each chapter. For example, a glossary is included in the appendices and the end of each
chapter contains a list of key terms. Skim through the chapters, appendices, and
any other supplemental materials required for your course, and identify two special
features. For each, explain what it is and how it can help you understand taxation
in this tax course.
19688_ch01_hr_002-043.indd 37
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-38
Part 1
Introduction and Basic Tax Model
2. LO.1, 4 In the following independent situations, is the tax position of the taxpayer
likely to change? Explain why or why not.
a. John started renting out a spare room in his home.
b. Theresa quit her job as a staff accountant and established her own practice as
a CPA.
c. Paul’s employer transferred him from its California office to an office in Florida.
Critical Thinking
3. LO.1, 4 Marvin is the executor and sole heir of his aunt’s estate. The estate includes
her furnished home, which Marvin is considering converting to rental property to generate additional cash flow. What are some of the tax considerations
Marvin may confront?
4.
LO.2 World War II converted the Federal income tax into a mass tax. Explain.
5.
LO.2 How does the pay-as-you-go procedure apply to wage earners? To persons
who have income from sources other than wages?
6.
LO.3 Jane, a tax practitioner, has reviewed the law on how a certain state’s income
tax applies to a client’s web-based consulting business but is unable to reach
a conclusion for which she has a high level of confidence. Assuming that Jane is a
knowledgeable and experienced tax professional, which Guiding Principles of Good
Tax Policy might not be followed by this state?
7.
LO.3 Distinguish between taxes that are regressive and those that are progressive.
Critical Thinking
8.
LO.4 Several years ago Ethan purchased the former parsonage of St. James Church
to use as a personal residence. To date, Ethan has not received any ad valorem
property tax bills from either the city or the county tax authorities.
a. What is a reasonable explanation for this oversight?
b. What should Ethan do?
Critical Thinking
9.
LO.4 The Adams Independent School District wants to sell a parcel of unimproved
land that it does not need. Its three best offers are as follows: from the state’s
Department of Public Safety (DPS), $2,300,000; from the Second Baptist Church,
$2,200,000; and from Baker Motors, $2,100,000. DPS would use the property for a
new state highway patrol barracks, Second Baptist would start a church school, and
Baker would open a car dealership. If you are the financial adviser for the school
district, which offer would you prefer? Why?
10. LO.4 The commissioners for Walker County are actively negotiating with Falcon
Industries regarding the location of a new manufacturing plant in the area.
Since Falcon is considering several other sites, a “generous tax holiday” may be
needed to influence the final choice. The local school district is opposed to any
“generous tax holiday.”
a. What would probably be involved in a generous tax holiday?
b. Why would the school district be opposed?
11. LO.4 Sophia lives several blocks from her parents in the same residential subdivision. Sophia is surprised to learn that her ad valorem property taxes for the
year were raised but those of her parents were lowered. What is a possible explanation for the difference?
12. LO.4 The Morgan family lives in Massachusetts. They moor their sailboat in Rhode
Island. What might be a plausible reason for this?
13. LO.4 Is the breadth and number of Federal excise taxes increasing or decreasing?
Explain.
14. LO.4 After her first business trip to a major city, Jayla is alarmed when she reviews
her credit card receipts. Both the hotel bill and the car rental charge are in
19688_ch01_hr_002-043.indd 38
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-39
excess of the price she was quoted. Was Jayla overcharged, or is there an explanation for the excess amounts?
15. LO.4 What is the difference between an excise tax and a general sales tax?
a.
b.
Do all states impose a general sales tax?
Does the Federal government impose a general sales tax?
16. LO.4 The Garcías live in Clay County, which is adjacent to Jackson County. Although
the retail stores in both counties are comparable, the Garcías usually drive
a few extra miles to shop in Jackson County. As to why the Garcías might do this,
consider the following:
a. Clay County is in a different state than Jackson County.
b. Clay County and Jackson County are in the same state.
17. LO.4 During a social event, Muriel and Caleb are discussing the home computer
each recently purchased. Although the computers are identical makes and
models, Muriel is surprised to learn that she paid a sales tax but Caleb did not.
Comment as to why this could happen.
Critical Thinking
18. LO.4 Distinguish between an estate tax and an inheritance tax.
a. Do some states impose both? Neither?
b. Which, if either, does the Federal government impose?
19. LO.4 Jake (age 72) and Jessica (age 28) were recently married. To avoid any transfer
taxes, Jake has promised to leave Jessica all of his wealth when he dies. Is
Jake under some misconception about the operation of the Federal gift and estate
taxes? Explain.
20. LO.4 Address the following issues:
a. What is the purpose of the unified transfer tax credit?
b. Is the same amount available for both the Federal gift tax and the estate tax?
Explain.
c. Does the use of the credit for a gift affect the amount of credit available for the
estate tax? Explain.
21. LO.4 Elijah and Anastasia are married and have five married children and nine
minor grandchildren. For 2022, what is the maximum amount they can give
to their family (including the sons- and daughters-in-law) without using any of their
unified transfer tax credit?
22. LO.4 What is the difference between the Federal income tax on individuals and
that imposed on corporations?
23. LO.4 As to those states that impose an income tax, comment on the following:
a. “Piggyback” approach and possible “decoupling” from this approach.
b. Use of IRS audit results as part of a state tax audit.
c. Credit for taxes paid to other states.
24. LO.4 In May 2022, Hernando, a resident of California, has his 2020 Federal income
tax return audited by the IRS. An assessment of additional tax is made because
he inadvertently omitted some rental income. In October 2022, California audits his
state return for the same year. Explain the coincidence.
25. LO.4 Mike Barr was an outstanding football player in college and expects to be
drafted by the NFL in the first few rounds. Mike has let it be known that he
would prefer to sign with a club located in Florida, Texas, or Washington. Mike sees
no reason why he should have to pay state income tax on his player’s salary. Is Mike
under any delusions? Explain.
19688_ch01_hr_002-043.indd 39
Critical Thinking
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-40
Part 1
Introduction and Basic Tax Model
Critical Thinking
26. LO.4, 5 A question on a state income tax return asks the taxpayer if any out-ofstate internet or mail-order catalog purchases were made during the year.
The question requires a yes or no answer, and if the taxpayer answers yes, the total
dollar amount of these purchases is to be provided.
a. Does this inquiry have any relevance to the state income tax? If not, why is it
being asked?
b. Your client, Hannah, wants to leave the question unanswered. As the preparer
of her return, how do you respond?
27. LO.4 Many state income tax returns contain checkoff boxes that allow taxpayers to
make donations to a multitude of local charitable causes. On what grounds
has this procedure been criticized?
28. LO.4 Many states have occasionally adopted amnesty programs that allow taxpayers
to pay back taxes with reduced penalties.
a. Besides the revenue generated, how are these programs advantageous?
b. Could an amnesty program be used by a state that does not levy an income tax?
c. Does the IRS utilize this approach?
29. LO.4 Contrast FICA and FUTA as to the following:
a. Purpose of the tax.
b. Upon whom imposed.
c. Governmental administration of the tax.
d. Reduction of tax based on a merit rating system.
30. LO.4 In connection with the Medicare component of FICA, comment on the
following:
a. Any dollar limitation imposed.
b. The applicability of the 0.9% increase in the 1.45% regular tax rate.
31. LO.4 One of the tax advantages of hiring family members to work in your business
is that FICA taxes are avoided. Do you agree with this statement? Explain.
32. LO.4 Describe the nature and purpose of the following taxes:
a. Severance taxes.
b. Franchise taxes.
c. Occupational fees.
d. Customs duties.
e. Export duties.
33. LO.4 Regarding the value added tax (VAT), comment on the following:
a. Popularity of this type of tax.
b. Nature of the tax.
c. Effect on government spending.
34. LO.4 Both a value added tax (VAT) and a national sales tax have been criticized as
regressive in their effect.
a. Explain.
b. How could this shortcoming be remedied?
35. LO.4, 5 Serena operates a gift shop. To reduce costs of credit card transactions, she
offers customers a discount if they pay in cash. For the holiday rush,
she hires some short-term workers but pays them cash and does not add them to
the payroll.
a. What are some of the tax problems Serena might have?
b. Assess Serena’s chances of audit by the IRS.
19688_ch01_hr_002-043.indd 40
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-41
36. LO.5 With regard to the IRS audit process, comment on the following:
a. The audit is resolved by mail.
b. The audit is conducted at the office of the IRS.
c. A “no change” RAR results.
d. A special agent joins the audit team.
37. LO.5 Aldo has just been audited by the IRS. He does not agree with the
agent’s ­findings but believes that he has only two choices: pay the proposed
­deficiency or resort to the courts. Do you agree with Aldo’s conclusion? Why or
why not?
38. LO.5 What purpose is served by a statute of limitations? How is it relevant in the
case of tax controversies?
39. LO.5 Regarding the statute of limitations on additional assessments of tax by the
IRS, determine the applicable period in each of the following situations. As­sume a calendar year individual with no fraud or substantial omission involved.
a. The income tax return for 2021 was filed on February 19, 2022.
b. The income tax return for 2021 was filed on June 25, 2022.
c. The income tax return for 2021 was prepared on April 4, 2022, but was never
filed. Through some misunderstanding between the preparer and the taxpayer,
each expected the other to file the return.
d. The income tax return for 2021 was never filed because the taxpayer thought
no additional tax was due.
40. LO.5 Brianna, a calendar year taxpayer, files her income tax return for 2021 on
February 3, 2022. Although she makes repeated inquiries, she does not receive
her refund from the IRS until May 28, 2022. Is Brianna entitled to interest on the
refund? Explain.
41. LO.5, 6 On a Federal income tax return filed five years ago, Andy inadvertently
omitted a large amount of gross income.
a. Andy seeks your advice as to whether the IRS is barred from assessing additional income tax in the event he is audited. What is your advice?
b. Would your advice differ if you were the person who prepared the return in
question? Explain.
c. Suppose Andy asks you to prepare his current year’s return. Would you do so?
Explain.
42. LO.5 Rita files her income tax return 35 days after the due date of the return without
obtaining an extension from the IRS. Along with the return, she remits a check
for $40,000, which is the balance of the tax she owes. Disregarding the interest element, what are Rita’s penalties for failure to file and for failure to pay?
43. LO.5 For tax year 2020, the IRS assesses a deficiency against David for $500,000.
Disregarding the interest component, what is David’s penalty if the deficiency
is attributable to:
a. Negligence?
b. Fraud?
44. LO.5, 6 In March 2022, Kuni asks you to prepare his Federal income tax returns
for tax years 2019, 2020, and 2021. In discussing this matter with him, you
discover that he also has not filed for tax year 2018. When you mention this fact,
Kuni tells you that the statute of limitations precludes the IRS from taking any action
as to this year.
19688_ch01_hr_002-043.indd 41
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
1-42
Part 1
Introduction and Basic Tax Model
a.
b.
Is Kuni correct about the application of the statute of limitations? Why or why
not?
If Kuni refuses to file for 2018, should you prepare returns for 2019 through
2021? Explain.
45. LO.5, 6 The Benson CPA firm is considering utilizing an offshore service provider to
prepare many of its tax returns. In this regard, what ethical considerations
must be taken into account?
46. LO.7 In terms of tax policy, what do the following mean?
a. Revenue neutrality.
b. Sunset provision.
c. Indexation.
47. LO.7 Some tax rules can be justified on multiple grounds (e.g., economic and
social). In this connection, comment on the possible justification for the rules
governing the following:
a. Pension plans.
b. Education.
c. Home ownership.
Critical Thinking
48. LO.7, 8 Discuss the probable justification for each of the following aspects of the
tax law. Be sure to use concepts and terminology covered in this chapter.
a. A tax credit is allowed for amounts spent to furnish care for minor children
while the parent works.
b. Deductions for interest on home mortgage and property taxes on a personal
residence.
c. The income-splitting benefits of filing a joint return.
d. Fines and penalties are not deductible.
e. Net operating losses of a current year can be carried forward to profitable years.
f. A taxpayer who sells property on an installment basis can recognize gain on
the sale over the period the payments are received.
g. The exclusion from Federal tax of certain interest income from state and local
bonds.
h. Prepaid income is taxed to the recipient in the year received and not in the
year earned.
49. LO.7 Mia owns a warehouse that has a cost basis to her of $80,000. The city condemns the warehouse to make room for a new fire station. It pays Mia $400,000
for the property, its agreed-to fair market value. Shortly after the condemnation, Mia
purchases another warehouse as a replacement. What is her recognized gain if the
new property cost:
a. $280,000?
b. $444,000?
c. $80,000?
d. What, if any, is the justification for deferring the recognition of gain on the
involuntary conversion?
50. LO.8 A mother sells a valuable collection of antiques to her son for $1,000. What
judicial concept might the IRS invoke to question this transaction?
19688_ch01_hr_002-043.indd 42
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Chapter 1 An Introduction to Taxation and Understanding the Federal Tax Law
1-43
Research Problems
Use internet tax resources to address the following questions. Look for reliable websites and blogs of the IRS and other government agencies, media outlets, businesses,
tax professionals, academics, think tanks, and political outlets.
Research Problem 1. Using information from this chapter as well as information from
the tax agency in your state (likely called the Department of Revenue) and your
local government, find all of the taxes to which a sole proprietor is subject. Create
a table that lists all of these taxes, the rate(s), and the level(s) of government that
imposes each tax.
Research Problem 2. Use congress.gov or another reliable website to find a proposal
for a carbon tax or a financial transactions tax. Draft a summary of the tax, and analyze it against five of the AICPA’s principles of good tax policy.
Critical Thinking
Research Problem 3. Find a Federal or state proposal for a soda tax or sweetened
beverage tax. Provide the bill number and a brief explanation. Also apply the
AICPA’s principles of good tax policy to support your recommendation for or
against the bill.
Critical Thinking
Research Problem 4. Visit the websites of a few public accounting firms to learn
how they are using data analytics and visualization in the tax function. In an e-mail
to your instructor, explain what you found, provide the source(s) you used, and
explain how you think the data analysis helps businesses engage in tax compliance and planning.
Communications
Research Problem 5. Use the IRS website to find Form W–12 (IRS Paid Preparer Tax
Identification Number (PTIN) Application and Renewal) and its instructions. Review
these documents and focus specifically on Question 11 (related to the data security
responsibilities of the paid preparer). One purpose of this question is to remind
preparers of their obligations to comply with the “Safeguards Rule” overseen by the
Federal Trade Commission. Use IRS Publication 4557, Safeguarding Taxpayer Data,
to find information on this rule. Prepare an e-mail to your instructor that briefly
describes this rule, and lists three actions a preparer could take to help meet this rule.
Communications
19688_ch01_hr_002-043.indd 43
Data Analytics
29/03/22 4:07 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
2
C h ap ter
Working with the
Tax Law
L e a r n i n g O b j e c t i v e s : After completing Chapter 2, you should be able to:
LO.1
LO.2
LO.3
LO.4
Distinguish between the statutory, administrative,
and judicial sources of the tax law and understand
the purpose of each source.
Locate and work with the appropriate tax law
sources.
Develop an awareness of tax research tools.
LO.5
LO.6
LO.7
Communicate the results of the tax research process
in a client letter and a tax file memorandum.
Apply tax research techniques and planning
procedures.
Be aware of taxation on the CPA examination.
Describe the tax research process.
Chapter Outline
2-1 Tax Law Sources, 2-2
2-1a Statutory Sources of the Tax Law, 2-2
2-1b Administrative Sources of the Tax Law, 2-6
2-1c Judicial Sources of the Tax Law, 2-10
2-1d Other Sources of the Tax Law, 2-17
2-2 Working with the Tax Law—Tax Research Tools, 2-18
2-2a Commercial Tax Services, 2-18
2-2b Using Electronic (Online) Tax Services, 2-19
2-2c Noncommercial Electronic (Online) Tax Services, 2-19
2-3 Working with the Tax Law—Tax Research, 2-20
2-3a Identifying the Problem, 2-21
2-3b Refining the Problem, 2-22
2-3c Locating the Appropriate Tax Law Sources, 2-22
19688_ch02_hr_002-041.indd 2
2-3d Assessing the Validity of Tax Law Sources, 2-23
2-3e Arriving at the Solution or at Alternative Solutions, 2-25
2-3f Communicating Tax Research, 2-26
2-4 Working with the Tax Law—Tax Planning, 2-28
2-4a Nontax Considerations, 2-29
2-4b Components of Tax Planning, 2-29
2-4c Tax Avoidance and Tax Evasion, 2-30
2-4d Follow-Up Procedures, 2-30
2-4e Tax Planning, 2-31
2-5 Taxation on the CPA Examination, 2-31
2-5a Preparation Blueprints, 2-31
2-5b Regulation Section, 2-31
29/03/22 4:09 PM
Get Complete eBook Download by Email at discountsmtb@hotmail.com
Get Complete eBook Download link Below for Instant Download:
https://browsegrades.net/documents/286751/ebook-payment-link-forinstant-download-after-payment