, SOLUTION MANUAL FOR Pearson's Federal
Taxation 2025 Comprehensive, 38th edition
Mitchell Franklin
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, Chapter I:1
An Introduction to Taxation
Discussion Questions
I:1-1 The Supreme Court held the income tax to be unconstitutional in 1895 because the
income tax was considered to be a direct tax. At that time, the U.S. Constitution required that an
income tax be apportioned among the states in proportion to their populations. This type of tax
system would be extremely difficult to administer because different rates of tax would apply to
individual taxpayers depending on their states of residence. p. I:1-2.
I:1-2 The pay-as-you-go withholding was needed in 1943 to avoid significant tax collection
problems as the tax base broadened from 6% of the population in 1939 to 74% in 1945.
Pay-as-you-go permitted the federal government to deduct taxes directly out of an employee's
wages. p. I:1-3.
I:1-3 Under a progressive tax rate structure, the tax rate increases as the taxpayer's income
increases. Currently, for 2024, tax rates of 10%, 12%, 22%, 24%, 32%, 35% or 37% apply
depending upon the taxpayer's filing status and taxable income levels. Under a proportional tax rate
or "flat tax" structure, the same tax rate applies to all taxpayers regardless of their income levels.
Under a regressive tax rate structure, the tax rate decreases with an increase in income level. The
concept of vertical equity holds that taxpayers with higher income levels should pay a higher
proportion of tax and that the tax should be borne by those who have the "ability to pay." Thus,
Congressman Patrick's opposition to the flat tax is philosophically correct; under a flat tax system,
all taxpayers pay taxes at the same rate, regardless of the ability to pay. pp. I:1-4 and I:1-5.
I:1-4 It is possible for the government to raise taxes without raising tax rates. Because there are
two components in computing a taxpayer's tax, the tax base and the tax rate, taxes can be raised
by increasing either the rate or the base. Thus, even though the Governor proclaimed that tax
rates have remained at the same level, adjustments to the tax base, such as the elimination of
deductions, result in tax increases which can be as much, or more, as increases in tax rates. p.
I:1-4.
I:1-5 The marginal tax rate is of greater significance in measuring the tax effect for Carmen's
decision. The marginal tax rate is the percentage that is applied to an incremental amount of
taxable income that is added to or subtracted from the tax base. Through the marginal tax rate,
the taxpayer may measure the tax effect of the charitable contribution to her church. If her
marginal tax rate is 24%, she will save 24¢ for each $1 contributed to her church. The average
tax rate is simply the total tax liability divided by taxable income. pp. I:1-5 and I:1-6.
I:1-6 Gift and estate taxes are levied when a transfer of wealth (property) takes place and are
both part of the unified transfer tax system. The tax base for computing the gift tax is the fair
market value of all gifts made in the current year minus an annual donee exclusion of $18,000
(2024) per donee, minus a marital deduction for gifts to spouse and a charitable contributions
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I:1-1
,deduction if applicable, plus the value of all taxable gifts in prior years. The tax base for the
estate tax is the decedent's gross estate, minus deductions for expenses, and a marital or
charitable deduction if applicable, plus taxable gifts made after 1976. pp. I:1-7 through I:1-10.
I:1-7 a. Cathy, the donor, is primarily liable for the gift tax on the two gifts. The children
are contingently liable for payment of the gift tax in the event the donor fails to pay.
b. Before considering the unified tax credit equivalent of $13.61 million for 2024, a
gift tax results on the two gifts for the current year 2024 computed as follows:
Total gifts $100,000
Minus: Annual gift tax exclusion ($18,000 x 2 donees) ( 36,000)
Gift tax base $ 64,000
Since Cathy has never made gifts in prior years, no gift tax will be due because of the substantial
unified tax credit that is available. pp. I:1-8 and I:1-9.
I:1-8 Carlos would report a taxable gain of $2,000 ($27,000 - $25,000). His tax basis in the
stock that he inherited is the fair market value on the date of his father’s death. pp. I:1-9 and I:1-10.
I:1-9 a. Most estates are not subject to the federal estate tax because of generous credit and
deduction provisions, such as the unified tax credit and the unlimited marital deduction. The
unified tax credit equivalent for 2024 is $13.61 million. This means that, at a minimum, for
decedents dying in 2024, no estate of $13.61 million or less will be subject to the federal estate tax.
b. This is a controversial question that has proponents on both sides of the issue.
Those that believe the estate tax should be reduced or eliminated basically argue that the estate
tax is a double tax, that is, the property of the decedent has already been subject to income
taxation during his or her lifetime and should not be subjected to further taxation at death. On the
other hand, proponents of retaining or increasing the estate tax believe in the ability to pay
principle. p. I:1-10.
I:1-10 a. Progressive.
b. Progressive.
c. Proportional.
d. Proportional.
e. Proportional. (However, state and local sales taxes are considered regressive when
measured against income).
pp. I:1-4 and I:1-5 and I:1-12.
I:1-11 Decrease. When Carolyn operates her business as a sole proprietor, she is considered to
be self-employed. A self-employment tax is imposed at the rate of 15.3% for 2024 (12.4%
OASDI + 2.9% Medicare) on all of her business income with a ceiling on the non-hospital
insurance (OASDI) portion of the tax base of $168,600 in 2024. Carolyn is also entitled to an
income tax deduction equal to 50% of the self-employment tax payments if she is self-employed.
If she works as an employee, however, the OASDI and Medicare taxes are imposed at the
employee level at a rate of 7.65% for 2024. The OASDI is imposed on earned income up to a
maximum of $168,600 in 2024 while Medicare taxes have no ceiling. Her employer would have
to match Carolyn’s OASDI and Medicare taxes. Thus, Social Security taxes are levied at the
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I:1-2
,same rate of 15.3% (7.65% on the employee and 7.65% on the employer). If the corporation does
not pay Carolyn a salary equal to its earnings, the Social Security taxes will be slightly less than
under the sole proprietorship. The hospital insurance portion of the FICA premium continues to
apply with no ceiling amount for employees, employers, and self-employed individuals. The rate
is 2.9% for self-employed individuals and 1.45% each for employees and employers. p. I:1-11.
I:1-12 a. Property taxes are primarily used by local governments and include both real
property taxes (real estate) and personal property taxes (tangible and intangible property).
b. Excise taxes are primarily used by the federal government and are imposed on
items such as alcohol, tobacco, telephone usage, and many other goods. While not as extensive
as the federal government, many state and local governments impose similar types of taxes.
c. Sales taxes are primarily used by state governments and constitute a major
revenue source for many states. Local governments are increasingly using sales taxes as well as
states. The local governments frequently tack-on 1¢ or 2¢ to the existing state sales tax rather
than imposing a separate sales tax.
d. Income taxes are the primary domain of the federal government and constitutes its
major source of revenue. However, many state and local governments now use the income tax in
their revenue structures.
e. Employment taxes are primarily used by the federal government. Social security
(FICA) taxes are a major source of federal revenue. Unemployment taxes are used by states as a
compliment to the federal unemployment compensation tax. pp. I:1-10 and I:1-11.
I:1-13 a. The five characteristics of a “good” tax are equity, certainty, convenience,
economy, and simplicity. Equity refers to the fairness of the tax to the taxpayers. A certain tax is
one that ensures a stable source of government revenue and provides taxpayers with some degree
of certainty concerning the amount of their annual tax liability. Convenience refers to the case of
assessment, collectability, and administration for the government and reasonable compliance
requirements for taxpayers. An economical tax requires minimal compliance costs for taxpayers
and minimal administration costs for the government. Simplicity means the tax system is simple
to understand and to comply.
b. 1. The federal income tax meets the first four criteria reasonably well, even
though many critics would suggest otherwise. The tax is reasonably fair in that the high-income
taxpayers pay the most tax, the low-income taxpayers the least tax. While tax laws are constantly
changing, most taxpayers have a pretty good idea of what their taxes are going to be for the tax
year and the federal income tax does provide the government with a stable source of revenue.
The tax is convenient to pay although compliance requirements for taxpayers have risen steadily
over the years. The tax is economical for the government to collect; however, the cost of
compliance for taxpayers is much too high as approximately 56% of all taxpayers pay a tax
preparer to prepare their tax returns. However, virtually no one would suggest that the federal
income tax law is simple. In fact, complexity is one of the law’s major flaws.
2. The state sales tax meets the criteria of certainty, convenience, economy
and simplicity quite well. However, the sales tax is criticized as not being equitable as it tends to
fall more heavily on lower and middle-income taxpayers.
3. Property taxes do not fare well according to the characteristics of a “good”
tax. From equity standpoint, the property tax is imposed on property owners without regard to
their income situation. Thus, a farmer may have substantial property but little income to pay the
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I:1-3
,property tax. Property taxes are certain but clearly not convenient in the sense that they are
normally assessed in a lump-sum amount once a year. Property taxes do not meet the economy
criteria. Property taxes are rather simple although differences in judgments as to valuation of
property are a problem. pp. I:1-12 through I:1-14.
I:1-14 a. Horizontal equity refers to the concept that similarly situated taxpayers should
pay approximately the same amount of tax. Vertical equity, on the other hand, refers to the
concept that higher income taxpayers should not only pay a higher amount of tax but should pay
a higher percentage of tax. Vertical equity is based on the notion that taxpayers who have the
“ability to pay” (e.g., higher income taxpayers) should pay more tax than lower income
taxpayers.
b. Fairness is an elusive term. Because of widely divergent opinions as to what
constitutes fairness, it logically follows that there are also many different and divergent opinions
as to what constitutes a “fair” tax structure. p. I:1-13.
I:1-15 Secondary objectives include the following:
a. Economic objectives such as stimulating private investment, reducing
unemployment, and mitigating the effects of inflation.
b. Encouraging certain activities such as research and development and small
business investment.
c. Social and public policy objectives, (e.g. encouraging charitable contributions and
discouraging illegal bribes). pp. I:1-14 and I:1-15.
I:1-16 Probably not. It would be difficult to achieve a simplified tax system and also provide
incentives to certain industries as well as achieve social objectives. To achieve a simplified tax
system would require the elimination of special purpose provisions, such as with the several
consumption tax proposals being forwarded. But consumption taxes generally are considered
unfair as they fall disproportionately on the low and middle class. pp. I:1-14 through I:1-16.
I:l-17 Taxpaying entities generally are required to pay income taxes on their taxable income.
The major taxpaying entities are individuals and C corporations. Flow-through entities generally
do not directly pay income taxes on their taxable income but merely pass the income on to a
taxpaying entity. The major flow-through entities are sole proprietorships, partnerships, S
corporations, limited liability companies (LLC), limited liability partnerships (LLP), and certain
trusts. Some entities do not neatly fall within each category and are actually hybrid entities. S
corporations, for example, are subject to income taxes in certain situations, such as taxes on
built-in gains, the LIFO recapture tax, etc. Not many S corporations incur these taxes. pp. I:1-16
through I:1-24.
I:1-18 Sally and Tom’s taxable income for 2024 would be $110,800, computed as follows:
AGI $ 140,000
Larger of itemized deductions ($22,000) or standard
deduction ($29,200) (29,200)
Taxable income $ 110,800
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I:1-4
,If Sally and Tom had itemized deductions of $32,000 rather than of $22,000, their taxable
income would be $108,000, computed as follows:
AGI $ 140,000
Larger of itemized deductions ($32,000) or standard
deduction ($29,200) (32,000)
Taxable income $ 108,000
As can be seen previously, the standard deduction of $29,200 is larger than $22,000 of their
itemized deductions, so they obviously would claim the standard deduction. Alternatively, if the
itemized deductions were $32,000, their taxable income would be 108,000 ($140,000 - $32,000)
as the itemized deductions exceed the standard deduction of $29,200. Taxpayers are allowed to
deduct the greater of itemized deductions or the standard deduction. pp. I:1-6, I:1-7, and I:1-17.
I:1-19 To properly respond to Bruin, tax calculations for both Bruin Corporation and John Bean
must be made for the year.
$400,000 dividend. If the $400,000 is distributed to John as a dividend, Bruin Corporation
would get no deduction for the dividend and would have corporate taxes of $105,000 ($500,000
x 0.21) based on taxable income of $500,000. John would then pay a maximum rate of 20% on
the dividend because his taxable income is greater than $518,900 given the tax bracket he is in
the 37% bracket starts at taxable income over $609,350 for single taxpayers, so the income taxes
due by John on the $400,000 dividend would be $80,000. Thus, the total income taxes would be
$185,000 ($105,000 + $80,000).
$400,000 salary. If the $400,000 is distributed to John as a salary, Bruin Corporation would be
allowed a deduction and the corporation’s taxable income now would be $100,000. The
corporate tax on $100,000 is $21,000. John would be required to pay income taxes on the
$400,000 at 37%, so the tax would be $148,000. The total income taxes for the year would be
$169,000.
As can be seen from the analysis above, the $400,000 salary would result in smaller taxes. This
results even though John is in the top 37% tax bracket. The tax savings would be even higher if
John were in a lower tax bracket. (Note that this solution ignores the incremental 3.8% tax on net
investment income for high income taxpayers, which is discussed in later chapters). pp. I:1-19 and
I:1-20.
I:1-20 The term “double taxation” refers to the taxing of the same income twice. This type of
taxation typically results from a C corporation paying tax on its taxable income and shareholders
paying income tax on any dividends received from the C corporation. The impact of double
taxation of C corporations has been substantially reduced by the fact that dividends generally are
taxed at a 15% rate with a maximum rate of 20%. An example of double taxation can be seen in
Example I:1-15 of the textbook. pp. I:1-19 and I:1-20.
I:1-21 Limited liability companies (LLCs) generally are taxed as partnerships. Therefore, the
LLC is not subject to income tax on its taxable income but such income is allocated to the
members (owners) of the LLC. Thus, only a single-level of taxation is imposed. The same
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I:1-5
,allocation rules that pertain to partnerships also apply to LLCs. Another principle feature of
LLCs is limited liability for owners (members) of the LLC. pp. I:1-22 and I:1-23.
I:1-22 To prevent double taxation, the tax law allows partners to increase their basis in the
partnership for any income that is allocated to the partner. Since partnership distributions are not
subject to taxation if such distributions are less than the partner’s basis, double taxation is
prevented. Similarly, to prevent double deductions, the tax law requires partners to decrease their
basis for any loss or deduction that is allocated to the partner. pp. I:1-21 and I:1-22.
I:1-23 Schedule K-1 is an integral part of both the annual partnership tax return and the S
corporation tax return. Partnerships and S corporations use the same allocation system. The K-1
reports a partner’s allocable share of partnership ordinary income and separately-stated items, such
as dividends, long-term capital gains, etc. A K-1 is prepared for each partner in the partnership and
is filed with Form 1065. So, if a partnership has ten partners, there will be ten K-1s that allocate the
total partnership income to each partner. A copy of each partner’s K-1 is provided to the partners so
that they can report the information on their own tax returns. pp. I:1-21 and I:1-22.
I:1-24 Quint’s taxable income for 2024 is computed as follows:
Allocable share of PDQ Partnership income ($150,000 x .3333) $50,000
Other income 15,000
Adjusted gross income (AGI) $ 65,000
Standard deduction $(14,600)
Taxable income $50,450
The $30,000 distribution from the partnership is considered a return of capital and is not taxable
to Quint. Since he reports his allocable share of partnership income, if the distribution were taxed
again, the result would be double taxation. If the partnership is eligible for the 20% qualified
business income (QBI) deduction, Quint would also be allowed a deduction of $10,000 ($50,000
x 0.20) for his share of partnership income. pp. I:1-17 and I:1-21.
I:1-25 Because of the vast volume of tax law sources, it is nearly impossible for any person to
have recall knowledge of the entire tax law. Thus, the ability to understand what the relevant
sources of tax law are, their relative weight (importance), and where to find the sources are vital
to a person working in the tax area. p. I:1-24.
I:1-26 Even though the Code is the highest authority of tax law sources, the Code contains
general language and does not address the many specific situations and transactions that occur.
To resolve tax questions concerning specific situations, administrative rulings and court
decisions are an integral part of the income tax law. p. I:1-24.
I:1-27 a. Ways and Means Committee (House of Representatives), Senate Finance
Committee (U.S. Senate) and the Joint Conference Committee.
b. Committee reports are helpful for two major purposes: (1) to explain the new law
before the Treasury Department drafts regulations on the tax law changes, and (2) to explain the
intent of Congress for passing the new law. pp. I:1-24 through I:1-26.
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I:1-6
,I:1-28 The National Office of the IRS issues revenue rulings to provide guidance to taxpayers
on specific factual situations, processes ruling requests from taxpayers (private letter rulings),
and prepares Revenue Procedures that assist taxpayers with compliance matters. Of course, the
National Office also provides administrative and human resources functions at the top level of
the organization. p. I:1-26.
I:1-29 Individuals most likely to be audited include those that may be involved in any of the
following situations:
• Individuals who are sole proprietors and incur significant expenses in connection with the
trade or business.
• Itemized deductions in excess of an average amount for the person's income level.
• Filing of a refund claim by a taxpayer who has been previously audited and the audit
resulted in a substantial tax deficiency.
• Individuals who are self-employed with substantial business income or income from a
profession such as a medical doctor. p. I:1-27.
I:1-30 a. Rarely will the IRS review each line of Anya’s return. Audits of individual
taxpayers generally focus on selected items on the return. Note: In prior years, the IRS had a
Taxpayer Compliance Measurement Program (TCMP) where a small number of taxpayers were
selected by a random sample and their returns were audited on a line-by-line basis. These audits
were primarily for statistical purposes. Currently, this program has been abandoned. However,
the IRS now uses the National Research Program (NRP) to select returns for audit. The NRP will
update data compiled in the old TCMP audits and develop new statistical models for identifying
returns most likely to contain errors.
b. Generally not all items on a return will be audited. All tax returns are initially
checked for mathematical accuracy and items that may be considered clearly erroneous. If
differences are noted the IRS sends the taxpayer a bill for the corrected amount. Upon an audit of
Anya's return, the IRS generally only examines selected items on the return. These items are
those that the IRS believes there is a possibility of error. p. I:1-27.
I:1-31 a. The term "hazards of litigation" refers to the probability of winning or losing a
case if it goes to court.
b. Because of the possibility that a case may be lost and the cost of litigation, both
the IRS and taxpayers frequently settle a case to avoid such possibilities. The IRS may also
decide to settle a case because it does not want to establish an unfavorable precedent of cases in a
specific area. A taxpayer may settle a case to avoid substantial legal and professional fees. p. I:1-
29.
I:1-32 No, just because the taxpayer has filed a return and received a refund, the IRS may still
audit a taxpayer. Tax returns that are selected for audit generally are audited a year or two after
the return is received by the IRS. p. I:1-28.
I:1-33 a. The statute of limitations remains open indefinitely if a fraudulent return is filed
or if no return is filed at all.
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I:1-7
, b. The general rule for the disallowance of tax deduction items is that an assessment may be
made against the taxpayer within three years from the later of the date the tax return was filed or
its due date.
c. A six-year statute of limitations applies if the taxpayer omits an item of gross
income that is in excess of 25 percent of the gross income that is reported on the return. p. I:1-28.
I:1-34 The best possible defensibly correct solution is one that is advantageous to the client but
is based upon substantial authoritative support (e.g., favorable court cases) even though the
position may be challenged upon audit by the IRS. p. I:1-30.
I:1-35 The four principal areas of activity for the profession of tax practice are: tax compliance
and procedure, tax research, tax planning and financial planning. Tax compliance and procedure
essentially consists of tax return preparation and assisting the taxpayer in dealing with the IRS.
Tax research is the process of developing the most defensibly correct solution to a tax problem.
Tax planning involves the process of reducing taxes so as to maximize a taxpayer's after-tax
return. Financial planning, while not exclusively related to tax, is an area for tax professionals to
assist clients with planning for their entire financial affairs. pp. I:1-29 through I:1-31.
I:1-36 a. Because income taxes may exceed 50% of a taxpayer's income (including federal,
state, and local income taxes and Social Security taxes), taxes are an extremely important part of
the financial planning process. Any financial plan that does not carefully consider taxes is a
flawed plan.
b. Because tax professionals see their clients at least once a year at a minimum
(preparation of their income tax returns) and are familiar with the client’s financial information,
this represents a perfect opportunity to perform financial planning. p. I:1-31.
I:1-37 No, the principal goal of tax planning is to maximize a taxpayer's after-tax cash flow, not
just the minimization of taxes due. For example, if a taxable investment generates a better return
after taxes are paid than a nontaxable investment, the taxable investment is superior even though
taxes must be paid. p. I:1-30.
I:1-38 Tax planning involves the evaluation of alternative courses of action. The evaluation of
alternative courses of action can be very time-consuming because of the numerous and complex
tax calculations necessary to arrive at an optimal solution. Using tax software has become an
essential tool in this process because of the speed and accuracy in which tax calculations can be
made as well as data analytic methods to analyze large amounts of tax data. pp. I:1-30 and I:1-
31. Tax planning and complex tax calculations, as well as tax research are increasingly
performed, or at least assisted, by artificial intelligence (AI).
Problems
I:1-39 a.
Income:
Salary $100,000
Business income 25,000
Copyright © 2025 Pearson Education, Inc.
I:1-8
Taxation 2025 Comprehensive, 38th edition
Mitchell Franklin
Notes
1- The file is chapter after chapter.
2- We have shown you few pages sample.
3- The file contains all Appendix and Excel sheet
if it exists.
4- We have all what you need, we make update
at every time. There are many new editions
waiting you.
5- If you think you purchased the wrong file You
can contact us at every time, we can replace it
with true one.
Our email:
, Chapter I:1
An Introduction to Taxation
Discussion Questions
I:1-1 The Supreme Court held the income tax to be unconstitutional in 1895 because the
income tax was considered to be a direct tax. At that time, the U.S. Constitution required that an
income tax be apportioned among the states in proportion to their populations. This type of tax
system would be extremely difficult to administer because different rates of tax would apply to
individual taxpayers depending on their states of residence. p. I:1-2.
I:1-2 The pay-as-you-go withholding was needed in 1943 to avoid significant tax collection
problems as the tax base broadened from 6% of the population in 1939 to 74% in 1945.
Pay-as-you-go permitted the federal government to deduct taxes directly out of an employee's
wages. p. I:1-3.
I:1-3 Under a progressive tax rate structure, the tax rate increases as the taxpayer's income
increases. Currently, for 2024, tax rates of 10%, 12%, 22%, 24%, 32%, 35% or 37% apply
depending upon the taxpayer's filing status and taxable income levels. Under a proportional tax rate
or "flat tax" structure, the same tax rate applies to all taxpayers regardless of their income levels.
Under a regressive tax rate structure, the tax rate decreases with an increase in income level. The
concept of vertical equity holds that taxpayers with higher income levels should pay a higher
proportion of tax and that the tax should be borne by those who have the "ability to pay." Thus,
Congressman Patrick's opposition to the flat tax is philosophically correct; under a flat tax system,
all taxpayers pay taxes at the same rate, regardless of the ability to pay. pp. I:1-4 and I:1-5.
I:1-4 It is possible for the government to raise taxes without raising tax rates. Because there are
two components in computing a taxpayer's tax, the tax base and the tax rate, taxes can be raised
by increasing either the rate or the base. Thus, even though the Governor proclaimed that tax
rates have remained at the same level, adjustments to the tax base, such as the elimination of
deductions, result in tax increases which can be as much, or more, as increases in tax rates. p.
I:1-4.
I:1-5 The marginal tax rate is of greater significance in measuring the tax effect for Carmen's
decision. The marginal tax rate is the percentage that is applied to an incremental amount of
taxable income that is added to or subtracted from the tax base. Through the marginal tax rate,
the taxpayer may measure the tax effect of the charitable contribution to her church. If her
marginal tax rate is 24%, she will save 24¢ for each $1 contributed to her church. The average
tax rate is simply the total tax liability divided by taxable income. pp. I:1-5 and I:1-6.
I:1-6 Gift and estate taxes are levied when a transfer of wealth (property) takes place and are
both part of the unified transfer tax system. The tax base for computing the gift tax is the fair
market value of all gifts made in the current year minus an annual donee exclusion of $18,000
(2024) per donee, minus a marital deduction for gifts to spouse and a charitable contributions
Copyright © 2025 Pearson Education, Inc.
I:1-1
,deduction if applicable, plus the value of all taxable gifts in prior years. The tax base for the
estate tax is the decedent's gross estate, minus deductions for expenses, and a marital or
charitable deduction if applicable, plus taxable gifts made after 1976. pp. I:1-7 through I:1-10.
I:1-7 a. Cathy, the donor, is primarily liable for the gift tax on the two gifts. The children
are contingently liable for payment of the gift tax in the event the donor fails to pay.
b. Before considering the unified tax credit equivalent of $13.61 million for 2024, a
gift tax results on the two gifts for the current year 2024 computed as follows:
Total gifts $100,000
Minus: Annual gift tax exclusion ($18,000 x 2 donees) ( 36,000)
Gift tax base $ 64,000
Since Cathy has never made gifts in prior years, no gift tax will be due because of the substantial
unified tax credit that is available. pp. I:1-8 and I:1-9.
I:1-8 Carlos would report a taxable gain of $2,000 ($27,000 - $25,000). His tax basis in the
stock that he inherited is the fair market value on the date of his father’s death. pp. I:1-9 and I:1-10.
I:1-9 a. Most estates are not subject to the federal estate tax because of generous credit and
deduction provisions, such as the unified tax credit and the unlimited marital deduction. The
unified tax credit equivalent for 2024 is $13.61 million. This means that, at a minimum, for
decedents dying in 2024, no estate of $13.61 million or less will be subject to the federal estate tax.
b. This is a controversial question that has proponents on both sides of the issue.
Those that believe the estate tax should be reduced or eliminated basically argue that the estate
tax is a double tax, that is, the property of the decedent has already been subject to income
taxation during his or her lifetime and should not be subjected to further taxation at death. On the
other hand, proponents of retaining or increasing the estate tax believe in the ability to pay
principle. p. I:1-10.
I:1-10 a. Progressive.
b. Progressive.
c. Proportional.
d. Proportional.
e. Proportional. (However, state and local sales taxes are considered regressive when
measured against income).
pp. I:1-4 and I:1-5 and I:1-12.
I:1-11 Decrease. When Carolyn operates her business as a sole proprietor, she is considered to
be self-employed. A self-employment tax is imposed at the rate of 15.3% for 2024 (12.4%
OASDI + 2.9% Medicare) on all of her business income with a ceiling on the non-hospital
insurance (OASDI) portion of the tax base of $168,600 in 2024. Carolyn is also entitled to an
income tax deduction equal to 50% of the self-employment tax payments if she is self-employed.
If she works as an employee, however, the OASDI and Medicare taxes are imposed at the
employee level at a rate of 7.65% for 2024. The OASDI is imposed on earned income up to a
maximum of $168,600 in 2024 while Medicare taxes have no ceiling. Her employer would have
to match Carolyn’s OASDI and Medicare taxes. Thus, Social Security taxes are levied at the
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,same rate of 15.3% (7.65% on the employee and 7.65% on the employer). If the corporation does
not pay Carolyn a salary equal to its earnings, the Social Security taxes will be slightly less than
under the sole proprietorship. The hospital insurance portion of the FICA premium continues to
apply with no ceiling amount for employees, employers, and self-employed individuals. The rate
is 2.9% for self-employed individuals and 1.45% each for employees and employers. p. I:1-11.
I:1-12 a. Property taxes are primarily used by local governments and include both real
property taxes (real estate) and personal property taxes (tangible and intangible property).
b. Excise taxes are primarily used by the federal government and are imposed on
items such as alcohol, tobacco, telephone usage, and many other goods. While not as extensive
as the federal government, many state and local governments impose similar types of taxes.
c. Sales taxes are primarily used by state governments and constitute a major
revenue source for many states. Local governments are increasingly using sales taxes as well as
states. The local governments frequently tack-on 1¢ or 2¢ to the existing state sales tax rather
than imposing a separate sales tax.
d. Income taxes are the primary domain of the federal government and constitutes its
major source of revenue. However, many state and local governments now use the income tax in
their revenue structures.
e. Employment taxes are primarily used by the federal government. Social security
(FICA) taxes are a major source of federal revenue. Unemployment taxes are used by states as a
compliment to the federal unemployment compensation tax. pp. I:1-10 and I:1-11.
I:1-13 a. The five characteristics of a “good” tax are equity, certainty, convenience,
economy, and simplicity. Equity refers to the fairness of the tax to the taxpayers. A certain tax is
one that ensures a stable source of government revenue and provides taxpayers with some degree
of certainty concerning the amount of their annual tax liability. Convenience refers to the case of
assessment, collectability, and administration for the government and reasonable compliance
requirements for taxpayers. An economical tax requires minimal compliance costs for taxpayers
and minimal administration costs for the government. Simplicity means the tax system is simple
to understand and to comply.
b. 1. The federal income tax meets the first four criteria reasonably well, even
though many critics would suggest otherwise. The tax is reasonably fair in that the high-income
taxpayers pay the most tax, the low-income taxpayers the least tax. While tax laws are constantly
changing, most taxpayers have a pretty good idea of what their taxes are going to be for the tax
year and the federal income tax does provide the government with a stable source of revenue.
The tax is convenient to pay although compliance requirements for taxpayers have risen steadily
over the years. The tax is economical for the government to collect; however, the cost of
compliance for taxpayers is much too high as approximately 56% of all taxpayers pay a tax
preparer to prepare their tax returns. However, virtually no one would suggest that the federal
income tax law is simple. In fact, complexity is one of the law’s major flaws.
2. The state sales tax meets the criteria of certainty, convenience, economy
and simplicity quite well. However, the sales tax is criticized as not being equitable as it tends to
fall more heavily on lower and middle-income taxpayers.
3. Property taxes do not fare well according to the characteristics of a “good”
tax. From equity standpoint, the property tax is imposed on property owners without regard to
their income situation. Thus, a farmer may have substantial property but little income to pay the
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,property tax. Property taxes are certain but clearly not convenient in the sense that they are
normally assessed in a lump-sum amount once a year. Property taxes do not meet the economy
criteria. Property taxes are rather simple although differences in judgments as to valuation of
property are a problem. pp. I:1-12 through I:1-14.
I:1-14 a. Horizontal equity refers to the concept that similarly situated taxpayers should
pay approximately the same amount of tax. Vertical equity, on the other hand, refers to the
concept that higher income taxpayers should not only pay a higher amount of tax but should pay
a higher percentage of tax. Vertical equity is based on the notion that taxpayers who have the
“ability to pay” (e.g., higher income taxpayers) should pay more tax than lower income
taxpayers.
b. Fairness is an elusive term. Because of widely divergent opinions as to what
constitutes fairness, it logically follows that there are also many different and divergent opinions
as to what constitutes a “fair” tax structure. p. I:1-13.
I:1-15 Secondary objectives include the following:
a. Economic objectives such as stimulating private investment, reducing
unemployment, and mitigating the effects of inflation.
b. Encouraging certain activities such as research and development and small
business investment.
c. Social and public policy objectives, (e.g. encouraging charitable contributions and
discouraging illegal bribes). pp. I:1-14 and I:1-15.
I:1-16 Probably not. It would be difficult to achieve a simplified tax system and also provide
incentives to certain industries as well as achieve social objectives. To achieve a simplified tax
system would require the elimination of special purpose provisions, such as with the several
consumption tax proposals being forwarded. But consumption taxes generally are considered
unfair as they fall disproportionately on the low and middle class. pp. I:1-14 through I:1-16.
I:l-17 Taxpaying entities generally are required to pay income taxes on their taxable income.
The major taxpaying entities are individuals and C corporations. Flow-through entities generally
do not directly pay income taxes on their taxable income but merely pass the income on to a
taxpaying entity. The major flow-through entities are sole proprietorships, partnerships, S
corporations, limited liability companies (LLC), limited liability partnerships (LLP), and certain
trusts. Some entities do not neatly fall within each category and are actually hybrid entities. S
corporations, for example, are subject to income taxes in certain situations, such as taxes on
built-in gains, the LIFO recapture tax, etc. Not many S corporations incur these taxes. pp. I:1-16
through I:1-24.
I:1-18 Sally and Tom’s taxable income for 2024 would be $110,800, computed as follows:
AGI $ 140,000
Larger of itemized deductions ($22,000) or standard
deduction ($29,200) (29,200)
Taxable income $ 110,800
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,If Sally and Tom had itemized deductions of $32,000 rather than of $22,000, their taxable
income would be $108,000, computed as follows:
AGI $ 140,000
Larger of itemized deductions ($32,000) or standard
deduction ($29,200) (32,000)
Taxable income $ 108,000
As can be seen previously, the standard deduction of $29,200 is larger than $22,000 of their
itemized deductions, so they obviously would claim the standard deduction. Alternatively, if the
itemized deductions were $32,000, their taxable income would be 108,000 ($140,000 - $32,000)
as the itemized deductions exceed the standard deduction of $29,200. Taxpayers are allowed to
deduct the greater of itemized deductions or the standard deduction. pp. I:1-6, I:1-7, and I:1-17.
I:1-19 To properly respond to Bruin, tax calculations for both Bruin Corporation and John Bean
must be made for the year.
$400,000 dividend. If the $400,000 is distributed to John as a dividend, Bruin Corporation
would get no deduction for the dividend and would have corporate taxes of $105,000 ($500,000
x 0.21) based on taxable income of $500,000. John would then pay a maximum rate of 20% on
the dividend because his taxable income is greater than $518,900 given the tax bracket he is in
the 37% bracket starts at taxable income over $609,350 for single taxpayers, so the income taxes
due by John on the $400,000 dividend would be $80,000. Thus, the total income taxes would be
$185,000 ($105,000 + $80,000).
$400,000 salary. If the $400,000 is distributed to John as a salary, Bruin Corporation would be
allowed a deduction and the corporation’s taxable income now would be $100,000. The
corporate tax on $100,000 is $21,000. John would be required to pay income taxes on the
$400,000 at 37%, so the tax would be $148,000. The total income taxes for the year would be
$169,000.
As can be seen from the analysis above, the $400,000 salary would result in smaller taxes. This
results even though John is in the top 37% tax bracket. The tax savings would be even higher if
John were in a lower tax bracket. (Note that this solution ignores the incremental 3.8% tax on net
investment income for high income taxpayers, which is discussed in later chapters). pp. I:1-19 and
I:1-20.
I:1-20 The term “double taxation” refers to the taxing of the same income twice. This type of
taxation typically results from a C corporation paying tax on its taxable income and shareholders
paying income tax on any dividends received from the C corporation. The impact of double
taxation of C corporations has been substantially reduced by the fact that dividends generally are
taxed at a 15% rate with a maximum rate of 20%. An example of double taxation can be seen in
Example I:1-15 of the textbook. pp. I:1-19 and I:1-20.
I:1-21 Limited liability companies (LLCs) generally are taxed as partnerships. Therefore, the
LLC is not subject to income tax on its taxable income but such income is allocated to the
members (owners) of the LLC. Thus, only a single-level of taxation is imposed. The same
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,allocation rules that pertain to partnerships also apply to LLCs. Another principle feature of
LLCs is limited liability for owners (members) of the LLC. pp. I:1-22 and I:1-23.
I:1-22 To prevent double taxation, the tax law allows partners to increase their basis in the
partnership for any income that is allocated to the partner. Since partnership distributions are not
subject to taxation if such distributions are less than the partner’s basis, double taxation is
prevented. Similarly, to prevent double deductions, the tax law requires partners to decrease their
basis for any loss or deduction that is allocated to the partner. pp. I:1-21 and I:1-22.
I:1-23 Schedule K-1 is an integral part of both the annual partnership tax return and the S
corporation tax return. Partnerships and S corporations use the same allocation system. The K-1
reports a partner’s allocable share of partnership ordinary income and separately-stated items, such
as dividends, long-term capital gains, etc. A K-1 is prepared for each partner in the partnership and
is filed with Form 1065. So, if a partnership has ten partners, there will be ten K-1s that allocate the
total partnership income to each partner. A copy of each partner’s K-1 is provided to the partners so
that they can report the information on their own tax returns. pp. I:1-21 and I:1-22.
I:1-24 Quint’s taxable income for 2024 is computed as follows:
Allocable share of PDQ Partnership income ($150,000 x .3333) $50,000
Other income 15,000
Adjusted gross income (AGI) $ 65,000
Standard deduction $(14,600)
Taxable income $50,450
The $30,000 distribution from the partnership is considered a return of capital and is not taxable
to Quint. Since he reports his allocable share of partnership income, if the distribution were taxed
again, the result would be double taxation. If the partnership is eligible for the 20% qualified
business income (QBI) deduction, Quint would also be allowed a deduction of $10,000 ($50,000
x 0.20) for his share of partnership income. pp. I:1-17 and I:1-21.
I:1-25 Because of the vast volume of tax law sources, it is nearly impossible for any person to
have recall knowledge of the entire tax law. Thus, the ability to understand what the relevant
sources of tax law are, their relative weight (importance), and where to find the sources are vital
to a person working in the tax area. p. I:1-24.
I:1-26 Even though the Code is the highest authority of tax law sources, the Code contains
general language and does not address the many specific situations and transactions that occur.
To resolve tax questions concerning specific situations, administrative rulings and court
decisions are an integral part of the income tax law. p. I:1-24.
I:1-27 a. Ways and Means Committee (House of Representatives), Senate Finance
Committee (U.S. Senate) and the Joint Conference Committee.
b. Committee reports are helpful for two major purposes: (1) to explain the new law
before the Treasury Department drafts regulations on the tax law changes, and (2) to explain the
intent of Congress for passing the new law. pp. I:1-24 through I:1-26.
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,I:1-28 The National Office of the IRS issues revenue rulings to provide guidance to taxpayers
on specific factual situations, processes ruling requests from taxpayers (private letter rulings),
and prepares Revenue Procedures that assist taxpayers with compliance matters. Of course, the
National Office also provides administrative and human resources functions at the top level of
the organization. p. I:1-26.
I:1-29 Individuals most likely to be audited include those that may be involved in any of the
following situations:
• Individuals who are sole proprietors and incur significant expenses in connection with the
trade or business.
• Itemized deductions in excess of an average amount for the person's income level.
• Filing of a refund claim by a taxpayer who has been previously audited and the audit
resulted in a substantial tax deficiency.
• Individuals who are self-employed with substantial business income or income from a
profession such as a medical doctor. p. I:1-27.
I:1-30 a. Rarely will the IRS review each line of Anya’s return. Audits of individual
taxpayers generally focus on selected items on the return. Note: In prior years, the IRS had a
Taxpayer Compliance Measurement Program (TCMP) where a small number of taxpayers were
selected by a random sample and their returns were audited on a line-by-line basis. These audits
were primarily for statistical purposes. Currently, this program has been abandoned. However,
the IRS now uses the National Research Program (NRP) to select returns for audit. The NRP will
update data compiled in the old TCMP audits and develop new statistical models for identifying
returns most likely to contain errors.
b. Generally not all items on a return will be audited. All tax returns are initially
checked for mathematical accuracy and items that may be considered clearly erroneous. If
differences are noted the IRS sends the taxpayer a bill for the corrected amount. Upon an audit of
Anya's return, the IRS generally only examines selected items on the return. These items are
those that the IRS believes there is a possibility of error. p. I:1-27.
I:1-31 a. The term "hazards of litigation" refers to the probability of winning or losing a
case if it goes to court.
b. Because of the possibility that a case may be lost and the cost of litigation, both
the IRS and taxpayers frequently settle a case to avoid such possibilities. The IRS may also
decide to settle a case because it does not want to establish an unfavorable precedent of cases in a
specific area. A taxpayer may settle a case to avoid substantial legal and professional fees. p. I:1-
29.
I:1-32 No, just because the taxpayer has filed a return and received a refund, the IRS may still
audit a taxpayer. Tax returns that are selected for audit generally are audited a year or two after
the return is received by the IRS. p. I:1-28.
I:1-33 a. The statute of limitations remains open indefinitely if a fraudulent return is filed
or if no return is filed at all.
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, b. The general rule for the disallowance of tax deduction items is that an assessment may be
made against the taxpayer within three years from the later of the date the tax return was filed or
its due date.
c. A six-year statute of limitations applies if the taxpayer omits an item of gross
income that is in excess of 25 percent of the gross income that is reported on the return. p. I:1-28.
I:1-34 The best possible defensibly correct solution is one that is advantageous to the client but
is based upon substantial authoritative support (e.g., favorable court cases) even though the
position may be challenged upon audit by the IRS. p. I:1-30.
I:1-35 The four principal areas of activity for the profession of tax practice are: tax compliance
and procedure, tax research, tax planning and financial planning. Tax compliance and procedure
essentially consists of tax return preparation and assisting the taxpayer in dealing with the IRS.
Tax research is the process of developing the most defensibly correct solution to a tax problem.
Tax planning involves the process of reducing taxes so as to maximize a taxpayer's after-tax
return. Financial planning, while not exclusively related to tax, is an area for tax professionals to
assist clients with planning for their entire financial affairs. pp. I:1-29 through I:1-31.
I:1-36 a. Because income taxes may exceed 50% of a taxpayer's income (including federal,
state, and local income taxes and Social Security taxes), taxes are an extremely important part of
the financial planning process. Any financial plan that does not carefully consider taxes is a
flawed plan.
b. Because tax professionals see their clients at least once a year at a minimum
(preparation of their income tax returns) and are familiar with the client’s financial information,
this represents a perfect opportunity to perform financial planning. p. I:1-31.
I:1-37 No, the principal goal of tax planning is to maximize a taxpayer's after-tax cash flow, not
just the minimization of taxes due. For example, if a taxable investment generates a better return
after taxes are paid than a nontaxable investment, the taxable investment is superior even though
taxes must be paid. p. I:1-30.
I:1-38 Tax planning involves the evaluation of alternative courses of action. The evaluation of
alternative courses of action can be very time-consuming because of the numerous and complex
tax calculations necessary to arrive at an optimal solution. Using tax software has become an
essential tool in this process because of the speed and accuracy in which tax calculations can be
made as well as data analytic methods to analyze large amounts of tax data. pp. I:1-30 and I:1-
31. Tax planning and complex tax calculations, as well as tax research are increasingly
performed, or at least assisted, by artificial intelligence (AI).
Problems
I:1-39 a.
Income:
Salary $100,000
Business income 25,000
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