Tax Midterm Chapter 1

1)In the following independent situations, is the tax position of the taxpayer likely to change? Explain why or why not. a.John used to make casual purchases and sales of real estate as an investor. Currently, he does so on a regular basis and has obtained a license as a dealer. b.Theresa quit her job as a staff accountant and has established her own practice as a CPA. c.After saving enough for a down payment, Paul has purchased a personal residence.

(LO 1) a.By becoming a dealer, any gains and losses John has are converted from capital to ordinary classification. b.Theresa has become self-employed. Now she will be subject to self-employment tax and will have to make quarterly installment payments of estimated income and payroll taxes. c.Due to the home mortgage interest deduction and property tax deduction, most new home- owners will itemize their deductions from AGI. Thus, Paul probably will no longer claim the standard deduction on his income tax return.

2)Marvin is the executer and sole heir of his aunt's estate. The estate includes her furnished home, which Marvin is considering converting to rental property to generate additional cash flow. What are some of the tax problems Marvin may confront?

(LO 1) The income tax consequences that result are Marvin's principal concern. Any rent he receives is taxed as income, but operating expenses and depreciation will generate deductions that offset some or all of the income or even yield a loss. Marvin must also consider the effect of other taxes. Because the property is being converted from residential to commercial use, he can expect an increase in the ad valorem property taxes levied by the local (and perhaps even the state) taxing authorities. Besides the real estate taxes, personal property taxes could be imposed on the furnishings.

5)How does the pay-as-you-go procedure apply to wage earners? To persons who have income from sources other than wages?

(LO 2) For wage earners, the tax law requires employers to withhold a specified dollar amount from wages paid to the employee to cover income taxes and payroll taxes. Persons with nonwage income generally are required to make quarterly payments to the IRS for estimated taxes. Both procedures ensure that taxpayers will be financially able to meet their annual tax liabilities. That is, the amounts withheld are meant to prepay the employee's income taxes and payroll taxes related to the wages earned.

3)The sixteenth amendment to the U.S. Constitution was passed to overturn a Supreme Court decision that had invalidated the Federal income tax. Do you agree? Why or why not?

(LO 2) The statement is only partly correct. The Federal income tax on corporations was not a problem as it had previously been sanctioned by the Supreme Court. What had been declared unconstitutional was the tax on individuals as it applied to the income from property.

4)World war II converted the Federal income tax into a mass tax. Explain.

(LO 2) To finance our participation in World War II, the scope of the income tax was expanded considerably—from a limited coverage of 6% to over 74% of the population. Hence, the description of the income tax as being a "mass tax" became appropriate.

7)Distinguish between taxes that are proportional and those that are progressive.

(LO 3) A tax is proportional if the rate of tax remains constant for any given income level. The tax is progressive if a higher rate of tax applies as the tax base increases.

6)Using Adam Smith's canon on economy, evaluate the federal income tax.

(LO 3) 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.

34)Both a value added tax (VAT) and a national sales tax have been criticized as being regressive in their effect. a.Explain. b.How could this shortcoming be remedied in the case of national sales tax?

(LO 4) a.Both the national sales tax and the VAT are taxes on consumption. Both taxes impose more of a burden on low-income taxpayers who must spend a larger proportion of their incomes on essential purchases. Thus, the taxes are regressive in effect. b.At least in the case of a national sales tax, the regressive effect might be partly remedied by granting some sort of credit, rebate, or exemption to low-income taxpayers.

29)Contrast FICA and FUTA as to do the following: a.Purpose of the tax. b.Upon whom imposed. c.Governmental administration of the tax. d.Reduction of tax based on a merit rating system.

(LO 4) a.FICA offers some measure of retirement security, and FUTA provides a modest source of income in the event of loss of employment. b.FICA is imposed on both employer and employee, while FUTA is imposed only on the employer. c.FICA is administered by the Federal government. FUTA, however, is handled by both the Federal and state government. d.This applies only to FUTA. The merit system rewards employers who have low employee turnover, because this reduces the payout of unemployment benefits.

23)As to those states that impose an income tax, comment on the following" a."Piggyback" approach and possible "decoupling" from this approach. b.Deductibility of Federal income taxes. c.Credit for taxes paid to other states.

(LO 4) a.For state income tax purposes, "piggyback" means making use of what was done for Federal income tax purposes. By "decoupling," a state decides not to allow a particular Federal provision (e.g., exclusion, deduction, credit) for state income tax purposes. b.A diminishing number of states allow a deduction for Federal income taxes paid. c.Most states allow their residents some form of tax credit for income taxes paid to other states.

10) The commissioners for Walker county are actively negotiating with Falcon Industries regarding the location of a new manufacturing plant in the area. As Falcon is considering several other sites, a "generous tax holiday" may be needed to influence the final choice. The local school district is opposed to any "generous tax holiday." a.What would probably be involved in a generous tax holiday? b.Why would the school district be opposed?

(LO 4) a.In this case, the "tax holiday" probably concerns exemption from ad valorem taxes. "Generous" could involve an extended period of time (e.g., 10 years) and include both realty and personalty. b.The school district could be affected in two ways. First, due to the erosion of the tax base, less revenue would be forthcoming. Second, new workers would mean new families and more children to educate.

16) The Gray's live in Clay County, which is adjacent to Jackson County. Although the retail stores in both counties are comparable, the Gray's usually drive a few extra miles to shop in Jackson County. As to why the Gray's might do this, consider the following: a.Clay County is in a different state than Jackson County. b.Clay County and Jackson County are in the same state.

(LO 4) a.Jackson County must be in a state that imposes a lower (or no) sales tax. With certain major purchases (i.e., big-ticket items), any use tax imposed by the state of the Grays' residence could come into play. b.In some states, the sales tax rate varies depending on the county and/or city.

32)Describe the nature and purpose of the following taxes; a.Severance taxes. b.Franchise taxes. c.Occupational fees. d.Customs duties. e.Export duties.

(LO 4) a.Severance taxes are transaction taxes that are based on the notion that the state has an interest in its natural resources. The tax is imposed on the extraction of minerals. b.Franchise taxes are levied on the right to do business in the state. Typically, they are imposed on corporations and are based on their capitalization. c.Occupational fees are applicable to trades or businesses and are licenses to practice. Most are not significant revenue producers, and the amounts collected are utilized to defray the cost of regulating the profession. d.Customs duties are taxes on the importation of certain foreign goods. They are imposed by the Federal government and are not found at the state and local level. e.Export duties are taxes imposed on the export of certain commodities (e.g., oil, coffee). They are common to less-developed nations and are not levied by the United States.

8)Several years ago Ethan purchased the former parsonage of St. James Church to use a personal residence. To date, Ethan has not received any ad valorem property tax bills from either city or the county tax authorities. a.What is a reasonable explanation for this oversight? b.What should Ethan do?

(LO 4) a.The parsonage probably was not listed on the property tax rolls because it was owned by a tax-exempt church. Apparently, the taxing authorities are not aware that ownership has changed. b.Ethan should notify the authorities of his purchase. This will force him to pay back taxes but will eliminate future interest and penalties.

20)Address the following issues: a.What is the purpose of the unified transfer tax credit? b.Is the same amount available for both the Federal gift tax and the estate tax? Explain. c.Does the use of the credit for a gift affect the amount of credit available for the estate tax? Explain.

(LO 4) a.The purpose of the unified transfer tax credit is to eliminate the tax on all but substantial gifts and estates. b.Yes. The credit for 2016 is $2,125,800; for 2015, it is $2,117,800. c.Yes. The credit is available to cover transfers by gift or by death (or both), but the amount can be used only once.

28)Many states have occasionally adopted amnesty programs that allow taxpayers to pay back taxes with reduced penalties. a.Besides the revenue generated, how are these programs advantageous? b.Could an amnesty program be used by a state that does not levy an income tax? c.Does the IRS utilize this approach?

(LO 4) a.They uncover taxpayers who were previously unknown to the taxing authority. b.Amnesty provisions can apply to other than income taxes (e.g., sales, franchise, severance). c.As of yet, no general amnesty program has been offered for the Federal income tax.

30)In connection with the Medicate component of FICA, comment on the following: a.Any dollar limitation imposed. b.The applicability of the .9% increase in the 1.45% regular tax rate.

(LO 4) a.Unlike the Social Security portion of FICA, there is no dollar limit on the imposition of the Medicare tax. b.The .9% Medicare addition applies to taxpayers with wages or net self-employment income in excess of $200,000 ($250,000 for married filing jointly).

21)Elijah and Anastasia are husband and wife who have five married children and nine minor grandchildren. For 2016, what is the maximum amount they can give to their family (including the sons- and daughters-in-law) without using any of their unified transfer tax credit?

(LO 4) $532,000. 19 donees (5 married children + 5 spouses + 9 grandchildren) × $14,000 (annual exclusion for 2016) × 2 donors (Elijah and Anastasia) = $532,000.

11)Sophia lives several blocks from her parents in the same residential subdivision. Sophia is surprised to learn that her ad valorem property taxes for the year were raised, while those of her parents were lowered. What is the possible explanation for the difference?

(LO 4) A possible explanation could be 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) The Adam's independent School district wants to sell a parcel of unimproved land that it does not need. Its three best offers are as follows: from the state's Department of Public Safety (DPS), $2.3 Million; from the Second Baptist Church, $2.2 Million; and Baker Motors, $2.1 Million. DPS would use the property for a new state highway patrol barracks, Second Baptist would start a church school, and Baker would open a car dealership. If you are the financial advisor for the school district, which offer would you prefer? Why?

(LO 4) Although the Baker Motors bid is the lowest, from a long-term financial standpoint, it is the best. The proposed use of the property by the state and the church probably will make it exempt from the school district's ad valorem tax. This would hardly be the case with a car dealership. In fact, commercial properties (e.g., car dealerships) often are subject to higher tax rates.

15)What is the difference between an excise tax and a general sales tax? a.Do all states impose a general sales tax? b.Does the federal government impose a general sales tax?

(LO 4) An excise tax is limited to a particular transaction (e.g., sale of gasoline), while a general sales tax covers a multitude of transactions (e.g., sale of all nonfood goods). a.The following states do not impose a general sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. b.There is no Federal general sales tax.

22)What is the difference between the federal income tax on individuals and that imposed on corporations?

(LO 4) Both taxes are progressive in nature, but the corporate income tax does not make any distinction as to deductions—only business deductions are allowed. Nor does it require the computation of adjusted gross income (AGI) or provide for the standard deduction and personal and dependency exemptions.

43)For tax year 2013, the IRS assesses a deficiency against David for $500,000. Disregarding the interest component, what is David's penalty if the deficiency is attributable to: a.Negligence? b.Fraud?

(LO 5) a.$100,000 (20% × $500,000). b.$375,000 (75% × $500,000). The answer presumes that civil (not criminal) fraud is involved.

17)During a social event, Muriel and Earl are discussing the home computer each recently purchased. Although the computers are identical makes and models, Muriel is surprised to learn that she paid a sales tax, while Earl did not. Comment as to why this could happen. a.Do some states impose both? Neither? b.Which, if either, does the Federal government impose?

(LO 4) Earl probably purchased his computer out of state through a catalog or via the Internet. In such cases, state collection of the sales (use) tax is not likely.

14)After his first business trip to a major city, Herman is alarmed when he reviews his credit card receipts. Both the hotel bill and the car rental charge are in excess of the price he was quoted. Was Herman overcharged, or is there an explanation for the excess amounts?

(LO 4) Herman could have been overcharged, but at least part of the excess probably is attributable to a hotel occupancy tax and a car rental tax. In major cities, these types of excise taxes have become a popular way of financing capital improvements such as sports arenas and stadiums. Consequently, the amount of the taxes could be significant.

25)Mike Barr was an outstanding football player in college and expects to be drafted by the NFL in the first few rounds. Mike has let it be known that he would prefer to sign with a club located in Florida, Texas or Washington. Mike sees no reason why he would have to pay state income tax on his player's salary. Is Mike under any delusions? Explain.

(LO 4) If Mike is drafted by a team in one of the listed states, he will escape state income tax on income earned within that state (e.g., training camp, home games). He will not, however, escape the income tax (state and local) imposed by jurisdictions where he plays away games. Called the "jock tax," it is applied to out-of-state athletes and entertainers.

18)Distinguish between an estate tax and an inheritance tax. a.Do some states impose both? Neither? b.Which, if either, does the Federal government impose?

(LO 4) If the tax is imposed on the right to pass property at death, it is classified as an estate tax. If it taxes the right to receive property from a decedent, it is termed an inheritance tax. a.Some states impose both an estate tax and an inheritance tax. Some states (e.g., Florida and Texas) levy neither tax. b.The Federal government imposes an estate tax.

19)Jake (age 72) and Jessica (age 28) were recently married. To avoid any transfer taxes, Jake has promised to leave Jessica all of his wealth when he dies. Is Jake under some misconception about the operation of the Federal gift and estate taxes? Explain.

(LO 4) Jake either has a severe misunderstanding as to the rules regarding transfer taxes or is lying to Jessica to delay any parting with his wealth. The marital deduction allows interspousal transfers (whether by gift or at death) free of any tax (either gift or estate). There is no tax reason, therefore, in the case of spousal transfers to prefer transfers at death over lifetime gifts.

31)One of the tax advantages of hiring family members to work in your business is that FICA taxes are avoided. Do you agree with this statement? Explain.

(LO 4) Only children under age 18 are excluded from FICA. Other family members, including spouses, must be covered.

12)The Morgan family lives in Massachusetts. They moor their sailboat in Rhode Island. What might be a plausible reason for the possible inconvenience?

(LO 4) Presuming that the dockage facilities are comparable in Massachusetts, the Morgans may be trying to avoid ad valorem taxes. Taxes on nonbusiness personalty vary from one state to another and are frequently avoided.

27)Many state income tax returns contain checkoff boxes that allow taxpayers to make donations to a multitude of local charitable causes. On what grounds has this procedure been criticized?

(LO 4) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that they are not paying for the donation.

13)Is the breadth and number of Federal excise taxes increasing or decreasing? Explain.

(LO 4) Until recently, it appeared that Federal excise taxes had declined significantly as to the number of transactions covered. Taxes on the sale of jewelry, leather goods, cosmetics, and admission to entertainment events are no longer taxed by the Federal government. But the enactment of the gas guzzler tax and the tax on tanning salons, in addition to the increase in the tax on tobacco products, seems to indicate an expansion of excise taxes at the Federal level.

24)In May 2016, Hernando, a resident of California, has his 2014 Federal income tax return audited by the IRS. An assessment of additional tax is made because he had inadvertently omitted some rental income. In October 2016, California audits his state return for the same year. Explain the coincidence.

(LO 4) What happened here likely is not a coincidence. The IRS probably notified the state of California regarding Hernando's omission of income. Thus, California followed up with its own audit.

35)Serena operates a lawn maintenance service in Southern California. As most of her employees are itinerant, they are paid on a day-to-day basis. Because of cash-flow problems, Serena requires her customers to pay cash for the services she provides. a.What time some of the tax problems Serena might have? b.Assess Serena's chances of audit by the IRS. c.A "no change" RAR results. d.A special agent joins the audit team.

(LO 4, 5) a.Due to the location of the business and the fact that the employees are "itinerant," Serena may be hiring undocumented aliens. Needless to say, this could cause serious nontax problems involving employment and immigration laws. As to tax problems, is Serena complying with the FICA and income tax withholding rules? Because of the high labor turnover Serena probably has, FUTA costs could be severe. b.Very high. First, Serena is self-employed. Second, she operates on a cash basis. Third, the opportunity to understate income and/or overstate expenses is extremely high.

26)A question on a state income tax return asks the tax payer if he or she made any out-of-state Internet or mail-order catalog purchases during the year. The question requires a yes or no answer, and if the taxpayer answers yes, the amount of such purchases is to be listed. a.Does such an inquiry have any relevance to the state income tax? If not, why is it being asked? b.Your client, Harriet, wants to leave the question unanswered. As the preparer of her return, how do you respond?

(LO 4, 5) a.This type of question has no relevance to the state income tax, but is a less than subtle way of encouraging taxpayers to pay any use tax due on Internet and mail-order purchases. b.As the preparer of the state income tax return, you should not leave questions unanswered unless there is a good reason for doing so. It appears that Harriet has no justifiable reason.

36)With regard to the IRS audit process, comment on the following: a.The audit is resolved by mail. b.The audit is conducted at the office of the IRS. c.A "no change" RAR results. d.A special agent joins the audit team.

(LO 5) a.A correspondence audit is probably involved. These audits involve a limited number of issues (i.e., taxpayer failed to report some dividend income) and most often are easily resolved. b.What is described is an office audit. c.The revenue agent's report (RAR) accepts the taxpayer's return as filed. d.When a special agent becomes involved, this usually means that fraud is suspected.

39)Regarding the statute of limitations on additional assessments of tax by the IRS, determine the applicable period in each of the following situations. Assume a calendar year individual with no fraud or substantial omission involved. a.The income tax return for 2015 was filed on February 19, 2016. b.The income tax return for 2015 was filed on June 25th, 2016. c.The income tax return for 2015 was prepared on April 4th, 2016, but was never filed. Through some misunderstanding between the preparer and the taxpayer, each expected the other to file the return. d.The income tax return for 2015 was never filed because the taxpayer thought no additional tax was due.

(LO 5) a.The normal three-year statute of limitations will begin to run on April 15, 2016. When the return is filed early, the regular filing date controls. b.Now the statute of limitations starts to run on the filing date. If the date of filing controlled (see part a. above), the taxpayer could shorten the assessment period by filing late. c.If a return that is due is not filed, the statute of limitations does not start to run. It does not matter that the failure to file was due to an innocent error on the part of the taxpayer or adviser. d.Regardless of the fact that an innocent misunderstanding was involved, there is no statute of limitations when a return is not filed.

42)Isabella files her income tax return 35 days after the due date of the return without obtaining an extension from the IRS. Along with the return, she remits a check for $40,000, which is the balance of the tax she owes. Disregarding the interest element, what are Isabella's penalties for failure to pay?

(LO 5) $4,000, determined as follows: Failure to pay penalty [.5% × $40,000 × 2 months] $ 400 Plus: Failure to file penalty [5% × $40,000 × 2 months] $4,000 Less failure to pay penalty for the same period (400) 3,600 Total penalties $4,000

37)Aldo has just been audited by the IRS. He does not agree with the agent's findings but believes that he only two choices: pay the proposed deficiency or resort to the courts. Do you agree with Aldo's conclusion? Why or why not?

(LO 5) In many unresolved audit disagreements at the agent level, the taxpayer should consider an appeal to the Appeals Division. Although it is part of the IRS, it is authorized to resolve audit disputes. It has greater settlement authority than does the agent. In many cases, a compromise reached at the Appeals Division can avoid a costly and time-consuming judicial proceeding.

40)Brianna, a calendar year taxpayer, files her income tax return for 2015 on February 3, 2016. Although she makes repeated inquiries, she does not receive her refund from the IRS until May 28th, 2016. Is Brianna entitled to interest on the refund? Explain.

(LO 5) No. Interest is not paid if the refund is made within 45 days of when the return was filed. However, a return is not considered filed until its due date. Thus, the period from April 15 to May 28 does not satisfy the 45-day requirement.

38)What purpose is served by a statute of limitations? How is it relevant in the case of tax controversies?

(LO 5) The purpose of a statute of limitations is to preclude parties from prosecuting stale claims. The passage of time makes the defense of such claims difficult because witnesses and other evidence may no longer be available. In the Federal tax area, statutes of limitations cover additional assessments by the IRS and the pursuit of refund claims by taxpayers.

44)In March 2016, Jim asks you to prepare his Federal income tax returns for tax years 2013, 2014, and 2015. In discussing this matter with him, you discover that he also has not filed for tax year 2012. When you mention this fact, Jim tells you that the statute of limitations precludes the IRS from taking any actions as to this year. a.Is Jim correct about the application of the statute of limitations? Why or Why not? b.If Jim refuses to file for 2012, should you prepare returns for 2013 through 2015? Explain.

(LO 5, 6) a.No. Because no return was filed, the statute of limitations never runs. But even if a return had been filed, the three-year period for the 2012 tax return would not expire until April 15, 2016, three years after the normal due date for filing. b.Although you can only recommend that the return be filed, you cannot force him to do so. However, you should not undertake the engagement for 2013 through 2015 if you cannot correctly reflect the tax liability due to the omission for 2012.

41)On a federal income tax return filed five years ago, Andy inadvertently omitted a large amount of gross income. a.Andy seeks your advice as to whether the IRS is barred from assessing additional income tax in the event he is audited. What is your advice? b.Would your advice differ if you were the person who prepared the return in the question? Explain c.Suppose Andy asks you to prepare his current year's return. Would you do so? Explain.

(LO 5, 6) a.Normally, the three-year statute of limitations applies to additional assessments the IRS can make. However, if a substantial omission from gross income is made, the statute of limitations is increased to six years. A substantial omission is defined as omitting in excess of 25% of the gross income reported on the return. b.No, it would not. The proper procedure would be to advise Andy to disclose the omission to the IRS. Absent the client's consent, do not make the disclosure yourself. c.If Andy refuses to make the disclosure and the omission has a material carryover effect to the current year, you should withdraw from the engagement.

45)The Benson CPA firm is considering utilizing an offshore service provider to prepare many of its tax returns. In this regard, what ethical considerations must be taken into account?

(LO 5, 6) The practice of outsourcing the preparation of tax returns is ethical if three steps are taken. •Maintain client confidentiality. •Verify the accuracy of the work done. •Notify the client, preferably in writing, of the outsourcing.

49)Mia owns a warehouse that has a cost basis to her of $80,000. The city condemns the warehouse to make room for a new fire station. It pays Mia $400,000 for the property, its agreed-to fair market value. Shortly after the condemnation, Mia purchases another warehouse as a replacement. What is her recognized gain if the new property cost: a.$280,000? b.$444,000? c.$80,000? d.What, if any, is the justification for deferring the recognition of gain on the involuntary conversion?

(LO 7) a.Mia's realized gain from the condemnation is $320,000 [$400,000 (amount of award) − $80,000 (cost basis of the warehouse)]. However, her recognized gain is limited to $120,000—the amount received that was not reinvested. b.None of the gain is recognized because Mia reinvested the full amount of the condemnation award. c.As none of the gain was reinvested, the full $320,000 is recognized as income. d.The involuntary conversion provision can be justified under the wherewithal to pay concept and the notion that the taxpayer's economic position has not changed. In part b., for example, Mia has retained none of the award and has reinvested in property similar to that taken by the city.

46)In terms of tax policy, what do the following mean? a.Revenue neutrality. b.Pay-as-you-go, or "paygo." c.Sunset provision. d.Indexation.

(LO 7) a.This is the ideal approach to handling a tax cut—for every dollar lost, a new dollar is gained. b.Pay-as-you-go is another way of describing revenue neutrality. Thus, tax cuts should not result in an overall loss of revenue. c.All the sunset provision does is reinstate the law as it existed prior to the tax cut. Here, the possibility exists that Congress will rescind (or postpone) the sunset provision before it takes effect. d.Indexation is a procedure whereby the IRS makes annual adjustments to certain key tax components to take into account inflation. Some of the more important components that are adjusted include tax brackets, standard deduction, and personal and dependency exemptions.

47)Some tax rules can be justified on multiple grounds (e.g., economic and social). In this connection, comment on the possible justification for the rules governing the following: a.Pension plans. b.Education. c.Home ownership.

(LO 7) a.To encourage pension plans is to stimulate saving (economic consideration). Also, it provides security from the private sector for retirement to supplement rather meager public programs (social considerations). b.To make education more widely available is to promote a socially desirable objective. A better educated workforce also serves to improve the country's economic capabilities. Thus, education tax incentives can be justified on both social and economic grounds. c.The encouragement of home ownership can be justified on both social and economic grounds.

48)Discuss the probable justification for each of the following aspects of tax law: a.A tax credit is allowed for amounts spent to furnish care for minor children while the parent works. b.Deductions for interest on home mortgage and property taxes on a personal residence. c.The income-splitting benefits of filing a joint return. d.Gambling losses in excess of gambling gains. e.Net operating losses of a current year can be carried back to profitable years. f.A taxpayer who sells property on an installment basis can recognize gain on the sale over the period payments are received. g.The exclusion from Federal tax of certain interest income from state and local bonds. h.Prepaid income is taxed to the recipient in the year received and not the year earned.

(LO 7, 8) a.Social considerations explain the credit. It is socially desirable to encourage parents to provide care for their children while they work. b.These deductions raise the issue of preferential tax treatment for homeowners—taxpayers who rent their personal residences do not receive comparable treatment. Even so, the encouragement of home ownership can be justified on economic and social grounds. c.The joint return procedure came about to equalize the position of married persons living in common law states with those residing in community property jurisdictions. Political and equity considerations caused this result. d.Social considerations dictate that the tax law should not be used to encourage certain activities that are deemed to be contrary to public policy. e.The NOL carryback provision is an equity consideration that is 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.

50)A mother sells a valuable collection of antiques to her daughter for $1,000. What judicial concept might the IRS invoke to question this transaction?

(LO 8) If the collection is worth more than $1,000, the mother has probably made a gift of the excess value to the daughter. Quite possibly the transaction could result in the imposition of a gift tax. Sales or other transactions between related parties are subject to the arm's length test. In this case, for example, would the mother have made this sale for $1,000 if the purchaser had been an unrelated third party?

33)Regarding the value added tax (VAT), comment on the following: a.Popularity of this type of tax. b.Nature of the tax. c.Effect on government spending.

LO 4) a.The United States is the only country in the OECD (Organization of Economic Cooperation and Development) that does not have a value added tax (VAT). Approximately 80 countries use a VAT. In spite of its extensive use by other countries, the adoption of a VAT by the United States appears doubtful. Instead, the U.S. places high reliance on the income tax as its major revenue source. b.A VAT taxes the increment in value as goods move through the production and manufacturing stages to the marketplace. Although the tax is paid by the producer, it is reflected in the selling price of the goods. Therefore, a VAT is a tax on consumption. c.Because it is an effective generator of revenue, the VAT has been criticized as leading to more government spending.