AN INTRODUCTION TO TAXATION

1-1 © 2023 Cengage ® . May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 1

AN INTRODUCTION TO TAXATION

AND UNDERSTANDING THE FEDERAL TAX LAW

SOLUTIONS TO PROBLEM MATERIALS

DISCUSSION QUESTIONS

• (LO 1) Various answers are possible, including using the Key Terms at the end of each chapter,

referring to the Glossary (Appendix C), looking up the footnote resources to the Internal Revenue Code in Appendix D, using chapter features (e.g., Global Tax Issues, Ethics & Equity, Tax Planning, and Framework 1040), examining the tax forms used in the chapters, and completing additional end-of-chapter assignments. All of these resources will help students engage more deeply with the materials and help their understanding.

2. (LO 1, 4)

• John must now document rental receipts and separate his home expenses between personal and

rental use, and he may be subject to the transient occupancy tax.

• Theresa has become self-employed. Now she will be subject to self-employment tax and may

have to make quarterly installment payments of estimated income and self-employment tax.Theresa will be required to make payroll tax payments if she hires individuals to work in her business.

• Paul’s employer might have some moving expenses that it can deduct (in general, Paul cannot

deduct moving expenses). Paul’s personal taxes will change because Florida does not impose an income tax but California does.

• (LO 1, 4) 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.

• (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.

• (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.

• (LO 3) The tax law of this state appears to violate the certainty and simplicity principles. 1 / 4

1-2 2023 Comprehensive Volume/Solutions Manual © 2023 Cengage ® . May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

• (LO 3) A tax is regressive if it represents a larger percentage of the income of a low-income taxpayer

relative to the income of a high-income taxpayer. Examples of regressive taxes include sales and excise taxes. A tax is progressive if it represents a larger percentage of the income of a high-income taxpayer relative to the income of a low-income taxpayer. The Federal income tax is an example of a progressive tax.

8. (LO 4)

• 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.

• Ethan should notify the authorities of his purchase. This will force him to pay back taxes but

may eliminate future interest and penalties.

• (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.

10. (LO 4)

• 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.

• 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.

• (LO 4) A possible explanation is that Sophia made capital improvements (e.g., added a swimming pool)

to her residence and her parents became retirees (e.g., reached age 65).

• (LO 4) Presuming that the dockage facilities are comparable in Massachusetts, the Morgans may be

trying to avoid ad valorem taxes. Taxes on nonbusiness property vary from one state to another and are frequently avoided.

• (LO 4) In general, Federal excise taxes apply to fewer items than in the past. Lawmakers have focused

on and increased certain Federal excise taxes (e.g., those on tobacco products, gasoline, and air travel).

• (LO 4) Jayla could have been overcharged, but it is likely that at least part of the excess 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.

• (LO 4) An excise tax is limited to a particular transaction (e.g., sale of gasoline), whereas a general

sales tax covers a multitude of transactions (e.g., sale of all nonfood goods).

• The following states do not impose a general sales tax: Alaska, Delaware, Montana, New

Hampshire, and Oregon.

• There is no Federal general sales tax.
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An Introduction to Taxation and Understanding the Federal Tax Law 1-3 © 2023 Cengage ® . May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

16. (LO 4)

• 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 Garcías’ residence could come into play.

• In some states, the sales tax rate varies depending on the county and/or city.

Note: Generally, buyers are subject to the sales and use tax rate where they live. For example, if the Garcías buy goods in a different state with a zero or lower sales tax rate than in their state, they owe use tax to their home state for the difference.

• (LO 4) Caleb 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. Caleb needs to pay use tax on his own (which is equal to the sales tax).

• (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.

• Some states impose both an estate tax and an inheritance tax. Some states (e.g., Florida and

Texas) levy neither tax.

• The Federal government imposes an estate tax.
• (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). As a result, in the case of spousal transfers, there is no tax reason to prefer transfers at death over lifetime gifts.

20. (LO 4)

• The purpose of the unified transfer tax credit is to eliminate the tax on all but substantial gifts

and estates.

• Yes. The credit for 2022 is $4,769,800; for 2021, it is $4,625,800.
• Yes. The credit is available to cover transfers by gift or by death (or both), but the amount can

be used only once.

• (LO 4) $608,000. 19 donees (5 married children + 5 spouses + 9 grandchildren)  $16,000 (annual

exclusion for 2022)  2 donors (Elijah and Anastasia) = $608,000.

• (LO 4) The individual income tax is progressive in nature; the corporate income tax is assessed at a flat

21% rate. In addition, 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 the deduction for qualified business income.

23. (LO 4)

• 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.

• States often use IRS audit results to identify errors that might also exist on the taxpayer’s state

tax return.

• Most states allow their residents some form of tax credit for income taxes paid to other states.
• (LO 4) What happened here likely is not a coincidence. The IRS probably notified the state of California

regarding Hernando’s omission of income, and California followed up with its own audit. 3 / 4

1-4 2023 Comprehensive Volume/Solutions Manual © 2023 Cengage ® . May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

• (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.

26. (LO 4, 5)

• This type of question has no relevance to the state income tax, but is a reminder to individual

taxpayers about the use tax and a simple way for individual taxpayers to pay any use tax due on internet and mail-order purchases. Without the line on the state income tax return, individual taxpayers would be required to file a separate use tax return.

• 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 Hannah has no justifiable reason.

• (LO 4) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that

they are not paying for the donation.

28. (LO 4)

• They uncover taxpayers who were previously unknown to the taxing authority. In addition,

amnesty programs can bring taxpayers who are not in compliance with tax laws into compliance.

• Amnesty provisions can apply to other than income taxes (e.g., sales, franchise, severance).
• No general amnesty program has been offered for any Federal taxes.

29. (LO 4)

• FICA offers some measure of retirement security, and FUTA provides a modest source of

income in the event of loss of employment.

• FICA is imposed on both employer and employee, while FUTA is imposed only on the

employer.

• FICA is administered by the Federal government. FUTA, however, is handled by both the

Federal and state government.

• This applies only to FUTA. The merit system rewards employers who have low employee

turnover because this reduces the payout of unemployment benefits.

30. (LO 4)

• Unlike the Social Security portion of FICA, there is no dollar limit on the imposition of the

Medicare tax.

• The 0.9% Medicare addition applies to taxpayers with wages or net self-employment income

in excess of $200,000 ($250,000 for married filing jointly).

• (LO 4) Only children under age 18 who are employed in a parent’s unincorporated trade or business

are excluded from FICA. Other family members, including spouses, must be covered.

32. (LO 4)

• 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.

• 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.

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