, Solution manual for South-Western Federal
Taxation 2022 Comprehensive 45th Edition James
C. Young
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 1
AN INTRODUCTION TO TAXATION
AND UNDERSTANDING THE FEDERAL TAX LAW
SOLUTIONS TO PROBLEM MATERIALS
DISCUSSION QUESTIONS
1. (LO 1) Various answers are possible, including using the Key Terms at the end of each chapter,
referring to the Glossary (Appendix C), looking up the footnote resources to the
Internal Revenue Code in Appendix D, using chapter features (e.g., Global Tax Issues, Ethics &
Equity, Tax Planning, and Framework 1040), examining the tax forms used in the chapters, and
completing additional end-of-chapter assignments. All of these resources will help students engage
more deeply with the materials and help their understanding.
2. (LO 1, 4)
a. John must now document rental receipts and separate his home expenses between personal
and rental use, and he may be subject to the transient occupancy tax.
b. Theresa has become self-employed. Now she will be subject to self-employment tax and may
have to make quarterly installment payments of estimated income and self-employment tax.
Theresa will be required to make payroll tax payments if she hires individuals to work in her
business.
c. Paul’s employer might have some moving expenses that it can deduct (in general, Paul cannot
deduct moving expenses). Paul’s personal taxes will change because Florida does not impose
an income tax but California does.
3. (LO 1, 4) The income tax consequences that result are Marvin’s principal concern. Any rent he
receives is taxed as income, but operating expenses and depreciation will generate deductions that
offset some or all of the income or even yield a loss. Marvin must also consider the effect of other
taxes. Because the property is being converted from residential to commercial use, he can expect an
increase in the ad valorem property taxes levied by the local (and perhaps even the state) taxing
authorities. Besides the real estate taxes, personal property taxes could be imposed on the furnishings.
4. (LO 2) To finance our participation in World War II, the scope of the income tax was expanded
considerably—from a limited coverage of 6% to over 74% of the population. Hence, the description
of the income tax as being a “mass tax” became appropriate.
5. (LO 2) For wage earners, the tax law requires employers to withhold a specified dollar amount from
wages paid to the employee to cover income taxes and payroll taxes. Persons with nonwage income
generally are required to make quarterly payments to the IRS for estimated taxes. Both procedures
ensure that taxpayers will be financially able to meet their annual tax liabilities. That is, the amounts
withheld are meant to prepay the employee’s income taxes and payroll taxes related to the wages
earned.
6. (LO 3) The tax law of this state appears to violate the certainty and simplicity principles.
1-1
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-2 2022 Comprehensive Volume/Solutions Manual
7. (LO 3) A tax is regressive if it represents a larger percentage of the income of a low-income taxpayer
relative to the income of a high-income taxpayer. Examples of regressive taxes include sales and
excise taxes. A tax is progressive if it represents a larger percentage of the income of a high-income
taxpayer relative to the income of a low-income taxpayer. The Federal income tax is an example of a
progressive tax.
8. (LO 4)
a. The parsonage probably was not listed on the property tax rolls because it was owned by a tax-
exempt church. Apparently, the taxing authorities are not aware that ownership has changed.
b. Ethan should notify the authorities of his purchase. This will force him to pay back taxes but
may eliminate future interest and penalties.
9. (LO 4) Although the Baker Motors bid is the lowest, from a long-term financial standpoint, it is the
best. The proposed use of the property by the state and the church probably will make it exempt from
the school district’s ad valorem tax. This would hardly be the case with a car dealership. In fact,
commercial properties (e.g., car dealerships) often are subject to higher tax rates.
10. (LO 4)
a. In this case, the “tax holiday” probably concerns exemption from ad valorem taxes.
“Generous” could involve an extended period of time (e.g., 10 years) and include both realty
and personalty.
b. The school district could be affected in two ways. First, due to the erosion of the tax base,
less revenue would be forthcoming. Second, new workers would mean new families and
more children to educate.
11. (LO 4) A possible explanation is that Sophia made capital improvements (e.g., added a swimming
pool) to her residence and her parents became retirees (e.g., reached age 65).
12. (LO 4) Presuming that the dockage facilities are comparable in Massachusetts, the Morgans may be
trying to avoid ad valorem taxes. Taxes on nonbusiness property vary from one state to another and
are frequently avoided.
13. (LO 4) In general, Federal excise taxes apply to fewer items than in the past. Lawmakers have
focused on and increased certain Federal excise taxes (e.g., those on tobacco products, gasoline, and
air travel).
14. (LO 4) Jayla could have been overcharged, but it is likely that at least part of the excess is attributable
to a hotel occupancy tax and a car rental tax. In major cities, these types of excise taxes have become
a popular way of financing capital improvements such as sports arenas and stadiums. Consequently,
the amount of the taxes could be significant.
15. (LO 4) An excise tax is limited to a particular transaction (e.g., sale of gasoline), whereas a general
sales tax covers a multitude of transactions (e.g., sale of all nonfood goods).
a. The following states do not impose a general sales tax: Alaska, Delaware, Montana, New
Hampshire, and Oregon.
b. There is no Federal general sales tax.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, An Introduction to Taxation and Understanding the Federal Tax Law 1-3
16. (LO 4)
a. Jackson County must be in a state that imposes a lower (or no) sales tax. With certain major
purchases (i.e., big-ticket items), any use tax imposed by the state of the Garcías’ residence
could come into play.
b. In some states, the sales tax rate varies depending on the county and/or city.
Note: Generally, buyers are subject to the sales and use tax rate where they live. For example, if the
Garcías buy goods in a different state with a zero or lower sales tax rate than in their state, they owe
use tax to their home state for the difference.
17. (LO 4) Caleb probably purchased his computer out of state through a catalog or via the internet. In
such cases, state collection of the sales (use) tax is not likely. Caleb needs to pay use tax on his own
(which is equal to the sales tax).
18. (LO 4) If the tax is imposed on the right to pass property at death, it is classified as an estate tax. If it
taxes the right to receive property from a decedent, it is termed an inheritance tax.
a. Some states impose both an estate tax and an inheritance tax. Some states (e.g., Florida and
Texas) levy neither tax.
b. The Federal government imposes an estate tax.
19. (LO 4) Jake either has a severe misunderstanding as to the rules regarding transfer taxes or is lying to
Jessica to delay any parting with his wealth. The marital deduction allows interspousal transfers
(whether by gift or at death) free of any tax (either gift or estate). As a result, in the case of spousal
transfers, there is no tax reason to prefer transfers at death over lifetime gifts.
20. (LO 4)
a. The purpose of the unified transfer tax credit is to eliminate the tax on all but substantial gifts
and estates.
b. Yes. The credit for 2021 is $4,625,800; for 2020, it is $4,577,800.
c. Yes. The credit is available to cover transfers by gift or by death (or both), but the amount
can be used only once.
21. (LO 4) $570,000. 19 donees (5 married children + 5 spouses + 9 grandchildren) $15,000 (annual
exclusion for 2021) 2 donors (Elijah and Anastasia) = $570,000.
22. (LO 4) The individual income tax is progressive in nature; the corporate income tax is assessed at a
flat 21% rate. In addition, the corporate income tax does not make any distinction as to deductions—
only business deductions are allowed. Nor does it require the computation of adjusted gross income
(AGI) or provide for the standard deduction and the deduction for qualified business income.
23. (LO 4)
a. For state income tax purposes, “piggyback” means making use of what was done for Federal
income tax purposes. By “decoupling,” a state decides not to allow a particular Federal
provision (e.g., exclusion, deduction, credit) for state income tax purposes.
b. States often use IRS audit results to identify errors that might also exist on the taxpayer’s
state tax return.
c. Most states allow their residents some form of tax credit for income taxes paid to other states.
24. (LO 4) What happened here likely is not a coincidence. The IRS probably notified the state of
California regarding Hernando’s omission of income, and California followed up with its own audit.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-4 2022 Comprehensive Volume/Solutions Manual
25. (LO 4) If Mike is drafted by a team in one of the listed states, he will escape state income tax on
income earned within that state (e.g., training camp, home games). He will not, however, escape the
income tax (state and local) imposed by jurisdictions where he plays away games. Called the “jock
tax,” it is applied to out-of-state athletes and entertainers.
26. (LO 4, 5)
a. This type of question has no relevance to the state income tax, but is a reminder to individual
taxpayers about the use tax and a simple way for individual taxpayers to pay any use tax due
on internet and mail-order purchases. Without the line on the state income tax return,
individual taxpayers would be required to file a separate use tax return.
b. As the preparer of the state income tax return, you should not leave questions unanswered
unless there is a good reason for doing so. It appears that Hannah has no justifiable reason.
27. (LO 4) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that
they are not paying for the donation.
28. (LO 4)
a. They uncover taxpayers who were previously unknown to the taxing authority. In addition,
amnesty programs can bring taxpayers who are not in compliance with tax laws into
compliance.
b. Amnesty provisions can apply to other than income taxes (e.g., sales, franchise, severance).
c. No general amnesty program has been offered for any Federal taxes.
29. (LO 4)
a. FICA offers some measure of retirement security, and FUTA provides a modest source of
income in the event of loss of employment.
b. FICA is imposed on both employer and employee, while FUTA is imposed only on the
employer.
c. FICA is administered by the Federal government. FUTA, however, is handled by both the
Federal and state government.
d. This applies only to FUTA. The merit system rewards employers who have low employee
turnover because this reduces the payout of unemployment benefits.
30. (LO 4)
a. Unlike the Social Security portion of FICA, there is no dollar limit on the imposition of the
Medicare tax.
b. The 0.9% Medicare addition applies to taxpayers with wages or net self-employment income
in excess of $200,000 ($250,000 for married filing jointly).
31. (LO 4) Only children under age 18 are excluded from FICA. Other family members, including
spouses, must be covered.
32. (LO 4)
a. Severance taxes are transaction taxes that are based on the notion that the state has an interest
in its natural resources. The tax is imposed on the extraction of minerals.
b. Franchise taxes are levied on the right to do business in the state. Typically, they are imposed
on corporations and are based on their capitalization.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, An Introduction to Taxation and Understanding the Federal Tax Law 1-5
c. Occupational fees are applicable to trades or businesses and are licenses to practice. Most are
not significant revenue producers, and the amounts collected are utilized to defray the cost of
regulating the profession.
d. Customs duties are taxes on the importation of certain foreign goods. They are imposed by
the Federal government and are not found at the state and local level.
e. Export duties are taxes imposed on the export of certain commodities (e.g., oil, coffee). They
are common in less-developed nations and are not levied by the United States.
33. (LO 4)
a. 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 100 countries use a
VAT. In spite of its extensive use by other countries, the adoption of a VAT by the United
States appears doubtful. Instead, the United States places high reliance on the income tax as
its major revenue source.
b. A VAT taxes the increment in value as goods move through the production and manufacturing
stages to the marketplace. Although the tax is paid by the producer, it is reflected in the selling
price of the goods. Therefore, a VAT is a tax on consumption.
c. Because it is an effective generator of revenue, the VAT has been criticized as leading to
more government spending.
34. (LO 4)
a. Both the national sales tax and the VAT are taxes on consumption. Both taxes impose more
of a burden on low-income taxpayers who must spend a larger proportion of their incomes on
essential purchases relative to higher-income taxpayers. As a result, the taxes are regressive
in effect.
b. The regressive effect might be partly remedied by granting some sort of credit, rebate, or
exemption to low-income taxpayers.
35. (LO 4, 5)
a. Serena may have record-keeping issues related to the cash transactions. The short-term
holiday workers should be on the payroll because they are employees, and Serena owes FICA
and FUTA on their wages and must file Forms 940 and 941 with the IRS. Serena must also
timely issue a W–2 wage form to each of her employees.
b. High. First, Serena is self-employed. Second, she operates partially on a cash basis. Third, the
opportunity to understate income and/or overstate expenses is high. Fourth, she has some
workers who appear to be misclassified and for whom she may not have issued tax reporting
forms.
36. (LO 5)
a. A correspondence audit is probably involved. These audits involve a limited number of issues
(i.e., taxpayer failed to report some dividend income) and most often are easily resolved.
b. An audit that is conducted in an IRS office is called an office audit.
c. The revenue agent’s report (RAR) accepts the taxpayer’s return as filed.
d. When a special agent becomes involved, this usually means that fraud is suspected.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-6 2022 Comprehensive Volume/Solutions Manual
37. (LO 5) In many unresolved audit disagreements at the agent level, the taxpayer should consider an
appeal to the Independent Office of Appeals. Although it is part of the IRS, it is authorized to resolve
audit disputes. It has greater settlement authority than does the agent. In many cases, a compromise
reached at the Independent Office of Appeals can avoid a costly and time-consuming judicial
proceeding.
38. (LO 5) The purpose of a statute of limitations is to preclude parties from prosecuting stale claims. The
passage of time makes the defense of such claims difficult because witnesses and other evidence may
no longer be available. In the Federal tax area, statutes of limitations cover additional assessments by
the IRS and the pursuit of refund claims by taxpayers.
39. (LO 5)
a. The normal three-year statute of limitations will begin to run on the original due date of the
return (usually, the fifteenth day of the fourth month after year-end; April 15). When the
return is filed early, the normal filing date controls.
b. Now the statute of limitations starts to run on the filing date. If the due date controlled (see
part a. above), the taxpayer could shorten the assessment period by filing late.
c. If a return that is due is not filed, the statute of limitations does not start to run. It does not
matter that the failure to file was due to an innocent error on the part of the taxpayer or
adviser.
d. Regardless of the fact that an innocent misunderstanding was involved, there is no statute of
limitations when a return is not filed.
40. (LO 5) No. Interest is not paid if the refund is made within 45 days of when the return was filed.
However, a return is not considered filed until its due date. As a result, the period from April 15 to
May 28, 2021, does not satisfy the 45-day requirement.
41. (LO 5, 6)
a. Normally, the three-year statute of limitations applies to additional assessments the IRS can
make. However, if a substantial omission from gross income is made, the statute of
limitations is increased to six years. A substantial omission is defined as omitting in excess of
25% of the gross income reported on the return.
b. No, it would not. The proper procedure would be to advise Andy to disclose the omission to
the IRS. Absent the client’s consent, do not make the disclosure yourself.
c. If Andy refuses to make the disclosure and the omission has a material carryover effect to the
current year, you should withdraw from the engagement.
42. (LO 5) $4,000, determined as follows:
Failure to pay penalty [0.5% $40,000 2 months] $ 400
Plus:
Failure to file penalty [5% $40,000 2 months] $4,000
Less failure to pay penalty for the same period (400) 3,600
Total penalties $4,000
43. (LO 5)
a. $100,000 (20% $500,000).
b. $375,000 (75% $500,000). The answer presumes that civil (not criminal) fraud is involved.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, An Introduction to Taxation and Understanding the Federal Tax Law 1-7
44. (LO 5, 6)
a. No. Because no return was filed, the statute of limitations never runs. But even if a return had
been filed, the three-year period for the 2017 tax return would not expire until April 15, 2021,
three years after the normal due date for filing.
b. Although you can only recommend that the return be filed, you cannot force him to do so.
However, you should not undertake the engagement for 2018 through 2020 if you cannot
correctly reflect the tax liability due to the omission for 2017.
45. (LO 5, 6) The practice of outsourcing the preparation of tax returns is ethical if three steps are taken.
• Maintain client confidentiality.
• Verify the accuracy of the work done.
• Notify the client, preferably in writing, of the outsourcing.
46. (LO 7)
a. This is the ideal approach to handling a tax cut—for every dollar lost, a new dollar is gained.
b. All the sunset provision does is reinstate the law as it existed prior to the tax cut. Here, the
possibility exists that Congress will rescind (or postpone) the sunset provision before it takes
effect.
c. Indexation is a procedure whereby the IRS makes annual adjustments to certain key tax
components to take into account inflation, as required by law. Some of the more important
components that are adjusted include tax brackets and the standard deduction amounts.
47. (LO 7)
a. To encourage pension plans is to stimulate saving (economic consideration). Also, it provides
security from the private sector for retirement to supplement rather meager public programs
(social considerations).
b. To make education more widely available is to promote a socially desirable objective. A
better educated workforce also serves to improve the country’s economic capabilities. As a
result, education tax incentives can be justified on both social and economic grounds.
c. The encouragement of home ownership can be justified on both social and economic
grounds.
48. (LO 7, 8)
a. Social considerations explain the credit. It is socially desirable to encourage parents to
provide care for their children while they work.
b. These deductions raise the issue of preferential tax treatment for homeowners—taxpayers
who rent their personal residences do not receive comparable treatment. Even so, the
encouragement of home ownership can be justified on economic and social grounds.
c. The joint return procedure came about to equalize the position of married persons living in
common law states with those residing in community property jurisdictions. Political and
equity considerations caused this result.
d. Activities deemed contrary to public policy should not result in tax savings.
e. The NOL carryforward provision is an equity consideration designed to mitigate the effect of
the annual accounting period concept.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, 1-8 2022 Comprehensive Volume/Solutions Manual
f. The installment method of reporting gain is consistent with the wherewithal to pay concept—
the seller is taxed when the payments are made by the purchaser.
g. The exclusion from Federal income taxation of interest from state and local bonds can be
justified largely on political considerations. Political goodwill is generated by allowing state
and local jurisdictions to secure financing at a lower cost (i.e., interest rate) due to favorable
Federal income tax treatment.
h. The treatment of prepaid income is justified under the wherewithal to pay concept. It also
eases the task of the IRS as to administration of the tax law.
49. (LO 7)
a. Mia’s realized gain from the condemnation is $320,000 [$400,000 (amount of award) −
$80,000 (cost basis of the warehouse)]. However, her recognized gain is limited to
$120,000—the amount received that was not reinvested.
b. None of the gain is recognized because Mia reinvested the full amount of the condemnation
award.
c. In this case, all of Mia’s $320,000 realized gain is recognized. Mia reinvested only $80,000
of the $400,000 award, so the $320,000 difference between these two amounts means any
realized gain will be recognized to the extent of this difference.
d. The involuntary conversion provision can be justified under the wherewithal to pay concept
and the notion that the taxpayer’s economic position has not changed. In part b., for example,
Mia has retained none of the award and has reinvested in property similar to that taken by the
city.
50. (LO 8) If the collection is worth more than $1,000, the mother has probably made a gift of the excess
value to her son. There is a possibility that the transaction could result in the assessment of a gift tax.
Sales or other transactions between related parties are subject to the arm’s length test. In this case, for
example, would the mother have made this sale for $1,000 if the purchaser had been an unrelated
third party?
RESEARCH PROBLEMS
These research problems require that students utilize online resources to research and answer the questions.
As a result, solutions may vary among students and courses. You should determine the skill and experience
levels of the students before assigning these problems, coaching where necessary. Encourage students to use
reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax
professionals, academics, think tanks, and political outlets to research their answers.
1. The sole proprietor is subject to Federal taxes on income, self-employment and payroll taxes (if the
sole proprietor has employees), and the gasoline excise tax. State taxes include income and sales and
use taxes. Local taxes include property tax, business license tax, and perhaps income tax.
2. An example of a carbon tax proposal of the 116th Congress is H.R. 5457, Carbon Reduction and Tax
Credit Act. An example of a financial transaction tax proposal of the 116th Congress is S. 1587,
Inclusive Prosperity Act of 2019. Similar proposals may exist for the 117th Congress. Students might
also find plans for these types of taxes that do not have legislative language.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Taxation 2022 Comprehensive 45th Edition James
C. Young
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 1
AN INTRODUCTION TO TAXATION
AND UNDERSTANDING THE FEDERAL TAX LAW
SOLUTIONS TO PROBLEM MATERIALS
DISCUSSION QUESTIONS
1. (LO 1) Various answers are possible, including using the Key Terms at the end of each chapter,
referring to the Glossary (Appendix C), looking up the footnote resources to the
Internal Revenue Code in Appendix D, using chapter features (e.g., Global Tax Issues, Ethics &
Equity, Tax Planning, and Framework 1040), examining the tax forms used in the chapters, and
completing additional end-of-chapter assignments. All of these resources will help students engage
more deeply with the materials and help their understanding.
2. (LO 1, 4)
a. John must now document rental receipts and separate his home expenses between personal
and rental use, and he may be subject to the transient occupancy tax.
b. Theresa has become self-employed. Now she will be subject to self-employment tax and may
have to make quarterly installment payments of estimated income and self-employment tax.
Theresa will be required to make payroll tax payments if she hires individuals to work in her
business.
c. Paul’s employer might have some moving expenses that it can deduct (in general, Paul cannot
deduct moving expenses). Paul’s personal taxes will change because Florida does not impose
an income tax but California does.
3. (LO 1, 4) The income tax consequences that result are Marvin’s principal concern. Any rent he
receives is taxed as income, but operating expenses and depreciation will generate deductions that
offset some or all of the income or even yield a loss. Marvin must also consider the effect of other
taxes. Because the property is being converted from residential to commercial use, he can expect an
increase in the ad valorem property taxes levied by the local (and perhaps even the state) taxing
authorities. Besides the real estate taxes, personal property taxes could be imposed on the furnishings.
4. (LO 2) To finance our participation in World War II, the scope of the income tax was expanded
considerably—from a limited coverage of 6% to over 74% of the population. Hence, the description
of the income tax as being a “mass tax” became appropriate.
5. (LO 2) For wage earners, the tax law requires employers to withhold a specified dollar amount from
wages paid to the employee to cover income taxes and payroll taxes. Persons with nonwage income
generally are required to make quarterly payments to the IRS for estimated taxes. Both procedures
ensure that taxpayers will be financially able to meet their annual tax liabilities. That is, the amounts
withheld are meant to prepay the employee’s income taxes and payroll taxes related to the wages
earned.
6. (LO 3) The tax law of this state appears to violate the certainty and simplicity principles.
1-1
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-2 2022 Comprehensive Volume/Solutions Manual
7. (LO 3) A tax is regressive if it represents a larger percentage of the income of a low-income taxpayer
relative to the income of a high-income taxpayer. Examples of regressive taxes include sales and
excise taxes. A tax is progressive if it represents a larger percentage of the income of a high-income
taxpayer relative to the income of a low-income taxpayer. The Federal income tax is an example of a
progressive tax.
8. (LO 4)
a. The parsonage probably was not listed on the property tax rolls because it was owned by a tax-
exempt church. Apparently, the taxing authorities are not aware that ownership has changed.
b. Ethan should notify the authorities of his purchase. This will force him to pay back taxes but
may eliminate future interest and penalties.
9. (LO 4) Although the Baker Motors bid is the lowest, from a long-term financial standpoint, it is the
best. The proposed use of the property by the state and the church probably will make it exempt from
the school district’s ad valorem tax. This would hardly be the case with a car dealership. In fact,
commercial properties (e.g., car dealerships) often are subject to higher tax rates.
10. (LO 4)
a. In this case, the “tax holiday” probably concerns exemption from ad valorem taxes.
“Generous” could involve an extended period of time (e.g., 10 years) and include both realty
and personalty.
b. The school district could be affected in two ways. First, due to the erosion of the tax base,
less revenue would be forthcoming. Second, new workers would mean new families and
more children to educate.
11. (LO 4) A possible explanation is that Sophia made capital improvements (e.g., added a swimming
pool) to her residence and her parents became retirees (e.g., reached age 65).
12. (LO 4) Presuming that the dockage facilities are comparable in Massachusetts, the Morgans may be
trying to avoid ad valorem taxes. Taxes on nonbusiness property vary from one state to another and
are frequently avoided.
13. (LO 4) In general, Federal excise taxes apply to fewer items than in the past. Lawmakers have
focused on and increased certain Federal excise taxes (e.g., those on tobacco products, gasoline, and
air travel).
14. (LO 4) Jayla could have been overcharged, but it is likely that at least part of the excess is attributable
to a hotel occupancy tax and a car rental tax. In major cities, these types of excise taxes have become
a popular way of financing capital improvements such as sports arenas and stadiums. Consequently,
the amount of the taxes could be significant.
15. (LO 4) An excise tax is limited to a particular transaction (e.g., sale of gasoline), whereas a general
sales tax covers a multitude of transactions (e.g., sale of all nonfood goods).
a. The following states do not impose a general sales tax: Alaska, Delaware, Montana, New
Hampshire, and Oregon.
b. There is no Federal general sales tax.
© 2022 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, An Introduction to Taxation and Understanding the Federal Tax Law 1-3
16. (LO 4)
a. Jackson County must be in a state that imposes a lower (or no) sales tax. With certain major
purchases (i.e., big-ticket items), any use tax imposed by the state of the Garcías’ residence
could come into play.
b. In some states, the sales tax rate varies depending on the county and/or city.
Note: Generally, buyers are subject to the sales and use tax rate where they live. For example, if the
Garcías buy goods in a different state with a zero or lower sales tax rate than in their state, they owe
use tax to their home state for the difference.
17. (LO 4) Caleb probably purchased his computer out of state through a catalog or via the internet. In
such cases, state collection of the sales (use) tax is not likely. Caleb needs to pay use tax on his own
(which is equal to the sales tax).
18. (LO 4) If the tax is imposed on the right to pass property at death, it is classified as an estate tax. If it
taxes the right to receive property from a decedent, it is termed an inheritance tax.
a. Some states impose both an estate tax and an inheritance tax. Some states (e.g., Florida and
Texas) levy neither tax.
b. The Federal government imposes an estate tax.
19. (LO 4) Jake either has a severe misunderstanding as to the rules regarding transfer taxes or is lying to
Jessica to delay any parting with his wealth. The marital deduction allows interspousal transfers
(whether by gift or at death) free of any tax (either gift or estate). As a result, in the case of spousal
transfers, there is no tax reason to prefer transfers at death over lifetime gifts.
20. (LO 4)
a. The purpose of the unified transfer tax credit is to eliminate the tax on all but substantial gifts
and estates.
b. Yes. The credit for 2021 is $4,625,800; for 2020, it is $4,577,800.
c. Yes. The credit is available to cover transfers by gift or by death (or both), but the amount
can be used only once.
21. (LO 4) $570,000. 19 donees (5 married children + 5 spouses + 9 grandchildren) $15,000 (annual
exclusion for 2021) 2 donors (Elijah and Anastasia) = $570,000.
22. (LO 4) The individual income tax is progressive in nature; the corporate income tax is assessed at a
flat 21% rate. In addition, the corporate income tax does not make any distinction as to deductions—
only business deductions are allowed. Nor does it require the computation of adjusted gross income
(AGI) or provide for the standard deduction and the deduction for qualified business income.
23. (LO 4)
a. For state income tax purposes, “piggyback” means making use of what was done for Federal
income tax purposes. By “decoupling,” a state decides not to allow a particular Federal
provision (e.g., exclusion, deduction, credit) for state income tax purposes.
b. States often use IRS audit results to identify errors that might also exist on the taxpayer’s
state tax return.
c. Most states allow their residents some form of tax credit for income taxes paid to other states.
24. (LO 4) What happened here likely is not a coincidence. The IRS probably notified the state of
California regarding Hernando’s omission of income, and California followed up with its own audit.
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25. (LO 4) If Mike is drafted by a team in one of the listed states, he will escape state income tax on
income earned within that state (e.g., training camp, home games). He will not, however, escape the
income tax (state and local) imposed by jurisdictions where he plays away games. Called the “jock
tax,” it is applied to out-of-state athletes and entertainers.
26. (LO 4, 5)
a. This type of question has no relevance to the state income tax, but is a reminder to individual
taxpayers about the use tax and a simple way for individual taxpayers to pay any use tax due
on internet and mail-order purchases. Without the line on the state income tax return,
individual taxpayers would be required to file a separate use tax return.
b. As the preparer of the state income tax return, you should not leave questions unanswered
unless there is a good reason for doing so. It appears that Hannah has no justifiable reason.
27. (LO 4) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that
they are not paying for the donation.
28. (LO 4)
a. They uncover taxpayers who were previously unknown to the taxing authority. In addition,
amnesty programs can bring taxpayers who are not in compliance with tax laws into
compliance.
b. Amnesty provisions can apply to other than income taxes (e.g., sales, franchise, severance).
c. No general amnesty program has been offered for any Federal taxes.
29. (LO 4)
a. FICA offers some measure of retirement security, and FUTA provides a modest source of
income in the event of loss of employment.
b. FICA is imposed on both employer and employee, while FUTA is imposed only on the
employer.
c. FICA is administered by the Federal government. FUTA, however, is handled by both the
Federal and state government.
d. This applies only to FUTA. The merit system rewards employers who have low employee
turnover because this reduces the payout of unemployment benefits.
30. (LO 4)
a. Unlike the Social Security portion of FICA, there is no dollar limit on the imposition of the
Medicare tax.
b. The 0.9% Medicare addition applies to taxpayers with wages or net self-employment income
in excess of $200,000 ($250,000 for married filing jointly).
31. (LO 4) Only children under age 18 are excluded from FICA. Other family members, including
spouses, must be covered.
32. (LO 4)
a. Severance taxes are transaction taxes that are based on the notion that the state has an interest
in its natural resources. The tax is imposed on the extraction of minerals.
b. Franchise taxes are levied on the right to do business in the state. Typically, they are imposed
on corporations and are based on their capitalization.
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, An Introduction to Taxation and Understanding the Federal Tax Law 1-5
c. Occupational fees are applicable to trades or businesses and are licenses to practice. Most are
not significant revenue producers, and the amounts collected are utilized to defray the cost of
regulating the profession.
d. Customs duties are taxes on the importation of certain foreign goods. They are imposed by
the Federal government and are not found at the state and local level.
e. Export duties are taxes imposed on the export of certain commodities (e.g., oil, coffee). They
are common in less-developed nations and are not levied by the United States.
33. (LO 4)
a. 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 100 countries use a
VAT. In spite of its extensive use by other countries, the adoption of a VAT by the United
States appears doubtful. Instead, the United States places high reliance on the income tax as
its major revenue source.
b. A VAT taxes the increment in value as goods move through the production and manufacturing
stages to the marketplace. Although the tax is paid by the producer, it is reflected in the selling
price of the goods. Therefore, a VAT is a tax on consumption.
c. Because it is an effective generator of revenue, the VAT has been criticized as leading to
more government spending.
34. (LO 4)
a. Both the national sales tax and the VAT are taxes on consumption. Both taxes impose more
of a burden on low-income taxpayers who must spend a larger proportion of their incomes on
essential purchases relative to higher-income taxpayers. As a result, the taxes are regressive
in effect.
b. The regressive effect might be partly remedied by granting some sort of credit, rebate, or
exemption to low-income taxpayers.
35. (LO 4, 5)
a. Serena may have record-keeping issues related to the cash transactions. The short-term
holiday workers should be on the payroll because they are employees, and Serena owes FICA
and FUTA on their wages and must file Forms 940 and 941 with the IRS. Serena must also
timely issue a W–2 wage form to each of her employees.
b. High. First, Serena is self-employed. Second, she operates partially on a cash basis. Third, the
opportunity to understate income and/or overstate expenses is high. Fourth, she has some
workers who appear to be misclassified and for whom she may not have issued tax reporting
forms.
36. (LO 5)
a. A correspondence audit is probably involved. These audits involve a limited number of issues
(i.e., taxpayer failed to report some dividend income) and most often are easily resolved.
b. An audit that is conducted in an IRS office is called an office audit.
c. The revenue agent’s report (RAR) accepts the taxpayer’s return as filed.
d. When a special agent becomes involved, this usually means that fraud is suspected.
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37. (LO 5) In many unresolved audit disagreements at the agent level, the taxpayer should consider an
appeal to the Independent Office of Appeals. Although it is part of the IRS, it is authorized to resolve
audit disputes. It has greater settlement authority than does the agent. In many cases, a compromise
reached at the Independent Office of Appeals can avoid a costly and time-consuming judicial
proceeding.
38. (LO 5) The purpose of a statute of limitations is to preclude parties from prosecuting stale claims. The
passage of time makes the defense of such claims difficult because witnesses and other evidence may
no longer be available. In the Federal tax area, statutes of limitations cover additional assessments by
the IRS and the pursuit of refund claims by taxpayers.
39. (LO 5)
a. The normal three-year statute of limitations will begin to run on the original due date of the
return (usually, the fifteenth day of the fourth month after year-end; April 15). When the
return is filed early, the normal filing date controls.
b. Now the statute of limitations starts to run on the filing date. If the due date controlled (see
part a. above), the taxpayer could shorten the assessment period by filing late.
c. If a return that is due is not filed, the statute of limitations does not start to run. It does not
matter that the failure to file was due to an innocent error on the part of the taxpayer or
adviser.
d. Regardless of the fact that an innocent misunderstanding was involved, there is no statute of
limitations when a return is not filed.
40. (LO 5) No. Interest is not paid if the refund is made within 45 days of when the return was filed.
However, a return is not considered filed until its due date. As a result, the period from April 15 to
May 28, 2021, does not satisfy the 45-day requirement.
41. (LO 5, 6)
a. Normally, the three-year statute of limitations applies to additional assessments the IRS can
make. However, if a substantial omission from gross income is made, the statute of
limitations is increased to six years. A substantial omission is defined as omitting in excess of
25% of the gross income reported on the return.
b. No, it would not. The proper procedure would be to advise Andy to disclose the omission to
the IRS. Absent the client’s consent, do not make the disclosure yourself.
c. If Andy refuses to make the disclosure and the omission has a material carryover effect to the
current year, you should withdraw from the engagement.
42. (LO 5) $4,000, determined as follows:
Failure to pay penalty [0.5% $40,000 2 months] $ 400
Plus:
Failure to file penalty [5% $40,000 2 months] $4,000
Less failure to pay penalty for the same period (400) 3,600
Total penalties $4,000
43. (LO 5)
a. $100,000 (20% $500,000).
b. $375,000 (75% $500,000). The answer presumes that civil (not criminal) fraud is involved.
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, An Introduction to Taxation and Understanding the Federal Tax Law 1-7
44. (LO 5, 6)
a. No. Because no return was filed, the statute of limitations never runs. But even if a return had
been filed, the three-year period for the 2017 tax return would not expire until April 15, 2021,
three years after the normal due date for filing.
b. Although you can only recommend that the return be filed, you cannot force him to do so.
However, you should not undertake the engagement for 2018 through 2020 if you cannot
correctly reflect the tax liability due to the omission for 2017.
45. (LO 5, 6) The practice of outsourcing the preparation of tax returns is ethical if three steps are taken.
• Maintain client confidentiality.
• Verify the accuracy of the work done.
• Notify the client, preferably in writing, of the outsourcing.
46. (LO 7)
a. This is the ideal approach to handling a tax cut—for every dollar lost, a new dollar is gained.
b. All the sunset provision does is reinstate the law as it existed prior to the tax cut. Here, the
possibility exists that Congress will rescind (or postpone) the sunset provision before it takes
effect.
c. Indexation is a procedure whereby the IRS makes annual adjustments to certain key tax
components to take into account inflation, as required by law. Some of the more important
components that are adjusted include tax brackets and the standard deduction amounts.
47. (LO 7)
a. To encourage pension plans is to stimulate saving (economic consideration). Also, it provides
security from the private sector for retirement to supplement rather meager public programs
(social considerations).
b. To make education more widely available is to promote a socially desirable objective. A
better educated workforce also serves to improve the country’s economic capabilities. As a
result, education tax incentives can be justified on both social and economic grounds.
c. The encouragement of home ownership can be justified on both social and economic
grounds.
48. (LO 7, 8)
a. Social considerations explain the credit. It is socially desirable to encourage parents to
provide care for their children while they work.
b. These deductions raise the issue of preferential tax treatment for homeowners—taxpayers
who rent their personal residences do not receive comparable treatment. Even so, the
encouragement of home ownership can be justified on economic and social grounds.
c. The joint return procedure came about to equalize the position of married persons living in
common law states with those residing in community property jurisdictions. Political and
equity considerations caused this result.
d. Activities deemed contrary to public policy should not result in tax savings.
e. The NOL carryforward provision is an equity consideration designed to mitigate the effect of
the annual accounting period concept.
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f. The installment method of reporting gain is consistent with the wherewithal to pay concept—
the seller is taxed when the payments are made by the purchaser.
g. The exclusion from Federal income taxation of interest from state and local bonds can be
justified largely on political considerations. Political goodwill is generated by allowing state
and local jurisdictions to secure financing at a lower cost (i.e., interest rate) due to favorable
Federal income tax treatment.
h. The treatment of prepaid income is justified under the wherewithal to pay concept. It also
eases the task of the IRS as to administration of the tax law.
49. (LO 7)
a. Mia’s realized gain from the condemnation is $320,000 [$400,000 (amount of award) −
$80,000 (cost basis of the warehouse)]. However, her recognized gain is limited to
$120,000—the amount received that was not reinvested.
b. None of the gain is recognized because Mia reinvested the full amount of the condemnation
award.
c. In this case, all of Mia’s $320,000 realized gain is recognized. Mia reinvested only $80,000
of the $400,000 award, so the $320,000 difference between these two amounts means any
realized gain will be recognized to the extent of this difference.
d. The involuntary conversion provision can be justified under the wherewithal to pay concept
and the notion that the taxpayer’s economic position has not changed. In part b., for example,
Mia has retained none of the award and has reinvested in property similar to that taken by the
city.
50. (LO 8) If the collection is worth more than $1,000, the mother has probably made a gift of the excess
value to her son. There is a possibility that the transaction could result in the assessment of a gift tax.
Sales or other transactions between related parties are subject to the arm’s length test. In this case, for
example, would the mother have made this sale for $1,000 if the purchaser had been an unrelated
third party?
RESEARCH PROBLEMS
These research problems require that students utilize online resources to research and answer the questions.
As a result, solutions may vary among students and courses. You should determine the skill and experience
levels of the students before assigning these problems, coaching where necessary. Encourage students to use
reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax
professionals, academics, think tanks, and political outlets to research their answers.
1. The sole proprietor is subject to Federal taxes on income, self-employment and payroll taxes (if the
sole proprietor has employees), and the gasoline excise tax. State taxes include income and sales and
use taxes. Local taxes include property tax, business license tax, and perhaps income tax.
2. An example of a carbon tax proposal of the 116th Congress is H.R. 5457, Carbon Reduction and Tax
Credit Act. An example of a financial transaction tax proposal of the 116th Congress is S. 1587,
Inclusive Prosperity Act of 2019. Similar proposals may exist for the 117th Congress. Students might
also find plans for these types of taxes that do not have legislative language.
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