Income Tax Chapt 1

Burt and Lisa are married and live in a common law state. Burt wants to make gifts to their four children in 2017. What is the maximum amount of the annual exclusion they will be allowed for these gifts? a. $112,000 b. $56,000 c. $14,000 d. $28,000 e. None of these choices are correct.

a. $112,000 4 (number of donees) × $14,000 (annual exclusion) × 2 (number of donors) = $112,000. It is assumed that Lisa will make the election to split the gifts.

Which, if any, of the following statements best describes the history of the Federal income tax? a. It did not exist during the Civil War. b. The Federal income tax on individuals was held by the U.S. Supreme Court to be allowable under the U.S. Constitution. c. The Federal income tax on corporations was held by the U.S. Supreme Court to be allowable under the U.S. Constitution. d. Both the Federal income tax on individuals and on corporations was held by the U.S. Supreme Court to be contrary to the U.S. Constitution. e. None of these choices are correct.

c. The Federal income tax on corporations was held by the U.S. Supreme Court to be allowable under the U.S. Constitution.

Provisions in the tax law that promote energy conservation and more use of alternative (non-fossil) fuels can be justified by: a. Economic and social considerations. b. Encouragement of small business. c. Political considerations. d. Promoting administrative feasibility. e. None of these choices are correct.

a. Economic and social considerations. Although it may be "good politics" to promote measures that ease the problem of global warming ("Political considerations"), the real justification is economic (curtail dependence on foreign oil) and social (reduce pollution)—"Economic and social considerations" The encouragement of small business ("Encouragement of small business") is a byproduct of these conservation provisions, but is not their justification.

Which of the following is a characteristic of the audit process? a. Less important issues are handled by means of a correspondence audit. b. Most taxpayer audits involve "special" agents. c. Self-employed taxpayers are less likely to be selected for audit than employed taxpayers. d. If a taxpayer disagrees with the IRS auditor's finding, the only resort is to the courts. e. None of these choices are correct.

a. Less important issues are handled by means of a correspondence audit. Special agents are assigned to an audit only when fraud might be involved ("Most taxpayer audits involve "special" agents"). Self-employed persons have more flexibility in manipulating income and deductions than do employed taxpayers ("Self-employed taxpayers are less likely to be selected for audit than employed taxpayers"). The next step after an initial audit would be the Appeals Division within the IRS ("If a taxpayer disagrees with the IRS auditor's finding, the only resort is to the courts"). Settlement at this level could avoid costly litigation.

Taxes levied by all states include: a. Tobacco excise tax. b. Individual income tax. c. Inheritance tax. d. General sales tax. e. None of these choices are correct.

a. Tobacco excise tax. All states impose a tobacco excise tax ("Tobacco excise tax"). Most states impose individual income taxes ("Individual income tax") and general sales taxes ("General sales tax"), and only some states impose inheritance taxes ("Inheritance tax").

David files his tax return 45 days after the due date. Along with the return, David remits a check for $40,000 which is the balance of the tax owed. Disregarding the interest element, David's total failure to file and to pay penalties are: a. $400 b. $4,000 c. $4,400 d. $3,600 e. None of these choices are correct.

b. $4,000 Following the procedure identified in Example 20, the penalty is determined as follows: Failure to pay penalty [0.5% × $40,000 × 2 (two months violation)] $ 400 Plus: Failure to file penalty [5% × $40,000 × 2 (two months violation)] $4,000 Less: Failure to pay penalty (400) Failure to file penalty; 3,600 Total penalties

Which, if any, of the following transactions will increase a taxing jurisdiction's revenue from the ad valorem tax imposed on real estate? a. A resident dies and leaves his farm to his church. b. A tax holiday issued 10 years ago has expired. c. A bankrupt motel is acquired by the Red Cross and is to be used to provide housing for homeless persons. d. A large property owner issues a conservation easement as to some of her land. e. None of these choices are correct.

b. A tax holiday issued 10 years ago has expired. Although a farm was probably subject to reduced valuation (due to its agricultural use), it will now be fully exempt since it is owned by a church ("A resident dies and leaves his farm to his church"). Property that is subject to a conservation easement is usually appraised at a lower value ("A large property owner issues a conservation easement as to some of her land"). The expiration of a tax holiday means that the property involved can now be taxed ("A tax holiday issued 10 years ago has expired"). The motel has been converted from business property to exempt charitable use ("A bankrupt motel is acquired by the Red Cross and is to be used to provide housing for homeless persons").

Allowing a domestic production activities deduction for certain manufacturing income can be justified: a. Based on the wherewithal to pay concept. b. By economic considerations. c. As mitigating the effect of the annual accounting period concept. d. As promoting administrative feasibility. e. None of these choices are correct.

b. By economic considerations. The deduction will encourage U.S. manufacturing. It also will lead to job growth and discourage the outsourcing of labor to overseas.

A characteristic of FUTA is that: a. It is applicable to spouses of employees but not to any children under age 18. b. Compliance requires following guidelines issued by both state and Federal regulatory authorities. c. It is imposed solely on the employee. d. It is imposed on both employer and employee. e. None of these choices are correct.

b. Compliance requires following guidelines issued by both state and Federal regulatory authorities. FUTA is imposed only on the employer ("It is imposed on both employer and employee" and "It is imposed solely on the employee"). "It is applicable to spouses of employees but not to any children under age 18" refers to FICA. Because the administration of FUTA is shared by Federal and state governments, employers must comply with the rules issued by each ("Compliance requires following guidelines issued by both state and Federal regulatory authorities").

A VAT (value added tax): a. Is not a tax on consumption. b. Is regressive in its effect. c. Has not proved popular outside of the U.S. d. Is used exclusively by third world (less developed) countries. e. None of these choices are correct.

b. Is regressive in its effect. Both the VAT and a general sales tax are taxes on consumption ("Is not a tax on consumption") and are regressive in effect ("Is regressive in its effect"). The VAT has been adopted by many countries ("Has not proved popular outside of the U.S".), many of which (e.g., Japan, Denmark) are not third world countries ("Is used exclusively by third world (less developed) countries").

Which, if any, of the following is a typical characteristic of an ad valorem tax on personalty? a. Taxpayer compliance is greater for personal use property than for business use property. b. The tax on automobiles sometimes considers the age of the vehicle. c. The tax on intangibles generates considerable revenue since it is difficult for taxpayers to avoid. d. Most states impose a tax on intangibles. e. None of these choices are correct.

b. The tax on automobiles sometimes considers the age of the vehicle. Taxpayer compliance is greater with business use property ("Taxpayer compliance is greater for personal use property than for business use property"). Very few states impose a tax on intangibles ("Most states impose a tax on intangibles") because it is easily avoided and does not generate much revenue ("The tax on intangibles generates considerable revenue since it is difficult for taxpayers to avoid").

Calculator Regarding proper ethical guidelines, which, if any, of the following is correct? a. If the exact amount of a deduction is not certain (e.g., around mid-$600s), it should be recorded as an odd amount (i.e., $649) so as to increase the appearance of greater certainty. b. The use of client estimates in preparing a return may be acceptable. c. If a client has made a mistake in a prior year's return and refuses to correct it, you should withdraw from the engagement. d. Under no circumstances should a question on a tax return be left unanswered. e. None of these choices are correct.

b. The use of client estimates in preparing a return may be acceptable. In some cases, the use of client estimates is acceptable ("The use of client estimates in preparing a return may be acceptable"), but they should not give the appearance of certainty ("If the exact amount of a deduction is not certain (e.g., around mid-$600s), it should be recorded as an odd amount (i.e., $649) so as to increase the appearance of greater certainty"). Questions can be left blank if their meaning is uncertain or the answer is not readily available or voluminous ("Under no circumstances should a question on a tax return be left unanswered"). Withdrawal is not necessary if the error is not material or does not have a carryover effect on the current year return ("If a client has made a mistake in a prior year's return and refuses to correct it, you should withdraw from the engagement").

Calculator Property can be transferred within the family group by gift or at death. One motivation for preferring the gift approach is: a. To shift income to higher bracket donees. b. To take advantage of the per donee annual exclusion. c. To avoid a future decline in value of the property transferred. d. To take advantage of the higher unified transfer tax credit available under the gift tax. e. None of these choices are correct.

b. To take advantage of the per donee annual exclusion The per donee annual exclusion is only available for gift tax purposes ("To take advantage of the per donee annual exclusion"). Ideally, gifts should involve property that is expected to appreciate in value ("To avoid a future decline in value of the property transferred"). A higher unified tax credit is not available for gift tax purposes ("To take advantage of the higher unified transfer tax credit available under the gift tax"). Usually the donor is trying to shift future income to lower bracket donees ("To shift income to higher bracket donees").

The proposed flat tax: a. Would eliminate the income tax. b. Would simplify the income tax. c. Is a tax on consumption. d. Would tax the increment in value as goods move through the production and manufacturing stages to the marketplace. e. None of these choices are correct.

b. Would simplify the income tax. There is only a single rate. The tax base is simplified by taxing only limited types of income. Many deductions and credits would be eliminated.

Which, if any, of the following transactions will decrease a taxing jurisdiction's ad valorem tax revenue imposed on real estate? a. A public school is razed and turned into a city park. b. A local university sells a dormitory that will be converted for use as an apartment building. c. A tax holiday is granted to an out-of-state business that is searching for a new factory site. d. An abandoned church is converted to a restaurant. e. None of these choices are correct.

c. A tax holiday is granted to an out-of-state business that is searching for a new factory site. "A tax holiday is granted to an out-of-state business that is searching for a new factory site" has an effect since the tax holiday was granted. "An abandoned church is converted to a restaurant" will increase taxes as the church was abandoned and previously exempt. "A public school is razed and turned into a city park" converts one tax-exempt property (i.e., school) into another (i.e., public park). "A local university sells a dormitory that will be converted for use as an apartment building" probably places the building on the tax rolls because it is no longer owned by a tax-exempt institution.

Characteristics of the "Fair Tax" (i.e., national sales tax) include which, if any, of the following: a. Abolition of the Federal individual (but not the corporate) income tax. b. Abolition of all Federal income taxes and payroll taxes but retention of the Federal estate and gift taxes. c. Abolition of all Federal income and payroll taxes as well as the Federal estate and gift taxes. d. Abolition of all Federal income taxes but retention of payroll taxes (including the self-employment tax). e. None of these choices are correct.

c. Abolition of all Federal income and payroll taxes as well as the Federal estate and gift taxes.

Social considerations can be used to justify: a. Allowing a Federal income tax deduction for state and local sales taxes. b. Allowing excess capital losses to be carried over to other years. c. Allowance of a credit for child care expenses. d. Allowing accelerated amortization for the cost of installing pollution control facilities. e. None of these choices are correct.

c. Allowance of a credit for child care expenses. Equity considerations justify "Allowing excess capital losses to be carried over to other years" and "Allowing a Federal income tax deduction for state and local sales taxes", and economic considerations justify "Allowing accelerated amortization for the cost of installing pollution control facilities".

A use tax is imposed by: a. All states and not the Federal government. b. The Federal government and a majority of the states. c. Most of the states and not the Federal government. d. The Federal government and all states. e. None of these choices are correct.

c. Most of the states and not the Federal government. A use tax is a complement to a general sales tax. Consequently, it is imposed by most states because only a few states do not have a general sales tax. At this point, the Federal government has no general sales tax.

Which, if any, is not one of Adam Smith's canons (principles) of taxation? a. Certainty b. Equality c. Simplicity d. Economy in collection e. Convenience of payment

c. Simplicity

Which, if any, of the following taxes are proportional (rather than progressive)? a. Federal gift tax b. Federal estate tax c. State general sales tax d. Federal corporate income tax e. All of these choices are correct.

c. State general sales tax Sales taxes are applied at a constant rate that does not progress.

Taxes not imposed by the Federal government include: a. Gas guzzler tax. b. Customs duties (tariffs on imports). c. Tax on rental cars. d. Tobacco excise tax. e. None of these choices are correct.

c. Tax on rental cars. The Federal government imposes an excise tax on tobacco ("Tobacco excise tax"), customs duties ("Customs duties (tariffs on imports)"), and a gas guzzler tax ("Gas guzzler tax"). It does not impose a tax on rental cars ("Tax on rental cars").

Indicate which, if any, statement is incorrect. State income taxes: a. Can piggyback to the Federal version. b. Can decouple from the Federal version. c. Can provide occasional amnesty programs. d. Cannot apply to visiting nonresidents. e. None of these choices are correct.

d. Cannot apply to visiting nonresidents. Many states piggyback to the Federal system ("Can piggyback to the Federal version"). Some states, due to revenue shortfalls, have decoupled from various provisions of the Federal version ("Can decouple from the Federal version"). The "jock tax," although much criticized, is very much in being ("Cannot apply to visiting nonresidents"). Some states have had more than one amnesty period ("Can provide occasional amnesty programs").

A characteristic of the fraud penalties is: a. The IRS has the same burden of proof in the case of criminal fraud than with civil fraud. b. The criminal fraud penalty is 75% of the deficiency attributable to the fraud. c. When negligence and civil fraud apply to a deficiency, the negligence penalty predominates. d. Criminal fraud can result in a fine and a prison sentence. e. None of these choices are correct.

d. Criminal fraud can result in a fine and a prison sentence. "Criminal fraud can result in a fine and a prison sentence" describes criminal fraud, while "The criminal fraud penalty is 75% of the deficiency attributable to the fraud" describes civil fraud. When both negligence and civil fraud exists as to the same deficiency, both penalties cannot apply and the civil fraud penalty predominates ("When negligence and civil fraud apply to a deficiency, the negligence penalty predominates"). In the case of criminal fraud, the IRS must also show willfulness on the part of the taxpayer ("The IRS has the same burden of proof in the case of criminal fraud than with civil fraud").

The U.S. (either Federal, state, or local) does not impose: a. Occupational fees. b. Severance taxes. c. Franchise taxes. d. Export duties. e. Custom duties.

d. Export duties.

In terms of probability, which of the following taxpayers would be least likely to be audited by the IRS? a. Taxpayer just won a $1 million slot machine jackpot at a Las Vegas casino. b. Taxpayer owns and operates a check-cashing service. c. Taxpayer has been audited several times before. d. Taxpayer is an employed electrician. e. Taxpayer just received a $3 million personal injury award as a result of a lawsuit.

d. Taxpayer is an employed electrician. Employees are subject to income tax withholding and have little opportunity to avoid reporting income ("Taxpayer is an employed electrician"). Casino gambling income is subject to Form 1099 reporting ("Taxpayer just won a $1 million slot machine jackpot at a Las Vegas casino").

State income taxes generally can be characterized by: a. Applying only to individuals and not applying to corporations. b. Allowance of a deduction for Federal income taxes paid. c. No provision for withholding procedures. d. The same date for filing as the Federal income tax. e. None of these choices are correct.

d. The same date for filing as the Federal income tax.

Both economic and social considerations can be used to justify: a. Allowance of a deduction for state and local income taxes paid. b. Disallowance of any deduction for expenditures deemed to be contrary to public policy (e.g., fines, penalties, illegal kickbacks, bribes to government officials). c. Favorable tax treatment for accident and health plans provided for employees and financed by employers. d. Various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. e. None of these choices are correct.

d. Various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education.

Federal excise taxes that are no longer imposed include: a. Tax on alcohol. b. Tax on the manufacture of sporting equipment. c. Tax on air travel. d. Tax on wagering. e. None of these choices are correct.

e. None of these choices are correct.

Taxes levied by both states and the Federal government include: a. Custom duties. b. General sales tax. c. Hotel occupancy tax. d. Franchise tax. e. None of these choices are correct.

e. None of these choices are correct. "General sales tax", "Hotel occupancy tax", and "Franchise tax" are levied at the state or local level. "Custom duties" is strictly a Federal levy.

A characteristic of FICA is that: a. It is administered by both state and Federal governments. b. It is imposed only on the employer. c. It provides a modest source of income in the event of loss of employment. d. It does not apply when one spouse works for the other spouse. e. None of these choices are correct.

e. None of these choices are correct. FICA is imposed on both the employer and the employee ("It is imposed only on the employer"). Spouses who work for each other are not exempt from the tax ("It does not apply when one spouse works for the other spouse"). Its objective is retirement income, not loss of employment ("It provides a modest source of income in the event of loss of employment"). It is administered only by the Federal government ("It is administered by both state and Federal governments").