Chapter 1 Solutions

9. 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 Districts 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. p. 1-7 11. Probably what has happened is that the appraised value of the residence has been raised. Unfortunately, there is often a time lag in the appraisal process, and the taxing authority has not yet taken into account any recent changes in value. See Tax in the News item on p. 1-8. Eileen may have avoided the sales tax but she will be vulnerable to the Wyoming use tax. This tax will be imposed when Wyoming discovers she has not paid its sales taxprobably when she registers the car in Wyoming. See the discussion in connection with Example 4. p. 1-10 As to gifts, Alvin can give Holly $1,013,000 [$13,000 (annual exclusion) + $1,000,000 (the equivalent of the $345,800 unified credit)] the first year without incurring any transfer tax. Additional gifts of $13,000 per year also can be made free of tax. Alternatively, by death Alvin can pass Holly $3,500,000 (the equivalent of $1,455,800 unified credit) free of estate tax. A good approach would be to give her the $1,013,000 now and pass her the $2,500,000 balance at death. This approach reduces the unified tax credit available at death by $345,800the amount used to cover the current gift. pp. 1-12 to 1-14 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. See Tax in the News on p. 1-15. 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. p. 1-24 The large amount involved means it received media coverage. IRS agents are instructed to take note of such items. Consequently, it would not be surprising if Lindas return for the year involved is audited. Keep in mind that this is a big ticket item in terms of possible income tax deficiencies. Mel operates a cash business where the potential for omission of income is high. Also, his erratic personal life could make him subject to retribution (i.e., informed on to the IRS).

14.

19.

26.

b.

36.

a.

b.

c.

Cindy could be a candidate for an audit for two reasons. First, her high gross income and AGI. Second, the large donation will exceed the norm for itemized charitable contributions for someone in her income category. As a headwaiter, Pierre will receive large tips. He will also share in the business of the valet service which invariably involves gratuities. With so much cash involved, the full reporting of income may not occur. The IRS is aware of this potential for omission. Most of Giselles income probably comes from cash tips. Regarding the past audits, were tax deficiencies assessed? If so, a return visit by the IRS is to be expected. Information received from a state taxing authority can lead to an IRS audit. This is apparently what has happened in the case of Marcus.

d.

e.

f.

pp. 1-19 and 1-20 40. a. The normal three-year statute of limitations will begin to run on April 15, 2010. When the return is filed early, the regular filing date controls. 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. 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 advisor. Regardless of the fact that an innocent misunderstanding was involved, there is no statute of limitations when a return is not filed.

b.

c.

d.

pp. 1-21 and 1-22 43. $4,500, determined as follows: Failure to pay penalty [0.5% $30,000 3 months] Plus: Failure to file penalty [5% $30,000 3 months] Less failure to pay penalty for the same period Total penalties p. 1-22 and Example 15 47. a. Energy credits are allowed for various residential improvements that conserve energy. Credits are available for taxpayers who purchase motor vehicles that operate on alternative (i.e., non-fossil) fuels. The $ 450 $4,500 (450) 4,050 $4,500

cost of installing pollution control devices can be expensed for tax purposes over a shorter period of time. p. 1-26 b. 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). pp. 1-26 and 1-27 To make education more widely available is to promote a socially desirable objective. A better educated workforce also serves to improve the countrys economic capabilities. Thus, education tax incentives can be justified on both social and economic grounds. p. 127 and Footnote 27 The encouragement of home ownership can be justified on both social and economic grounds. p. 1-28 The treatment of prepaid income can be justified on the notion of promoting administrative feasibility. As a practical matter, the best time to impose a tax is when the taxpayer has the funds. p. 1-32 The installment method of reporting gain is consistent with the wherewithal to pay conceptthe seller is taxed when the payments are made by the purchaser. p. 1-30 What is described is the indexation procedure. The procedure avoids the so-called bracket creep caused by inflation and can be justified on equity grounds. p. 1-30 As noted in the text, the tackle box exemption from the Federal excise tax on sporting goods can be explained under political considerations. Quite clearly, the provision is an example of special interest legislation. p. 1-30 The limitations placed on casualty and theft losses reduce the number of such deductions and thereby simplifies the audit process. Thus, they can be justified in the interest of administrative feasibility. p. 132 and Footnote 33

c.

d.

51.

a.

b.

c.

d.

e.

Chapter 3 Solutions
18. a. b. Because he is a U.S. citizen, Oliver must file a Federal income tax return. If the parties make an election under 6013(g). Although such an election allows Oliver to file a joint return, it subjects all of Reginas foreign income to U.S. taxation.

Global Tax Issues on p. 3-25 28. a. AGI Less: Itemized deductions Personal and dependency exemptions (5 $3,650) Taxable income AGI Less: Standard deduction (head of household) Personal and dependency exemptions (5 $3,650) Taxable income AGI Less: Itemized deductions Personal and dependency exemptions (4 $3,650) Taxable income AGI Less: Standard deduction (surviving spouse) Personal and dependency exemptions (5 $3,650) Taxable income $65,000 (12,000) (18,250) $34,750 $80,000 (8,400) (18,250) $53,350 $75,000 (9,500) (14,600) $50,900 $58,000 (11,400) (18,250) $28,350

b.

c.

d.

e.

AGI Less: Itemized deductions Personal and dependency exemptions (2 $3,650) Taxable income

$64,000 (9,900) (7,300) $46,800

pp. 3-9, 3-10, and Table 3.1 30. Salary Interest on bonds Interest on CD Dividend AGI Itemized deductions Personal and dependency exemptions (3 $3,650) Taxable income $60,000 3,000 2,000 2,200 $67,200 (10,200) (10,950) $46,050

The interest ($3,000) on the bonds is taxable. Excluded from gross income are the life insurance proceeds ($100,000) and the inheritance ($200,000). The loan repayment ($5,000) is a nontaxable return of capital. Mattie chose to itemize her deductions from AGI ($10,200) because it provided the greater deduction. pp. 3-3, 3-10, Figure 3.1, and Exhibits 3.1 to 3.3 33. a. Four. Two personal and two dependency exemptions. Elton is a qualifying child, so his gross income does not matter. Trista is not a qualifying childalthough a full-time student, she is not under age 24. However, Trista fits under the qualifying relative category. She passes the gross income test because the tuition portion of a scholarship is nontaxable. Two. One personal and one dependency exemption. Regardless of the year of divorce, Clint cannot qualify as he is not a member of Audrys household. Olive meets the relationship test. Three. One personal and two dependency exemptions. As Andy is a qualified child, he is not subject to the gross income test. Paige meets all of the requirements of a qualifying relative. Two. One personal and one dependency exemption. Andy, as a qualifying child, is still immune from the gross income test. In a community property situation, however, Paige is treated as having $4,000 in gross income (50% $8,000). Thus, she fails the gross income test and cannot be a qualifying relative.

b.

c.

d.

pp. 3-12 to 3-18 and 3-37 36. a. Jenny is a qualifying child as to all three parties. Therefore, the father, uncle, and grandmother are eligible to claim him as a dependent.

b.

In this tie-breaker situation, the father (as parent) will take preference. If the father forgoes the exemption, the grandmother is next in order of preference, due to a higher AGI.

p. 3-14 and Table 3.4 37. a. Three. As a niece, Ida is a qualifying child. Under the qualifying child category, Ida does not have to meet the gross income test. In this regard, her age and student status does make a difference. One. Since Clint is not a qualifying child, the gross income test applies. Three. The parents need not live with Trent as they meet the relationship test. Though not stated, it is assumed that the gross income test is satisfied. One. Carol can claim a personal exemption. Because of Form 8332, the dependency exemptions for the children belong to Jack.

b. c.

d.

pp. 3-12 and 3-18 39. a. Wages Money market interest Bond interest (City of Boston bond interest is tax-exempt) Gross income Less: Standard deduction* Personal exemption** Taxable income Money market interest Bond interest Total unearned income Minus: $950 + $950 standard deduction Income taxed at parents rate Income taxed at Taylors rate Total tax ($1,600 10%)*** $4,000 1,900 0 $5,900 (4,300) (0) $1,600 $1,900 0 $1,900 (1,900) $ 0 $1,600 $ 160

*A dependents standard deduction is limited to the greater of $950 or the sum of his or her earned income plus $300. **A dependent may not claim a personal exemption on his or her return. ***Since Taylors unearned income is not more than $1,900, her tax is determined without using her parents rate. Thus, Taylors 2010 tax liability is $160 ($1,600 taxable income 10%). pp. 3-11, 3-31, Exhibit 3.1, and Example 11 40. a. Regardless of where the parties reside, it is essential that the damage of the joint return be undone. The joint return test applies to both the qualifying child and qualifying relative categories of dependency

exemptions. The situation can be rectified by filing separate returns on or before April 15, 2011. In Louisiana, one-half of the daughters income, or $5,500 (50% $11,000), is assigned to John. Being a qualifying child, the daughter can be claimed as a dependent. John, however, is subject to the gross income test contained in the qualifying relative category. Since $5,500 exceeds $3,650, John cannot be claimed as a dependent. b. As noted in part a., the joint return problem needs to be resolved. In New Jersey, none of the daughters income is earned by John. Consequently, John now meets the gross income test of a qualifying relative. The daughter also can be claimed as a dependent since there is no gross income test applicable to the qualifying child category.

Examples 48, 50, and 51 44. a. Earned income Interest income Gross income and AGI Less: Standard deduction [greater of $950 or $2,000 (earned income) + $300] Taxable income Taxed at parents rate: Unearned income Less: $950 + $950 Net unearned income (taxed at parents rate) Taxed at Charlenes rate: Taxable income Less: amount taxed at parents rate Taxed at Charlenes rate c. The parental election cannot be made as Charlenes income is not solely from interest and dividends. $2,000 4,000 $6,000 (2,300) $3,700 $4,000 (1,900) $2,100 $3,700 (2,100) $1,600

b.

p. 3-32 and Example 41 51. a. Ophelia has the following results: LTCG (land) STCL (ADM) STCG (boat and trailer) Loss on camper (nondeductible) $3,000 (1,000) 2,000 0

Thus, she has a net LTCG of $3,000 and a net STCG of $1,000. Her tax is $800 [($3,000 15%) + ($1,000 35%)]. b. $150 [($3,000 0%) + ($1,000 15%)].

pp. 3-34 and 3-35