Fed Tax 1 Ch 1
Sally and Tom are married, have three dependent children, and file a joint return in 2019. If they have adjusted gross income (AGI) of $ 90 000 and itemized deductions of $ 10 000, what is their taxable income for 2019?
Adjusted gross income $90,000 Minus: Standard deduction (24,400) Taxable income $65,600
If a taxpayer files his or her tax return and receives a tax refund from the IRS, does this mean that the IRS feels that the return is correct and will not be subject to a future audit?
No. It only means the taxpayer has filed a return and received a refund, the IRS may still audit a taxpayer.
Distinguish between taxpaying entities and flow-through entities from the standpoint of the federal income tax law.
Taxpaying entities, such as individuals and C corporations, are required to pay income taxes on their taxable income. Flow-through entities, such as sole proprietorships, partnerships, S corporations, LLCs, LLPs, and certain trusts, generally do not directly pay income taxes on their taxable income but merely pass the income on to a taxpaying entity.
For flow-through entities, such as partnerships, how does the tax law use partner basis adjustments to prevent double taxation of partnership income?
The tax law allows partners to increase their basis in the partnership for any income that is allocated to the partner. Partnership distributions are not subject to taxation if such distributions are less than the partner's basis, so double taxation is prevented.
Why was pay-as-you-go withholding needed in 1943?
The pay-as-you-go withholding was needed in 1943 to avoid significant tax collection problems as the tax base broadened from 6% of the population in 1939 to 74% in 1945. Pay-as-you-go permitted the federal government to deduct taxes directly out of an employee's wages.
The primary objective of the federal income tax law is to raise revenue. What are its secondary objectives?
A. Economic objectives such as stimulating private investment, reducing unemployment, and mitigating the effects of inflation. B. Social and public policy objectives, (e.g. encouraging charitable contributions and discouraging illegal bribes). C. Encouraging certain activities such as research and development and small business investment. D. All of the above Answer
The PDQ Partnership earned ordinary income of $ 150 comma 000 in 2019. The partnership has three equal partners, Pete, Donald, and Quint. Quint, who is single, uses the standard deduction, and has other income of $ 15 comma 000 (not connected with the partnership) in 2019. He receives a $ 30 comma 000 distribution from the partnership during the year. What is Quint's taxable income in 2019?
Allocable share of PDQ Partnership income $50,000 Other taxable income 15,000 Adjusted gross income (AGI) $65,000 Minus: Deductions from AGI: Standard deduction (12,200) Quint's taxable income $52,800
Keith Thomas and Thomas Brooks began a new consulting business on January 1, 2019. They organized the business as a C corporation, KT, Inc. During 2019, the corporation was successful and generated revenues of $ 2 000 000. KT had operating expenses of $ 800 000 before any payments to Keith or Thomas. During 2019, KT paid dividends to Keith and Thomas in the amount of $ 450 000 each. Assume that Keith's wife earned $ 120 000 from her job, they file a joint return, have itemized deductions of $ 40 000, and have no children. (Assume the qualified dividends tax rate is 15%.)
Begin by calculating the tax liability for KT. Gross income $2,000,000.00 Minus: Operating expenses (800,000.00) Taxable income $1,200,000.00 Corporate tax $252,000.00 Compute the tax liability of Keith and his wife. Salary income $120,000.00 Dividend income 450,000.00 Adjusted gross income (AGI) $570,000.00 Minus: Deductions from AGI: Itemized deductions $(40,000.00) Taxable income $530,000.00 Tax on taxable income without dividends (tax rate schedule) $9,317.00 Tax on dividends 67,500.00 Total tax (Individual) $76,817.00 Requirement b. Instead of organizing the consulting business as a C corporation, assume Keith and Thomas organized the business as a limited liability company, KT, LLC. KT made a distribution of $ 450 comma 000 each to Keith and Thomas during 2019. Compute the total tax liability of KT and Keith for 2019. Ignore any and additional tax on net investment income. (If an input field is not used in the table, leave the input field empty; do not select a label or enter a zero. Do not round intermediary calculations. Only round the amounts you enter in the input fields to the nearest cent. Use the tax rate schedule for necessary tax calculations. Enter a "0" for items with a zero balance.) Begin by calculating the tax liability for KT, LLC. Gross income $2,000,000.00 Minus: Operating expenses (800,000.00) Taxable income $1,200,000.00 Corporate tax $0.00 Compute the tax liability of Keith for 2019. Pass-through income from KT, LLC $600,000.00 Salary income 120,000.00 Adjusted gross income (AGI) $720,000.00 Minus: Deductions from AGI: Itemized deductions (40,000.00) Taxable income $680,000.00 Tax on taxable income without dividends (tax rate schedule) $189,740.00 Tax on dividends 0.00 Total tax (Individual) $189,740.00
Carolyn operates a consulting business as a sole proprietor (unincorporated). Carolyn has been approached by one of her major clients to become an employee. If she accepts the new job, she would no longer operate her consulting business. From the standpoint of paying Social Security taxes, would Carolyn's Social Security taxes increase or decrease if she becomes an employee? Why? (Assume Carolyn will earn less than $200,000.)
Decrease. Being self-employed, a self-employment tax is imposed at a 15.3% rate on all of the business income earned in 2019 with a ceiling on the non-hospital insurance (OASDI) portion of the tax base of $ 132 900. Carolyn is also entited to an income tax deduction equal to 50% of the self-employment tax payments. An employee only pays 7.65% of wages paid with an equal amount of tax imposed on the employer.
What is meant by the term "double taxation" of corporations? Choose an example of double taxation using a corporation and shareholder.
Double taxation refers to the taxing of the same income twice. This type of taxation typically results from a C corporation paying tax on its taxable income and shareholders paying income tax on any dividends received from the C corporation. During 2019, Crimson Corporation generated gross income of $ 1 comma 500 comma 000 and had ordinary and necessary deductions of $ 900 comma 000, resulting in taxable income of $ 600 comma 000. Based on the corporation tax rate of 21%, Crimson would be subject to taxes of $ 126 comma 000 ($ 600 comma 000 x 21%). Assume the corporation paid dividends to shareholders during 2019 of $ 400 comma 000. Further assume that the taxable income of the shareholders is such that they pay a tax rate of 15% on qualified dividends. The shareholders collectively would have to pay individual income taxes of $ 60 comma 000 ($ 400 comma 000 x 15%) as the tax rate on qualified dividends is 15%. The total tax on the corporation's taxable income of $ 600 comma 000, therefore, would be $ 186 comma 000 ($ 126 comma 000 paid by Crimson Corporation plus $ 60 comma 000 paid by the shareholders).
Why is a thorough knowledge of sources of tax law so important for a professional person who works in the tax area?
Due to the vast volume of tax law sources, it is impossible for any person to have recall knowledge of the tax law. Thus, the ability to understand what the relevant sources of tax law are, their relative importance, and where to find the sources are vital to a person working in the tax area.
Most estates are not subject to the federal estate tax. a. Why is this the case? b. Should most estates be subject to the federal estate tax? Why or why not?
Most estates are not subject to the federal estate tax because of generous credit and deduction provisions, such as the unified tax credit and the unlimited marital deduction. The unified tax credit equivalent for 2019 is $ 11 400 000. This means that, at a minimum, for decedents dying in 2019, no estate of $ 11 400 000 or less will be subject to the federal estate tax. This is controversial and has proponents on both sides. Some people say "no" because it is considered a double tax. Others say "yes" because they believe in the "ability to pay" principle, based on income or wealth.
Anya is concerned that she will be audited by the IRS. a. Under what circumstances is it possible that the IRS will review each line item on her tax return? b. Is it likely that all items on Anya's return will be audited?
Rarely will the IRS review each line of Anya's return. Audits of individual taxpayers generally focus on selected line items on the return. The audit procedure does not involve a complete audit of all items on the return. No, it is not likely that all items on Anya's return will be audited.
Clay, who was single, died in 2019 and has a gross estate valued at $ 8 500 000. Six months after his death, the gross assets are valued at $ 9 000 000. The estate incurs funeral and administration expenses of $ 125 000. Clay had debts amounting to $ 150 000 and bequeathed all of his estate to his children. During his life, Clay made no taxable gifts.
Requirement a. What is the amount of Clay's taxable estate? (Complete all input fields. Enter a "0" for applicable amounts.) Gross estate $8,500,000 Minus: Funeral and administrative expenses (125,000) Debts (150,000) Taxable estate $8,225,000 Requirement b. What is the tax base for computing Clay's estate tax? (Complete all input fields. Enter a "0" for applicable amounts.) Taxable estate $8,225,000 Plus Gifts after 1976 0 Estate tax base $8,225,000 Requirement c. What is the amount of estate tax owed if the tentative estate tax (before credits) is $ 3 comma 235 800? Estate tax from rate schedule $3,235,800 Minus Unified credit 2019 (4,505,800) Estate tax due $0 Requirement d. Alternatively, if, six months after his death, the gross assets in Clay's estate declined in value to $ 7 500 000, can the administrator of Clay's estate elect the alternate valuation date? What are the important factors that the administrator should consider as to whether the alternate valuation date should be elected? Yes , because the aggregate value of the estate decreased during the six-month period following the date of death, the alternate valuation date may be selected by the administrator. The important factors in deciding whether to use the alternate valuation date are the amount of estate taxes to be saved, and the impact on the beneficiaries income tax situation . Requirement e. How would your answer change in parts a, b, and c if Clay's gross estate was $ 18 500 000 rather than $ 8 500 000 and the tentative estate tax before credits was $ 7 235 800? Part a. Taxable estate $18,225,000 Part b. Tax base $18,225,000 Part c. Estate tax due $2,730,000
Jane and Geoffry are married and file a joint return. They expect to have $ 450 comma 000 of taxable income in the next year and are considering whether to purchase a personal residence that would provide additional tax deductions of $ 45 comma 000 for mortgage interest and real estate taxes.
Requirement a. What is their marginal tax rate for purposes of making this decision? (Enter amounts as percentages to one decimal place.) What is the marginal tax rate if the personal residence is not purchased? 35 % What is the marginal tax rate if the personal residence is purchased? 32 % Requirement b. What is the tax savings if the residence is acquired? (Do not round intermediary calculations. Only round the amounts you input in the cells to the nearest cent.) Tax without purchase of personal residence $107,887.00 Tax with purchase of personal residence 92,233.00 Tax savings $15,654.00
Lauren, a single taxpayer, had the following income and deductions for the tax year 2019:
Salary $61,000 Business income 26,000 Interest income 6,000 Tax-exempt interest income 4,400 Total income from whatever source derived 97,400 Minus: Exclusions, as provided in the tax law Tax-exempt interest income (4,400) Gross income 93,000 Minus: Deductions for Adjusted gross income Business expenses (10,000) Adjusted gross income (AGI) $83,000 Minus: Deductions from AGI: Itemized deductions (19,000) Taxable income $64,000 Tax $9,939 Requirement b. Compute Lauren's marginal, average, and effective tax rates. (Round your answers to two decimal places, X.XX%.) Lauren's marginal tax rate is 22.00 %. Lauren's average tax rate is 15.53 %. Lauren's effective tax rate is 11.37 %. Requirement c. For tax planning purposes, which of the three rates in Part b is the most important? From a tax planning point of view, the marginal rate is the most important rate because it measures the tax saving from each additional $1 of deduction .
What types of taxpayers are more likely to be audited by the IRS?
Select the types of taxpayers are more likely to be audited by the IRS. Filing of a refund claim by a taxpayer who has been previously audited and the audit resulted in a substantial tax deficiency. Individuals who are sole proprietors and incur significant expenses in connection with the trade or business. Individuals who are self-employed with substantial business income or income from a profession such as a medical doctor. Itemized deductions in excess of an average amount for the person's income level.
Carmen has computed that her average tax rate is 16% and her marginal tax rate is 24% for the current year. She is considering whether to make a charitable contribution to her church before the end of the tax year. Which tax rate is of greater significance in measuring the tax effect for her decision? Explain.
The marginal tax rate is of greater significance in measuring the tax effect for Carmen's decision. The marginal tax rate is the percentage that is applied to an incremental amount of taxable income that is added to or subtracted from the tax base. If her marginal tax rate is 24%, she will save 24 cents for every $1 contributed to her church. The average tax rate is simply the total tax liability divided by taxable income.
The Supreme Court in 1895 ruled that the income tax was unconstitutional because the tax needed to be apportioned among the states in proportion to their populations. Why would the requirement of proportionality be so difficult to administer?
This type of tax system would be extremely difficult to administer because different rates of tax would apply to individual taxpayers depending on their states of residence.
Diane, a married taxpayer, makes the following gifts during the current year (2019): $ 30 comma 000 to her church, $ 62 comma 000 to her daughter, and $ 43 comma 000 to her husband. Requirement What is the amount of Diane's taxable gifts for the current year (assuming that she does not elect to split the gifts with her spouse)? (To arrive at taxable gifts, a $ 15 comma 000 annual exclusion is allowed per donee for 2019. Complete all answer boxes. Enter a "0" for any zero amounts.)
Total gift given Taxable gift Gift to daughter $62,000 $47,000 Gift to husband 43,000 0 Contribution to church 30,000 0 Total $135,000 $47,000
Congressman Patrick indicates that he is opposed to tax proposals that call for a flat tax rate because the structure would not tax those individuals who have the ability to pay the tax. Discuss the position of the congressman, giving consideration to tax rate structures (e.g., progressive, proportional, and regressive) and the concept of equity.
Under a progressive tax rate structure, the tax rate increases as the taxpayer's income increases. Under a proportional tax rate or flat tax structure, the same tax rate applies to all taxpayers regardless of their income levels. Under a regressive tax rate structure, the tax rate decreases with an increase income level. The concept of vertical equity holds that taxpayers with higher income levels should pay a higher proportion of tax and that the tax should be borne by those who have the "ability to pay". Thus, Congressman Patrick's opposition to the flat tax is theoretically correct.
Which of the following individuals is most likely to be audited?
a. Connie has a $20,000 net loss from her unincorporated business (a cattle ranch). She also received a $200,000 salary as an executive of a corporation. Connie is most likely to be audited. Individuals who have unincorporated businesses that produce significant tax losses are likely to get audited by the IRS. b. Craig has AGI of $20,000 from wages and uses the standard deduction. Craig is not likely to be audited. c. Dale fails to report $120 of dividends from a stock investment. His taxable income is $40,000 and he has no other unusually large itemized deductions or business expenses. A Form 1099 is reported to the IRS. Dale is not likely to be audited. It is likely that the Form 1099 will be checked against the reported amount and the IRS center will send Dale a bill for the corrected amount of tax.
Many tax professionals have moved into the field of financial planning for their clients. a. How do taxes impact financial planning for a client? b. Why do tax professionals have a perfect opportunity to perform financial planning for their clients?
a. How do taxes impact financial planning for a client? Income taxes may exceed 50% of a taxpayer's income and therefore, are an extremely important part of the financial planning process. Any financial plan that does not carefully consider taxes is a flawed plan. b. Why do tax professionals have a perfect opportunity to perform financial planning for their clients? Tax professionals see their clients at least once a year to prepare their tax returns, which presents a perfect opportunity to perform financial planning.
The three different levels of government (federal, state, and local) must impose taxes to carry out their functions. For each of the types of taxes below, discuss which level of government primarily uses that type of tax. a. Property taxes b. Excise taxes c. Sales taxes d. Income taxes e. Employment taxes
a. Property taxes are primarily used by local government(s) and include both real property taxes and personal property taxes. b. Excise taxes are primarily used by the federal government(s) and are imposed on items such as alcohol, tobacco, telephone usage, and other goods. c. Sales taxes are primarily used by state and local government(s) and constitute a major revenue source. d. Income taxes are the primary domain of the federal and state government(s) and constitute a major revenue source. e. Employment taxes are primarily used by the federal and state government(s) and constitute a major revenue source.
Congressional committee reports are an important source of information concerning the legislative enactment of tax law. a. Name the three Congressional committee reports that are issued in connection with a new tax bill. b. Of what importance are Congressional committee reports to tax practitioners?
a. Select the three Congressional committee reports that are issued in connection with a new tax bill. (Complete all answer boxes.) Ways and Means Committee Joint Conference Committee Senate Finance Committee b. Of what importance are Congressional committee reports to tax practitioners? (Complete all answer boxes.) To explain the new law before the Treasury Department drafts regulations on the tax law changes. To explain the intent of Congress for passing the new law.
What is the statute of limitations for transactions involving: a. Fraud (e.g., failure to file a tax return) b. Disallowance of tax deduction items c. The omission of rental income that is equal to greater than 25% of the taxpayer's reported gross income
a. What is the statute of limitations for transactions involving fraud (e.g., failure to file a tax return). The statute of limitations remains open indefinitely if a fraudulent return is filed or if no return is filed at all. b. What is the statute of limitations for transactions including the disallowance of tax deduction items. The general rule for the disallowance of tax deduction items is that an assessment may be made against the taxpayer within three years from the later of the date the tax return was filed or its due date. c. What is the statute of limitations for transactions involving the omission of rental income that is equal to greater than 25% of the taxpayer's reported gross income. A six year statute of limitations applies if the taxpayer omits an item of gross income that is in excess of 25% of the gross income that is reported on the return.
Why are the gift and estate taxes called wealth transfer taxes? What is the tax base for computing each of these taxes?
Gift and estate taxes are levied when a transfer of wealth (property) takes place and are part of the unified transfer tax system.
Is the principal goal of tax planning to absolutely minimize the amount of taxes that a taxpayer must pay?
No, the principal goal of tax planning is to maximize a taxpayer's after-tax cash flow, not just the minimization of taxes due.
Carlos inherits 100 shares of Allied Corporation stock from his father. The stock cost his father $ 8 000 and had a $ 25 000 FMV on the date of his father's death in 2019. The alternate valuation date was not elected. If Carlos sells the Allied Corporation stock for $ 27 000, what would be his taxable gain on the sale? (Taxable gain = Proceeds of sale - Tax basis of stock sold)
Carlos' taxable gain on the sale of Allied stock is $2,000 .
Limited liability companies (LLCs) are very popular today as a form of organization. Assume a client asks you to explain what this type of organization is all about. Prepare a brief description of the federal income tax aspects of LLCs.
Limited liability companies (LLCs) are generally taxed as partnerships. Therefore, the LLC is not subject to income tax on its taxable income but such income is allocated to the members (owners) of the LLC. Thus, a single-level of taxation is imposed. The same allocation rules that pertain to partnerships also apply to LLCs.
The profession of tax practice involves four principal areas of activity. Discuss these four areas.
Select the four areas of practice and a description of each. Area of practice Description Tax compliance and procedure Tax return preparation and assisting the taxpayer in dealing with the IRS. Tax research Process of developing the most defensibly correct solution to a tax problem. Tax planning Process of reducing taxes so as to maximize a taxpayer's after-tax return. Financial planning Assist clients with planning for all of their financial affairs.
Indicate which of the following taxes are generally progressive, proportional, or regressive:
Tax Type a. State income taxes Progressive b. Federal estate tax Progressive c. Corporate state franchise tax Proportional d. Property taxes Proportional e. State and local sales taxes (when not measured against income) Proportional
What is the tax base for computing each of these taxes?
Tax base for the gift tax is: fair market value of all gifts made in the current year minus an annual donee exclusion of $ 15000 for 2019, minus a marital deduction for gifts to spouse and charitable deduction if applicable, plus the value of all taxable gifts in prior years. The tax base for the estate tax is: the decedent's gross estate, minus deductions for expenses, and a marital or charitable deduction if applicable, plus taxable gifts made after 1976.
The Internal Revenue Code is the most authoritative source of income tax law. In trying to resolve an income tax question, however, a tax researcher also consults administrative rulings (Income Tax Regulations, Revenue Rulings, etc.) and court decisions. Why wouldn't the tax researcher just consult the Code since it is the highest authority? Similarly, why is there a need for administrative rulings and court decisions?
The Code contains general language and does not address the many specific situations and transactions that occur. To resolve tax questions concerning specific situations, administrative rulings and court decisions are an integral part of the income tax law.
Cathy, who is single, makes gifts of $50,000 to each of her two adult children. a. Who is primarily liable for the gift tax on the two gifts, Cathy or the two children? b. If Cathy has never made a taxable gift in prior years, is a gift tax due on the two gifts? (Answer before taking the unified tax credit into account.)
Cathy, the donor, is primarily liable for the gift tax on the two gifts. The children are contingently liable for payment of the gift tax in the event the donor fails to pay. Yes, a gift tax must be considered on the two gifts. She is permitted a $ 15000 annual exclusion for gifts of a present interest to each donee. Since Cathy has never made a taxable gift, no gift tax will be due because of the unified credit that is available.
The governor of your state stated in a recent political speech that he has never supported any income tax increases as the tax rates have remained at the same level during his entire term of office. Yet, you believe that you are paying more tax this year than in previous years even though your income has not increased. How can both you and the governor be correct? In other words, is it possible for the government to raise taxes without raising tax rates?
Yes, it is possible because there are two components in computing a taxpayer's tax, the tax base and the tax rate. Taxes can be raised by increasing either component. Thus, even though the Governor proclaimed that tax rates have remained at the same level, adjustments to the tax base, such as the elimination of deductions, result in tax increases which can be as much, or more, as increases in tax rates.
