Chapter 1 Questions 1-40

Give some examples of the wherewithal to pay concept.

) Examples include like-kind exchanges, involuntary conversions, transfers of property to a controlled corporation, transfers of property to a partnership, and tax-free reorganization.

10. LO.2 In the past, Congress has considered proposals that would allow a taxpayer to claim a tax credit for tuition paid to send a dependent to a private school. Is there any justification for such a proposal? Explain.

) Such a provision might be justified on social considerations because private schools do relieve the public sector of the cost of educating these students. Equity also might serve as a justification since the parents are, in effect, paying twice for the cost of education: first through taxes paid to finance public education and second for the tuition paid to the private school.

If a tax bill is vetoed by the President, the provisions cannot become law. Evaluate this statement

A president's veto can be overridden by a two-thirds vote in both the House and Senate.

9. LO.2 Would the deductibility of political campaign expenditures be contrary to public policy? Explain.

Allowing a deduction for campaign expenditures in excess of campaign contributions, some believe, would encourage the use of a candidate's personal wealth as a means of winning elections.

11. LO.2 Other than raising revenue, what considerations explain various provisions in our tax laws?

Although the major objective of the Federal tax law is the raising of revenue, other considerations explain many provisions. In particular, economic, social, equity, and political factors play a significant role. Added to these factors is the impact the Treasury Department, Internal Revenue Service, and the courts have had and will continue to have on the evolution of Federal tax law.

Nontaxable corporate divisive reorganizations.

By allowing corporations to split or combine (i.e., merge or consolidate) without adverse tax consequences, small corporations are in a position to compete more effectively with larger counterparts.

Have nonrevenue factors had any impact upon the development of our taxation system? If so, how?

Economic, social, equity, and political factors play a significant role in the formulation of tax laws. Furthermore, the IRS and the courts have had impacts on the evolution of tax laws. For example, control of the economy has been an important economic consideration in passing a number of laws (e.g., rapid depreciation, changes in tax rates).

8. LO.2 What purpose is served by the various deductions and credits allowed for education expenses?

Encouraging taxpayers to obtain additional education is socially desirable. It is also desirable to have a well-educated workforce (so it could also fit under economic considerations).

.5 Federal tax legislation generally originates in the Senate Finance Committee. Comment on the validity of this statement

False. Federal tax legislation generally originates in the House of Representatives, where it is first considered by the House Ways and Means Committee. Tax bills can originate in the Senate only when they are attached as riders to other legislative proposals as was the case with the American Taxpayer Relief Act of 2012.

Can recognized gain exceed the realized gain? Explain.

Generally, a recognized (taxable) gain cannot exceed the realized gain.

Taxpayer is in the 10% tax bracket for Federal income tax purposes. The 33% tax bracket.

If the taxpayer is in the 10% tax bracket, one dollar of a deduction for state or local taxes would save ten cents of Federal income tax liability. In the 33% tax bracket, the saving becomes thirty-three cents. The deduction approach (as opposed to the allowance of a credit) favors high bracket taxpayers.

Under the annual accounting period concept, what time period is normally selected for final settlement of most tax liabilities?

One year.

Explain the continuity of interest concept.

Primarily concerned with business readjustments, the continuity of interest concept permits tax-free treatment only if the taxpayer retains a substantial continuing interest in the property transferred to the new business. Due to the continuing interest retained, the transfer should not have tax consequences because the position of the taxpayer has not changed. This concept applies to transfers to controlled corporations (Chapter 4), corporate reorganizations (Chapter 7), and transfers to partnerships (Chapter 10).

The concept of equity is relative. Explain

Reasonable persons can, and often do, disagree about what is fair or unfair. In the tax area, moreover, equity is generally tied to a particular taxpayer's personal situation. For example, the text discusses the difference in tax treatment for taxpayers renting an apartment versus purchasing a house. Another equity difference relates to how a business is organized (i.e., partnership versus corporation). Equity, then, is not what appears fair or unfair to any one taxpayer or group of taxpayers. It is, instead, what the tax law recognizes.

In a like-kind exchange, recognized gain is postponed and not avoided. Explai

Recognition of gain ultimately occurs when the property is disposed of.

Why is there a grace period for contributions to a Keogh retirement plan

Requiring a taxpayer to make a contribution to a Keogh retirement plan by the end of the year would force an accurate determination of net self-employment income long before the income tax return must be prepared and filed.

Why is personal saving desirable for the U.S. economy?

Saving leads to capital formation and thus makes funds available to finance home construction and industrial expansion. For example, the tax laws provide incentives to encourage savings by giving private retirement plans preferential treatment.

Explain how the following tax provisions encourage small businesses: a The nature of a shareholder's loss on a stock investment.

Section 1244 allows ordinary loss treatment on the worthlessness of small business corporation stock. Since such stock normally would be a capital asset, the operation of § 1244 converts a less desirable capital loss into a more attractive ordinary loss. Such tax treatment was designed to aid small businesses in raising needed capital through the issuance of stock.

The tax rate applicable to corporations.

The corporate income tax rates favor those corporations with taxable income under $75,000. On a relative basis, it is the smaller corporations that will benefit the most from the graduated corporate tax rates. Further, the $11,750 in tax savings that result from the graduated rate structure is phased out for corporations with taxable income in excess of $100,000.

A provision of the Code allows a taxpayer a deduction for Federal income tax purposes for state and local income taxes paid. Does this provision eliminate the effect of multiple taxation of the same income? Why or why not? In this connec- tion, consider the following

The deduction allowed for Federal income tax purposes for state and local income taxes is not designed to neutralize the effect of multiple taxation on the same income. At most, this deduction provides only partial relief. Only the allowance of a full tax credit would achieve complete neutrality.

Contrast the tax treatment between a community property state and a common law state

The difference between common law and community property systems centers around the property rights possessed by married persons. In a common law system, each spouse owns whatever he or she earns. Under a community property system, one-half of the earnings of each spouse is considered owned by the other spouse. Assume, for example, Harold and Ruth are husband and wife, and their only income is the $80,000 annual salary Harold receives. If they live in New York (a common law state), the $80,000 salary belongs to Harold. If, however, they live in Texas (a community property state), the $80,000 salary is divided equally, in terms of ownership, between Harold and Ruth.

How does the installment method overcome the harsh treatment of the annual accounting treatment concept

The installment method on the sale of property permits the gain to be recognized over the payout period.

How does the tax law encourage technological progress?

The tax law encourages technological progress by allowing immediate (or accelerated) deductions and tax credits for research and development expenditures.

What purpose is served by allowing a deduction for contributions to qualified charitable organizations?

This deduction can be explained by social considerations. The deduction shifts some of the financial and administrative burden of socially desirable programs from the public (the government) sector to the private (the citizens) sector.

Heather and her partners operate a profitable partnership. Because the busi- ness is expanding, the partners would like to transfer it to a newly created corporation. Heather is concerned, however, over the possible tax consequences that would result from incorporating. Please comment.

Under the general rule, a transfer of a partnership's assets to a new corporation could result in a taxable gain. However, if certain conditions are met, § 351 postpones the recognition of any gain (or loss) on the transfer of property by Heather to a controlled corporation. The wherewithal to pay concept recognizes the inequity of taxing a transaction when Heather lacks the means with which to pay any tax. Besides, Heather's economic position would not change significantly as a result of such a transfer. Heather owned the assets before the transfer and still would own the assets after a transfer to a controlled corporation.

White Corporation lends $425,000 to Blue Corporation with no provision for interest. White Corporation and Blue Corporation are owned by the same share- holders. How might the IRS restructure this transaction with adverse tax consequences?

Under § 482 the IRS has the authority to allocate income and deductions among businesses owned or controlled by the same interests when the allocation is necessary to prevent the evasion of taxes or to clearly reflect the income of each business. Pursuant to § 482, therefore, the IRS might allocate interest income to White Corporation even though none was provided for in the loan agreement.

What is meant by revenue neutrality

When enacting tax legislation, Congress often is guided by the concept of revenue neutrality so that any changes neither increase nor decrease the net revenues raised under the prior rules. Revenue neutrality does not mean that any one taxpayer's tax liability remains the same. Since this liability depends upon the circumstances involved, one taxpayer's increased tax liability could be another's tax saving. Revenue-neutral tax reform does not reduce deficits, but at least it does not aggravate the problem.

Taxpayer, an individual, has itemized deductions that are less than the standard deduction

With the standard deduction, a taxpayer is, indirectly, obtaining the benefit of a deduction for any state or local income taxes he or she may have paid. This is so because the standard deduction is in lieu of itemized deductions, which include the deductions for state and local income taxes.

Assume the same facts as in Question 13. Heather is also worried that once the partnership incorporates, the business will be subject to the Federal corporate income tax. What suggestions do you have

Yes, once incorporated, the business may be subject to the Federal corporate income tax. However, the corporate tax rates might be lower than Heather's individual tax rates, especially if dividends are not paid to Heather.The corporate income tax could be avoided altogether by electing to be an S corporation. An S corporation is generally not taxed at the corporate level; instead, the income flows through the corporate veil and is taxed at the shareholder level. An S election allows a business to operate as a corporation but be taxed like a partnership.

Determine the subparts of § 1563(a)(1)(A).

§ 1563 (a) (1) (A)

List some tax provisions used to deter affluent taxpayers from obtaining preferential tax treatment

• Alternative minimum tax. • Imputed interest rules. • Limitation on the deductibility of interest on investment indebtedness. • Unreasonable accumulated earnings tax. • Personal holding company tax.