, Solution manual for South-Western Federal
Taxation 2023 Essentials of Taxation Individuals
and Business Entities, 26th Edition Annette Nellen
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
INTRODUCTION TO TAXATION
SOLUTIONS TO PROBLEM MATERIALS
PROBLEMS
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 Digging Deeper), 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 3, 5, 6) Some tax and nontax considerations James should investigate include the following:
• State and local income taxes.
• State and local sales taxes.
• State and local property taxes.
• Employee implications of the move (Will James lose current employees? Is the labor market
better in the new location? Is cost of living lower or higher in new location?).
• Logistics/transportation of products to customers (specifically document lower costs).
• State infrastructure (better in new location?).
3. (LO 1, 2, 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.
4. (LO 3)
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.
5. (LO 1, 6) (See Digging Deeper 1.) As to Adam Smith’s canon on economy, the Federal income tax
yields a mixed result. From the standpoint of the IRS, economy exists as collection costs are nominal
(when compared with revenue generated). The government's cost of collecting Federal taxes amounts
to less than one-half of 1 percent of the revenue collected. Economy is not present, however, if one
looks to the compliance effort and costs expended by taxpayers. According to recent estimates, about
56% of individual taxpayers who file a return pay a preparer, and one-third purchase tax software.
1-1
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-2 2023 Essentials of Taxation/Solutions Manual
6. (LO 3) Jang probably will be required to pay the Washington use tax if, and when, he applies for
Washington license plates. In this case, the use tax probably is the same amount as the Washington
sales tax. See the discussion in connection with Example 14 in the textbook.
7. (LO 3) 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.
8. ((LO 3, 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).
9. (LO 5, 6) SWFT, LLP
5191 Natorp Boulevard
Mason, OH 45040
February 25, 2022
Cynthia Clay
1206 Seventh Avenue
Fort Worth, TX 76101
Dear Cynthia:
I am writing this letter to help you decide on what form of entity to choose for your new food delivery
business. In our phone conversation, you indicated that you expect to have losses for the first two
years in this business and then make substantial profits in subsequent years. You and Marco also
indicated that you are concerned about potential personal liability.
While I can’t make a conclusive recommendation based on the information you have given me, I can
provide you with some general guidelines that should simplify your decision. First, given your
concern about personal liability, a partnership does not appear to be a desirable option (you would
both be personally liable for any injuries to customers). Similarly, given your expectation of losses in
the first two years, it does not appear that a C corporation would be a desirable choice, at least
initially. This is because any losses in the corporation could only be used to offset future corporate
profits—you could not use the losses to immediately offset your personal tax liability.
Thus, two choices exist which provide limited liability and deductibility of losses on your personal
income tax return. These are the S corporation and the limited liability company. If you choose an
S corporation, we would probably convert the entity to a C corporation when the business becomes
profitable. At that point, profits would be taxed at the C corporation rate. A second tax would be levied
on your personal income tax return for any dividends paid by the corporation once it achieves C status.
In contrast, limited liability companies are taxed like partnerships—all income would be taxed on your
personal income tax return in profitable years. The relative desirability of each of these two forms
depends on a number of factors. One of the most important factors in your situation is the relationship
between your personal tax rate and the tax rate of a C corporation. If you are in a high tax bracket and if
the income in the business is sufficiently low, you might be best off choosing the S corporation.
Alternatively, if you expect the business to generate a sufficiently large profit each year, it might be best
to choose the limited liability company. The qualified business income deduction for income from flow-
through entities along with the flat tax rate of 21% that applies to corporations also must be taken into
consideration.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, Introduction to Taxation 1-3
If you would like me to give you a clearer recommendation, we should meet at your earliest
convenience. If you have any additional questions, please call me.
Best regards,
Julian Jackson, CPA
10. (LO 5, 6)
a. Year 1 Year 2 Year 3
Corporate Tax Liability
Sales revenue $150,000 $320,000 $600,000
Cash expenses (30,000) (58,000) (95,000)
Depreciation (25,000) (20,000) (40,000)
Taxable income $ 95,000 $242,000 $465,000
Corporate tax liability $ 19,950 $ 50,820 $ 97,650
Cash Available for Dividends
Sales revenue $150,000 $320,000 $600,000
Tax-free interest income 5,000 8,000 15,000
Cash expenses (30,000) (58,000) (95,000)
Corporate tax liability (19,950) (50,820) (97,650)
Cash available for dividends $105,050 $219,180 $422,350
Ashley’s After-Tax Cash Flow
Dividend received $105,050 $219,180 $422,350
Tax on dividend at 15% rounded (15,758) (32,877) (63,353)
After-tax cash flow $ 89,292 $186,303 $358,997
PV of cash flow* $ 79,729 $148,521 $255,534
Total present value $483,784
*Present value factors (.8929, .7972, .7118) from Appendix E.
b. Year 1 Year 2 Year 3
Individual Tax Liability
Sales revenue $150,000 $320,000 $600,000
Cash expenses (30,000) (58,000) (95,000)
Depreciation (25,000) (20,000) (40,000)
Taxable income $ 95,000 $242,000 $465,000
Individual tax liability** $ 23,750 $ 60,500 $116,250
**Rate = 25%
Ashley’s After-Tax Cash Flow
Sales revenue $150,000 $320,000 $600,000
Tax-free interest income 5,000 8,000 15,000
Cash expenses (30,000) (58,000) (95,000)
Individual tax liability (23,750) (60,500) (116,250)
After-tax cash flow $101,250 $209,500 $403,750
PV of cash flow* $ 90,406 $167,013 $287,389
Total present value $544,808
*Present value factors (.8929, .7972, .7118) from Appendix E.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-4 2023 Essentials of Taxation/Solutions Manual
c. If Ashley wants to have access to all available cash from the business, then she will have to
pay out dividends annually. As seen in the answers to parts a. and b. above, the present value
of future cash flows is substantially greater if she does not incorporate under this assumption.
Alternatively, if she does not need to pay out dividends, then she may be better off by
incorporating, since only the corporate tax will be incurred, which is less than her individual
tax. The value of her stock will increase and she then can sell the stock at a later date at
favorable capital gains rates.
11. (LO 1) PowerPoint presentations will vary. In favor of high progressivity:
• Ability to pay.
• Fairness of result.
• Benefits of government skew toward those at upper-income levels.
Contrary to high progressivity:
• Discouragement of work and innovation.
• Unfairness of result.
• Civic engagement by those at lower-income levels requires “skin in the game.”
12. (LO 3)
a. In terms of taxpayer compliance, an ad valorem tax on personalty is less desirable than one
on realty. However, a tax on business personalty, such as inventory, is to be preferred over
one on personal use (i.e., nonbusiness) personalty.
b. A tax on stock and bonds would be too easily avoided. The taxing authority would have no
means of ascertaining ownership of these assets.
c. Poor taxpayer compliance is to be expected for any tax on personal use personalty. However,
if boats had to be periodically licensed (e.g., safety inspection), this could provide the taxing
authority with a means of discovering unreported boat ownership.
13. (LO 2, 7)
a. Economic justification. The tax law addresses the energy crisis—in terms of both reliance on
foreign oil and the need to ease the problem of climate change.
b. Economic justification. See the comments under part a. above.
c. Economic justification. Research and development activities are encouraged by allowing
immediate or faster write-off of these expenditures.
d. Social justification. The charitable deduction helps fund private organizations and causes that
are operated in the interest of the general welfare. This relieves government of the need for
considerable public funding.
e. Economic justification. Known as the S election, the provision encourages small businesses
to operate in the corporate form without suffering all of the tax disadvantages of the regular
(C) corporation.
14. (LO 4, 7)
a. Social considerations explain the credit. It is socially desirable to encourage parents to
provide care for their children while they work.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, Introduction to Taxation 1-5
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.
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.
15. (LO 3) (See Digging Deeper 3.) A value added tax (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.
A national sales tax taxes numerous transactions and is collected on the final sale of goods and services to
the consumer. Consequently, it is collected from the consumer and not the producer of the product as does
a VAT.
In terms of taxpayer compliance, a VAT is preferable to a national sales tax. Without significant
collection efforts, a national sales tax could easily be circumvented or avoided in many ways (e.g.,
resorting to a barter system of doing business).
16. (LO 3) 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,
Nevada, and Texas) levy neither tax.
b. The Federal government imposes an estate tax.
17. (LO 2, 7) Students’ e-mails may vary. Build interaction into the exercise wherever possible, asking
the student to send and receive e-mail in a professional and responsible manner.
18. (LO 2, 7)
a. Madden’s Federal income tax liability is $25,672, computed as follows.
10% × $10,275 $ 1,028
12% × ($41,775 − $10,275) 3,780
22% × ($89,075 − $41,775) 10,406
24% × ($132,650 − $89,075) 10,458
Total Federal income tax $25,672
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-6 2023 Essentials of Taxation/Solutions Manual
b. 10%, 12%, 22%, and 24%.
c. 24%.
d. 19.4% ($25,672 ÷ $132,650).
e. 17.6% ($25,672 ÷ $145,600).
19. (LO 3, 4, 6) 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.
20. (LO 2, 7) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that
they are not paying for the donation.
BRIDGE DISCIPLINE PROBLEMS
1. Solutions may vary among students.
2. Solutions may vary among students.
3. Solutions may vary among students.
4. When taxes become “too high,” taxpayers increase the rates of tax cheating, because the payoff from
misconduct increases. Property and transaction taxes are difficult to cheat on, as the tax base is easily
detectible, while cheating on taxes on income and asset transfers may be more easily accomplished,
and enforcement activities by the taxing agency become more expensive. High rates of tax cheating
can lead to several undesirable consequences.
• A “conspicuous consumption” society, wherein taxpayers use their tax underpayments to increase
their lifestyles in a public fashion.
• A loss of confidence in the self-assessment system, such that certain levels of cheating are
assumed to occur, and the number of cheaters increases.
• The “missing revenue” keeps the government from delivering the goods and services that the
taxes are supposed to pay for.
• Political gridlock can occur when it becomes impossible to raise tax rates high enough, or
broaden the tax base enough, to offset the cheaters’ “missing revenue.”
5. 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.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, Introduction to Taxation 1-7
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. An example of a sweetened beverage tax proposal is H.R. 2772 (117th Congress), the SWEET Act.
Proposals also exist in a number of states and cities. Some cities, including Berkeley, California,
Philadelphia, Pennsylvania, and Boulder, Colorado, have already enacted soda taxes. Considerations
in analyzing these proposals include issues of regressivity (an equity and fairness issue), complexity
of definitions, burden of enforcement, and neutrality in affecting decision making. Cook County,
Illinois (Chicago) passed and then repealed a sweetened beverage tax due to a number of these issues.
2. Each of the Big Four firms has information on data analytics and how it can be used for tax purposes:
• pwc.com/us/en/services/tax/tax-innovation.html
• home.kpmg.com/xx/en/home/services/tax/global-indirect-tax/data-and-analytics.html
• ey.com/en_gl/tax/how-data-analytics-is-transforming-tax-administration
• www2.deloitte.com/global/en/pages/technology/articles/making-data-and-analysis-a-
priority.html
Students should also find how the IRS and state tax agencies are using big data to improve
audit selection and enforcement. For example, see IRS, Advance Data & Analytics at:
• irs.gov/about-irs/strategic-goals/advance-data-analytics
3. The Safeguards Rule was created as part of the Gramm-Leach-Bliley Act in 1999 (P.L. 106−102).
The FTC summarizes this rule as follows: “The Safeguards Rule requires financial institutions under
FTC jurisdiction to have measures in place to keep customer information secure. In addition to
developing their own safeguards, companies covered by the Rule are responsible for taking steps to
ensure that their affiliates and service providers safeguard customer information in their care.” This
rule applies to all paid return preparers.
• ftc.gov/enforcement/rules/rulemaking-regulatory-reform-proceedings/safeguards-rule
IRS Publication 4557 includes several actions preparers should take to protect client data and meet
the Safeguards Rule. In reviewing student answers, confirm that they understand the Safeguards Rule
and why a preparer obtaining or renewing a PTIN is asked to confirm that they have a data security
plan. The publication lists numerous actions; consider whether the three actions the student describes
are among the most important.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 2
WORKING WITH THE TAX LAW
SOLUTIONS TO PROBLEM MATERIALS
DISCUSSION QUESTIONS
1. (LO 1) See Exhibit 2.4.
a. The Tax Court must follow its own cases, the pertinent U.S. Circuit Court of Appeals, and the
Supreme Court.
b. The Court of Federal Claims must follow its own decisions, the Federal Circuit Court of
Appeals, and the Supreme Court.
c. The District Court must follow its own decisions, the pertinent U.S. Circuit Court of Appeals,
and the Supreme Court.
2. (LO 1, 3) SWFT, LLP
5191 Natorp Boulevard
Mason, OH 45040
October 20, 2022
Ms. Sonja Bishop
Tile, Inc.
100 International Drive
Tampa, FL 33620
Dear Ms. Bishop:
This letter is in response to your request about information concerning a conflict between
a U.S. treaty with Spain and a section of the Internal Revenue Code (IRC). The major reasons for
treaties between the United States and certain foreign countries is to eliminate double taxation and to
render mutual assistance in tax enforcement.
IRC § 7852(d) provides that if a U.S. treaty is in conflict with a provision in the IRC, neither will take
general precedence. Rather, the more recent of the two will have precedence. In your case, the treaty
with Spain takes precedence over the IRC section.
A taxpayer must disclose on the tax return any positions where a treaty overrides a tax law. There is a
$1,000 penalty per failure to disclose for individuals and a $10,000 penalty per failure to disclose for
corporations.
Should you need more information, feel free to contact me.
Sincerely,
Jeffrey Hanks, CPA
Tax Partner
2-1
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Taxation 2023 Essentials of Taxation Individuals
and Business Entities, 26th Edition Annette Nellen
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
INTRODUCTION TO TAXATION
SOLUTIONS TO PROBLEM MATERIALS
PROBLEMS
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 Digging Deeper), 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 3, 5, 6) Some tax and nontax considerations James should investigate include the following:
• State and local income taxes.
• State and local sales taxes.
• State and local property taxes.
• Employee implications of the move (Will James lose current employees? Is the labor market
better in the new location? Is cost of living lower or higher in new location?).
• Logistics/transportation of products to customers (specifically document lower costs).
• State infrastructure (better in new location?).
3. (LO 1, 2, 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.
4. (LO 3)
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.
5. (LO 1, 6) (See Digging Deeper 1.) As to Adam Smith’s canon on economy, the Federal income tax
yields a mixed result. From the standpoint of the IRS, economy exists as collection costs are nominal
(when compared with revenue generated). The government's cost of collecting Federal taxes amounts
to less than one-half of 1 percent of the revenue collected. Economy is not present, however, if one
looks to the compliance effort and costs expended by taxpayers. According to recent estimates, about
56% of individual taxpayers who file a return pay a preparer, and one-third purchase tax software.
1-1
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-2 2023 Essentials of Taxation/Solutions Manual
6. (LO 3) Jang probably will be required to pay the Washington use tax if, and when, he applies for
Washington license plates. In this case, the use tax probably is the same amount as the Washington
sales tax. See the discussion in connection with Example 14 in the textbook.
7. (LO 3) 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.
8. ((LO 3, 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).
9. (LO 5, 6) SWFT, LLP
5191 Natorp Boulevard
Mason, OH 45040
February 25, 2022
Cynthia Clay
1206 Seventh Avenue
Fort Worth, TX 76101
Dear Cynthia:
I am writing this letter to help you decide on what form of entity to choose for your new food delivery
business. In our phone conversation, you indicated that you expect to have losses for the first two
years in this business and then make substantial profits in subsequent years. You and Marco also
indicated that you are concerned about potential personal liability.
While I can’t make a conclusive recommendation based on the information you have given me, I can
provide you with some general guidelines that should simplify your decision. First, given your
concern about personal liability, a partnership does not appear to be a desirable option (you would
both be personally liable for any injuries to customers). Similarly, given your expectation of losses in
the first two years, it does not appear that a C corporation would be a desirable choice, at least
initially. This is because any losses in the corporation could only be used to offset future corporate
profits—you could not use the losses to immediately offset your personal tax liability.
Thus, two choices exist which provide limited liability and deductibility of losses on your personal
income tax return. These are the S corporation and the limited liability company. If you choose an
S corporation, we would probably convert the entity to a C corporation when the business becomes
profitable. At that point, profits would be taxed at the C corporation rate. A second tax would be levied
on your personal income tax return for any dividends paid by the corporation once it achieves C status.
In contrast, limited liability companies are taxed like partnerships—all income would be taxed on your
personal income tax return in profitable years. The relative desirability of each of these two forms
depends on a number of factors. One of the most important factors in your situation is the relationship
between your personal tax rate and the tax rate of a C corporation. If you are in a high tax bracket and if
the income in the business is sufficiently low, you might be best off choosing the S corporation.
Alternatively, if you expect the business to generate a sufficiently large profit each year, it might be best
to choose the limited liability company. The qualified business income deduction for income from flow-
through entities along with the flat tax rate of 21% that applies to corporations also must be taken into
consideration.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, Introduction to Taxation 1-3
If you would like me to give you a clearer recommendation, we should meet at your earliest
convenience. If you have any additional questions, please call me.
Best regards,
Julian Jackson, CPA
10. (LO 5, 6)
a. Year 1 Year 2 Year 3
Corporate Tax Liability
Sales revenue $150,000 $320,000 $600,000
Cash expenses (30,000) (58,000) (95,000)
Depreciation (25,000) (20,000) (40,000)
Taxable income $ 95,000 $242,000 $465,000
Corporate tax liability $ 19,950 $ 50,820 $ 97,650
Cash Available for Dividends
Sales revenue $150,000 $320,000 $600,000
Tax-free interest income 5,000 8,000 15,000
Cash expenses (30,000) (58,000) (95,000)
Corporate tax liability (19,950) (50,820) (97,650)
Cash available for dividends $105,050 $219,180 $422,350
Ashley’s After-Tax Cash Flow
Dividend received $105,050 $219,180 $422,350
Tax on dividend at 15% rounded (15,758) (32,877) (63,353)
After-tax cash flow $ 89,292 $186,303 $358,997
PV of cash flow* $ 79,729 $148,521 $255,534
Total present value $483,784
*Present value factors (.8929, .7972, .7118) from Appendix E.
b. Year 1 Year 2 Year 3
Individual Tax Liability
Sales revenue $150,000 $320,000 $600,000
Cash expenses (30,000) (58,000) (95,000)
Depreciation (25,000) (20,000) (40,000)
Taxable income $ 95,000 $242,000 $465,000
Individual tax liability** $ 23,750 $ 60,500 $116,250
**Rate = 25%
Ashley’s After-Tax Cash Flow
Sales revenue $150,000 $320,000 $600,000
Tax-free interest income 5,000 8,000 15,000
Cash expenses (30,000) (58,000) (95,000)
Individual tax liability (23,750) (60,500) (116,250)
After-tax cash flow $101,250 $209,500 $403,750
PV of cash flow* $ 90,406 $167,013 $287,389
Total present value $544,808
*Present value factors (.8929, .7972, .7118) from Appendix E.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-4 2023 Essentials of Taxation/Solutions Manual
c. If Ashley wants to have access to all available cash from the business, then she will have to
pay out dividends annually. As seen in the answers to parts a. and b. above, the present value
of future cash flows is substantially greater if she does not incorporate under this assumption.
Alternatively, if she does not need to pay out dividends, then she may be better off by
incorporating, since only the corporate tax will be incurred, which is less than her individual
tax. The value of her stock will increase and she then can sell the stock at a later date at
favorable capital gains rates.
11. (LO 1) PowerPoint presentations will vary. In favor of high progressivity:
• Ability to pay.
• Fairness of result.
• Benefits of government skew toward those at upper-income levels.
Contrary to high progressivity:
• Discouragement of work and innovation.
• Unfairness of result.
• Civic engagement by those at lower-income levels requires “skin in the game.”
12. (LO 3)
a. In terms of taxpayer compliance, an ad valorem tax on personalty is less desirable than one
on realty. However, a tax on business personalty, such as inventory, is to be preferred over
one on personal use (i.e., nonbusiness) personalty.
b. A tax on stock and bonds would be too easily avoided. The taxing authority would have no
means of ascertaining ownership of these assets.
c. Poor taxpayer compliance is to be expected for any tax on personal use personalty. However,
if boats had to be periodically licensed (e.g., safety inspection), this could provide the taxing
authority with a means of discovering unreported boat ownership.
13. (LO 2, 7)
a. Economic justification. The tax law addresses the energy crisis—in terms of both reliance on
foreign oil and the need to ease the problem of climate change.
b. Economic justification. See the comments under part a. above.
c. Economic justification. Research and development activities are encouraged by allowing
immediate or faster write-off of these expenditures.
d. Social justification. The charitable deduction helps fund private organizations and causes that
are operated in the interest of the general welfare. This relieves government of the need for
considerable public funding.
e. Economic justification. Known as the S election, the provision encourages small businesses
to operate in the corporate form without suffering all of the tax disadvantages of the regular
(C) corporation.
14. (LO 4, 7)
a. Social considerations explain the credit. It is socially desirable to encourage parents to
provide care for their children while they work.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, Introduction to Taxation 1-5
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.
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.
15. (LO 3) (See Digging Deeper 3.) A value added tax (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.
A national sales tax taxes numerous transactions and is collected on the final sale of goods and services to
the consumer. Consequently, it is collected from the consumer and not the producer of the product as does
a VAT.
In terms of taxpayer compliance, a VAT is preferable to a national sales tax. Without significant
collection efforts, a national sales tax could easily be circumvented or avoided in many ways (e.g.,
resorting to a barter system of doing business).
16. (LO 3) 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,
Nevada, and Texas) levy neither tax.
b. The Federal government imposes an estate tax.
17. (LO 2, 7) Students’ e-mails may vary. Build interaction into the exercise wherever possible, asking
the student to send and receive e-mail in a professional and responsible manner.
18. (LO 2, 7)
a. Madden’s Federal income tax liability is $25,672, computed as follows.
10% × $10,275 $ 1,028
12% × ($41,775 − $10,275) 3,780
22% × ($89,075 − $41,775) 10,406
24% × ($132,650 − $89,075) 10,458
Total Federal income tax $25,672
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,1-6 2023 Essentials of Taxation/Solutions Manual
b. 10%, 12%, 22%, and 24%.
c. 24%.
d. 19.4% ($25,672 ÷ $132,650).
e. 17.6% ($25,672 ÷ $145,600).
19. (LO 3, 4, 6) 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.
20. (LO 2, 7) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that
they are not paying for the donation.
BRIDGE DISCIPLINE PROBLEMS
1. Solutions may vary among students.
2. Solutions may vary among students.
3. Solutions may vary among students.
4. When taxes become “too high,” taxpayers increase the rates of tax cheating, because the payoff from
misconduct increases. Property and transaction taxes are difficult to cheat on, as the tax base is easily
detectible, while cheating on taxes on income and asset transfers may be more easily accomplished,
and enforcement activities by the taxing agency become more expensive. High rates of tax cheating
can lead to several undesirable consequences.
• A “conspicuous consumption” society, wherein taxpayers use their tax underpayments to increase
their lifestyles in a public fashion.
• A loss of confidence in the self-assessment system, such that certain levels of cheating are
assumed to occur, and the number of cheaters increases.
• The “missing revenue” keeps the government from delivering the goods and services that the
taxes are supposed to pay for.
• Political gridlock can occur when it becomes impossible to raise tax rates high enough, or
broaden the tax base enough, to offset the cheaters’ “missing revenue.”
5. 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.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, Introduction to Taxation 1-7
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. An example of a sweetened beverage tax proposal is H.R. 2772 (117th Congress), the SWEET Act.
Proposals also exist in a number of states and cities. Some cities, including Berkeley, California,
Philadelphia, Pennsylvania, and Boulder, Colorado, have already enacted soda taxes. Considerations
in analyzing these proposals include issues of regressivity (an equity and fairness issue), complexity
of definitions, burden of enforcement, and neutrality in affecting decision making. Cook County,
Illinois (Chicago) passed and then repealed a sweetened beverage tax due to a number of these issues.
2. Each of the Big Four firms has information on data analytics and how it can be used for tax purposes:
• pwc.com/us/en/services/tax/tax-innovation.html
• home.kpmg.com/xx/en/home/services/tax/global-indirect-tax/data-and-analytics.html
• ey.com/en_gl/tax/how-data-analytics-is-transforming-tax-administration
• www2.deloitte.com/global/en/pages/technology/articles/making-data-and-analysis-a-
priority.html
Students should also find how the IRS and state tax agencies are using big data to improve
audit selection and enforcement. For example, see IRS, Advance Data & Analytics at:
• irs.gov/about-irs/strategic-goals/advance-data-analytics
3. The Safeguards Rule was created as part of the Gramm-Leach-Bliley Act in 1999 (P.L. 106−102).
The FTC summarizes this rule as follows: “The Safeguards Rule requires financial institutions under
FTC jurisdiction to have measures in place to keep customer information secure. In addition to
developing their own safeguards, companies covered by the Rule are responsible for taking steps to
ensure that their affiliates and service providers safeguard customer information in their care.” This
rule applies to all paid return preparers.
• ftc.gov/enforcement/rules/rulemaking-regulatory-reform-proceedings/safeguards-rule
IRS Publication 4557 includes several actions preparers should take to protect client data and meet
the Safeguards Rule. In reviewing student answers, confirm that they understand the Safeguards Rule
and why a preparer obtaining or renewing a PTIN is asked to confirm that they have a data security
plan. The publication lists numerous actions; consider whether the three actions the student describes
are among the most important.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 2
WORKING WITH THE TAX LAW
SOLUTIONS TO PROBLEM MATERIALS
DISCUSSION QUESTIONS
1. (LO 1) See Exhibit 2.4.
a. The Tax Court must follow its own cases, the pertinent U.S. Circuit Court of Appeals, and the
Supreme Court.
b. The Court of Federal Claims must follow its own decisions, the Federal Circuit Court of
Appeals, and the Supreme Court.
c. The District Court must follow its own decisions, the pertinent U.S. Circuit Court of Appeals,
and the Supreme Court.
2. (LO 1, 3) SWFT, LLP
5191 Natorp Boulevard
Mason, OH 45040
October 20, 2022
Ms. Sonja Bishop
Tile, Inc.
100 International Drive
Tampa, FL 33620
Dear Ms. Bishop:
This letter is in response to your request about information concerning a conflict between
a U.S. treaty with Spain and a section of the Internal Revenue Code (IRC). The major reasons for
treaties between the United States and certain foreign countries is to eliminate double taxation and to
render mutual assistance in tax enforcement.
IRC § 7852(d) provides that if a U.S. treaty is in conflict with a provision in the IRC, neither will take
general precedence. Rather, the more recent of the two will have precedence. In your case, the treaty
with Spain takes precedence over the IRC section.
A taxpayer must disclose on the tax return any positions where a treaty overrides a tax law. There is a
$1,000 penalty per failure to disclose for individuals and a $10,000 penalty per failure to disclose for
corporations.
Should you need more information, feel free to contact me.
Sincerely,
Jeffrey Hanks, CPA
Tax Partner
2-1
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
