Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition

Preview (16 of 659 Pages)

100%

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 1 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.Chapter1Business Income, Deductions, and Accounting MethodsSOLUTIONS MANUALDiscussion Questions1.[LO 1] What is an “ordinary and necessary” business expenditure?“Ordinary” and “necessary” imply that an expense must be customary andhelpful, respectively. Because these terms are subjective, the tests are ambiguous.However, ordinary is interpreted by the courts as including expenses which may beunusual for a specific taxpayer (but not for that type of business) and necessary isnot interpreted as only essential expenses. These limits can be contrasted with thereasonable limit on amounts and the bona fide requirement for profit motivation.2.[LO1]Explainhowcost of goods soldis treatedwhena business sellsinventory.Under the return of capital principle, cost of goods sold represents a reduction ingross income rather than a business expense. For example, if a taxpayer sellsinventory for $100,000 and reports a cost of goods sold of $40,000, the business’sgross income is $60,000 ($100,000–40,000) not$100,000.3.[LO 1]Whether a businessexpense is “reasonable in amount” is often a difficultquestion.Explain why determining reasonableness is difficult and describeacircumstance where reasonableness is likely to be questioned by the IRS.Reasonableness is an issue of factand circumstance,and extravagance is difficultto determinebecause of the subjectivity and multitude of factors involved indetermining price. Reasonableness is most likely to be an issue when a payment ismade to a related individual or the taxpayer enjoys some personal benefitincidental to the expenditure.4.[LO 1] Jake is a professional dog trainer who purchases and trains dogs for use bylaw enforcement agencies. Last year Jake purchased 500 bags of dog food from alarge pet food company at an average cost of $30 per bag. This year, however,Jake purchased500 bags of dog food from a local pet food company at an averagecost of $45 per bag. Under what circumstances would the IRS likely challenge thecost Jake’s dog food as unreasonable?Acommon test for reasonableness is whether the expenditure is comparabletoanarm's length amount–a price charged by objective (unrelated) individuals who donot receive any incidental personal benefits.Hence, the IRS is most likely tochallenge the cost of the dog foodif Jake’srelativescontrolor ownthe local petfood companyand was benefiting from the increased price.

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 2 preview image

Loading page ...

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 3 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.5.[LO 2] What kinds of deductions are prohibited as a matter of public policy? Whymight Congress deem it important to disallow deductions for expendituresthat areagainst public policy?The IRC lists bribes, kickbacks, and “other” illegal payments as nondeductible.Congress didn’t want the tax benefits associated with deductions to benefit orsubsidize wrongdoing. Of course, this rationale doesn’t really explain theprohibition against deducting political contributions which is probably betterexplained by the potential perception that political efforts are being subsidized bytaxpayers.6.[LO2] Provide an example of an expense associated with the production of tax-exempt income,and explainwhat might happen ifCongressrepealed theprohibition against deducting expenses incurred to produce tax-exempt income.Two commonexamples are interest expense associated with debt used to purchasemunicipal bonds and life insurance premiums paid on key man insurance. If thisprohibition were repealed, then taxpayers would have an incentive to borrow toinvest in municipal bonds orborrow to invest in employee life insurance. Thisformer practice would lead to higher demand for municipal bonds (less yield) andless revenue for the government. The latter practice would lead to higher demandfor insurance (higher premiums?) and less revenue for the government. Bothpractices could lead to a perception of inequity between those taxpayers able toutilize the tax arbitrage to reduce taxes and those who could not use the practice.7.[LO2] {Research}Peggy is a rodeo clown,and this year she expended $1,000 onspecial “funny” clothes and outfits. Peggy would like to deduct the cost of theseclothes as work-related because she refuses to wear the clothes unless she isworking. Under what circumstances can Peggy deduct the cost of her clownclothes?Taxpayersmay deduct the cost of uniforms or special clothing they use in theirbusiness when the clothing is not appropriate to wear as ordinary clothing outsidethe place of business.InPeggy’scase, theclown clothes areanalogous to specialuniforms or protective garments and could be deductible. SeeD. Techner, TCMemo 1997-498.Erhard Seminar Training, TC Memo 1986-526 provides anexample of clothes that were not deductible because they were appropriate fornormal wear. However, the cost of clothing would not likely be deductible if theclothes were unacceptable solely because of the taxpayer’s sense of fashion.8.[LO 2] Jimmy is asole proprietor of a smalldry-cleaningbusiness. This monthJimmy paid for his groceries by writing checks from the checking accountdedicated to thedry-cleaningbusiness.Why do you supposeJimmyisusing hisbusiness checking account rather than his personal checking account to pay forpersonal expenditures?

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 4 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.Jimmy might be trying to reduce his bank chargesby using one account for bothpersonal and business expenditures, but he could also be trying to disguisepersonal expenditures as business expenses. By commingling business andpersonal expenditures, Jimmy will need to separate personal and businessexpenditures before claiming any business deductions.9.[LO2]Troy operates an editorial service that often entertainsprospectiveauthorsto encourage them to use Troy's service. This year Troypaid$3,000 for the cost ofmeals and $6,200 for the cost of entertainingauthors. Describethe conditions underwhichTroy can deducta portion ofthe cost of the mealsas a business expense.To deducthalfof the cost of mealsas a business expense, themeals must beordinary and necessary to Troy’s business and theamount must be reasonableunder the circumstances. In addition,Troy oran employee must be present whenthe meal is furnished, andthe meal must befurnished to an actual or potentialbusiness associate. Finally, the cost of the meals must be separately stated (byinvoice) from the cost of theentertainment(the cost of the entertainment is notdeductible).10.[LO 2] Jenny uses her car for both business and personal purposes. She purchasedthe auto this year and drove 11,000 miles on business trips and 9,000 miles forpersonal transportation. Describe how Jenny will determine the amount ofdeductible expensesassociated with the auto.Because only the expense relating to business use is deductible, the taxpayer mustallocate the expenses between the business and personal use portions.A commonmethod of allocation is relative use. In this instance Jenny would calculate thebusiness portion based upon the ratio of business miles to total miles (11/20 or 55percent). She would thendeduct the costs of operating the vehiclefor businesspurposesplus depreciation onthe business portion (55 percent) ofthe vehicle’s taxbasis. Alternatively, in lieu of deducting these costs,Jennymayelect todeduct astandard amount for each business mile she drives. The standard mileage rate(58cents per mile for 2019)represents the per-mile cost of operating an automobile(including depreciationor lease payments).Once Jenny has made this election,she must continue to use it throughout the life of the auto.11.[LO1,LO2]What expenses are deductible when a taxpayer combines bothbusiness andpersonal activities on a trip? How do the rules for international traveldiffer from the rules for domestic travel?If the taxpayer has both business and personal motives for a trip,but the primaryor dominant motive is business, the taxpayer may deduct the transportation costs toget to the place of business,but she may deduct only meals (50%), lodging,transportation on site,and incidental expenditures for the business portion of thetravel. If the taxpayer’s primary purpose for the trip is personal, the taxpayer maynot deduct transportation costs totravel to and from thelocation but the taxpayer

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 5 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.may deduct meals (50%), lodging, transportation, and incidental expenditures forthe business portion of the trip.For international travel in excess of one week, thetaxpayer must allocate the cost of the transportation between personal(nondeductible) and business (deductible) activities. Taxpayers generallydetermine the nondeductible portion of the transportationcosts by multiplying thetravel costs by a ratio of personal activity days to total days travelling.Finally,remember that travel days areconsidered business activity days for both domesticand international travel.12.[LO 2]Clyde lives and operates a sole proprietorship inDallas, Texas. This yearClyde found it necessary totravel to Fort Worth (about 25 miles away) forlegitimate business reasons. Is Clyde’s trip likely to qualify as“away from home,”and why would this designation matter?Besides the cost of transportation, the deduction for travel expenses includes meals(50%), lodging, and incidental expenses. However, travel expenses are onlydeductible if the taxpayer is away from home overnight while traveling. For thispurpose, a taxpayer is considered to be away from home overnight ifthetripisofsufficient duration to require sleep or rest.It’s likely that Clyde’s trip will notsatisfy this condition and that he will not be able to deduct half the cost of mealsand the entirecost of lodging.13.[LO 2] Describe the record-keeping requirements for business deductions expensesincluding mixed-motive expenditures.Taxpayers mustkeep specific, written, contemporaneous records of time, amount ofthe expenditure, and business purpose of the travel. No deductions are allowedabsent sufficient records to document business purpose. Records of theexpenditure amount,however,may not be necessary if the taxpayer claims perdiem amounts.14.[LO2]Describe thecomputation of thelimit placed onthe business interestdeduction. Is the disallowed interesteverdeductible?The deduction of business interest expense is limited tothe sum of business interestincome plus30 percent of the business's adjusted taxable income. Business interestis defined as any interest paid on debt allocable to a trade or business activity, andadjusted taxable income is taxable income allocable to the business activitycomputed before deductions for interest, depreciation, amortization, or depletion.Disallowed business interest can be carried forward indefinitely.15.[LO 3]Explain the difference between calculating a loss deduction for a businessasset that was partially damaged in an accident and a loss deduction for a businessasset that was stolen or completely destroyed in an accident.When a business asset is completely destroyed or stolen, the amount of thebusiness’s loss is calculated as though the business sold the asset for the insuranceproceeds, if any (i.e., insurance proceeds minus adjusted basis). If the asset is

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 6 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.damaged but not completely destroyed, the amount of the loss is the amount of theinsurance proceeds minus the lesser of (1) the asset’s tax basis or (2) the decline inthe value of the asset due to the casualty.16.[LO 3]How does a casualty loss on a business asset differ when the asset is stolenas opposed to destroyed in a fire?The difference between a fire and a theft is that the casualty loss from the fire ismeasured and deducted in the year of the casualty whereas the loss from the theft ismeasured and deducted in the year the theft is discovered.17.[LO 4] What is the difference between a full tax year and a short tax year?Describe circumstances in whichabusiness may have a short tax year.A full tax year consistsof 12 months while short years are less than 12 months.Abusiness may report incomeona short year in its first year of existence (forexample, it reports income on a calendar year end and starts business afterJanuary 1) or in its final year of existence (for example, a calendar year businessends its business before December 31).18.[LO4]Explain why a taxpayer might choose one tax year-end over another ifgiven a choice.A business might use a calendar year (ends on December 31), a fiscal year (endson the last day of a month other than December) or a 52/53 week fiscal year end(ends on the same day of the week every year). Not all types of tax years areavailable to all types of businesses. The rules for determining the tax yearsavailable to the business depends on whether the business is a sole proprietorship,a flow-through entity, or C corporation.If allowed an unfettered choice, taxpayerswith a flow-through business might choose a tax year other than a calendar year topostpone the recognition of business income into the next calendar year (basedupon when income flowsthrough the business to its owners).Also, a retail businessmight choose a 52/53 week fiscal year to avoid inventory counts on busy day sales.Further, a business might choose a fiscal year end that coincides with the end ofthe season.19.[LO4]Compare and contrast the different year-ends available to soleproprietorships, flow-through entities, and Ccorporations.C corporations are generally allowed to select a calendar, fiscal, or 52/53 weekyear-end whereas other business entities generally must adopt tax years consistentwith the owners’ tax years.20.[LO4]Why does the law generally require partnerships to adopt a tax yearconsistent with the year used by the partners?The tax laws impose the tax year consistency requirement to minimize income taxdeferral opportunities for the owners.To illustrate the deferral, suppose thatapartner’s tax year-end is December 31, year 1 and her partnership’s tax year-end

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 7 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.is January 31, year 2. In year 2, the partner is treated as though she earned theentire amount of her share of the partnership’s income on January 31, year 2.Thus, even though 11/12ths of the partnership’s income was actually earned inyear 1 (February through December of year 1), forpurposes of paying taxeson theincome, the partnergets to defer this income until year 2.21.[LO 4]How does an entity choose its tax year? Is it the same process no matterthe type of tax year-end the taxpayer adopts?A business adopts its calendar year end or fiscal year end by filing its initial taxreturn. In contrast, a business adopts a 52/53 week year end by filing a specialelection with the IRS. Once a business establishes its tax year, it generally mustreceive permission from the IRS to change.22.[LO 5]Explain when an expenditureshouldbe “capitalized”based uponaccounting principles. From time to time, it is suggested that all businessexpenditures should bededucted when incurredfor tax purposes. Do you agreewith this proposition, and if so, why?Under accounting principles an expenditure should be “capitalized” whenthebenefitsfrom the expenditure occur in two different periods. The cost is spreadacross the applicable periods through a periodic charge such as depreciation oramortization.The tax lawdiffers fromaccountingprinciples, butthe rationale forthe tax rules is based upon the same matching principle, expenditures should berecognized in the period that revenues are generated.The proposition todeductallbusiness expenditures is usually defended on the grounds of simplification,encouraging capital investment, and lack of bias (at least over the long run) andcriticized on the grounds of potential economic bias (at least in the short run) andrevenue loss by the government.23.[LO 5]Describe the 12-month rule for determining whether and to what extentbusinesses should capitalize or immediately deduct prepaid expenses such asinsurance or security contracts.Explain the apparent rationale for this rule.Abusiness expenditure or business liabilitymaybeimmediately deducted(ratherthan capitalized)ifthe expenditure or liability relates to a business expense wherethecontract period(1) doesnot last more than a yearand (2) does not extendbeyond the end of the taxable year following the tax year in which the taxpayermakes the payment.The rule could be rationalized as an attempt to simplify thededuction for expenditures that merely span tax years and would not likely result inmaterial differences in taxable income should the expenditure be capitalized acrossboth periods.24.[LO 5]Explain why Congress sometimes mandates that businesses use particularaccounting methods while other times Congress is content to requirebusinesses touse the same accounting methods for tax purposes that they use for financialaccounting purposes.

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 8 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.Thenatural tension between financial reporting incentives and tax reportingincentives may be the reason the tax laws indicate that as a general rule businessesmust use the same accounting methods for tax purposes that they use for financialaccounting purposes.That is,businessesthatwant to accelerate book income(ordelay taxable income) are also required toaccelerate taxable income(or delayfinancialincome).Thus, using the same method for both tends to neutralizeincentives to stretch numbersin one direction or the other.Congress specifies thatbusinesses are required to use other, presumably moreappropriate, accountingmethods for tax purposes when financial accounting methods do not “clearlyreflect income” for tax purposes or when dictated by policy or administrativeconcerns.25.[LO 5] Why is it not surprising that specific rules differ between tax accountingand financial accounting?Tax policy objectives often differ from the objectives motivating financialaccounting rules.Tax accounting attempts to maximize revenue for the governmentwhile financial accounting attempts to minimize overstatements that might misleadinvestors and creditors.Hence, for policy and administrativereasons, the tax lawsidentify several circumstances when businesses must use specific tax accountingmethods to determine taxable income no matter what accounting method they usefor financial reporting purposes.26.[LO 5] Fred is considering using the accrual method for his next business venture.Explain to Fred the conditions for recognizing income for tax purposes under theaccrual method.Ataxpayermustrecognizeincome if(1) all the events have occurred that arenecessary to fix the right to receivea paymentand (2) the amount of the paymentcan be determined with reasonable accuracy.27.[LO 5]Describe the all-events test for determining income and describe how todetermine the date on which the all-events test has been met.The all events test requires ataxpayertorecognizeincome if the taxpayer has afixedright to receivea paymentand the amount of the paymentcan be determinedwith reasonable accuracy.The all-events testis typically meton the earliest of thefollowing three dates: (1) the date the business provides the service or transfersgoods, (2) the date payment is due, or (3) the date payment is received.28.[LO 5] Compare and contrast the tax treatment for rental income received inadvance and advance payments forgoods andservices.For tax purposes, businesses must immediately recognize prepaid rental or interestincome (it isrecognizedbeforeit isearned).The all-events test generally requiresbusinesses receiving advance paymentsfor servicesto recognize the income whenthey receive the paymentrather than when they perform the services. The IRSprovidesthatbusinesses receiving advance payments for services may defer

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 9 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.recognizing the prepayment as income until the tax year following the year theyreceive the payment. This one-year deferral does not apply if (or the extent towhich) the income is actually earned by the end of the year of receipt, if theprepayment was included in financial reporting income, or if the prepayment wasfor rent (unlessrentalreceipts are bundled with goods or services, prepaymentsare taxedon receipt).29.[LO 5] Compare and contrast the rules for determining the tax treatment of advancepayments for services versus advance payments for goods.For tax purposes, the all-events test generally requires businesses receivingadvance payments for services to recognize the income when they receive thepayment, rather than when they perform the services.Under the Tax Cuts and JobsActbusinessesusing the accrual method andreceiving advance payments forgoodsorservices mayelect one of two accounting methods. Under the full inclusionmethod, the business can elect to recognize the income. Under the deferral method,the business can elect todefer recognizing the prepayment as income until the taxyear following the year they receive the payment. This one-year deferralelectiondoes not apply if (or the extent to which) the income is actually earned by the endof the year of receipt, if the prepayment was included in financial reporting income,or if the prepayment was for interest or rent (taxpayers must recognize prepaidinterest and rental income on receipt).In contrast, when a cashbasis businessreceives an advance payment for goodsor servicesto beprovidedin the future, thebusinessmust recognize the income immediately.30.[LO 5]{Research}Jack operateslarge home repairbusiness as a soleproprietorship. Besides providing services, Jack also sellshome repairsupplies tohomeowners.However, these sales constitute a relatively small portion of Jack’sincome. Describe the conditions under which Jack would need to account for salesand purchases of plumbing supplies using the accrual method.Hint:read§471(a)andReg.§1.471-1.Jack can use the cash method and avoid using accrual for sales if his businessreportsaverage gross receipts of $25 million or less or less for the three-tax yearperiod ending with the prior tax year. In addition, under §471(a) the Secretary isempowered to determine when a business must account for inventories.Even ifJack’s business exceeds the $25 million threshold, under Reg/§1.471-1 a businessmustonlyaccount for inventories whensales of “merchandise”are amaterial“income-producing factor.” The determination of whatis “merchandise” andwhatamount of inventorysales constitutea “material” income-producing factor isdetermined by facts and circumstances on a case-by-case basis. One likelycharacteristic is the level of sales and another is the income generated by sales ofinventory relative to the overall income of the business.In addition, there is anexception under Reg.§1.162-3and Rev. Proc. 2001-10, 2001-1 CB 272, for cash-method businessesthat also provide services. If the business hasaverage annual

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 10 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.gross receiptsofless than $1 million over a three-year period, then itcan elect totreat inventories as incidental materials and supplies. Thus, Jack is not required touse the accrual method for sales and purchases of plumbing supplies if he satisfiesthe average annual gross receipts test. In addition, Prop. Reg. §1.162-3(a)allowstaxpayerstodeduct thecosts of buying incidental materials and supplies in theyear of purchase if no physicalinventoryis taken at the beginning and end of thetax year (assuming taxable income is clearly reflected).31.[LO 5]Explainwhy Congress enacted the UNICAP rules and describe the burdensthese rules place on taxpayers.Congress enacted these rules primarily for two reasons. First, the rules acceleratetax revenues for the government by deferring deductions for thecapitalized costsuntil the business sells the associated inventory. Second, Congress enacted these“uniform” rules to reduce variation in the costs businesses include in inventory.The burden placed on taxpayers is primarily related to record-keeping (identifyingan allocation method and keeping records of indirect costs). In addition, there isthe time value related to the deduction of the indirect costs. When UNICAP wasimposed, the indirect costs allocated to ending inventory were not deductible untilthe following period whereas without UNICAP these would have been deductedimmediately. Hence, in a sense taxpayers subject to the UNICAP rules made aninterest free loan to the government of the taxes associated with this deferral.32.[LO 5] Compare and contrast financial accounting rules withthe tax rules underUNICAP (§263A).Explain whethertheUNICAP rulestend to accelerate or deferincome relative to the financial accounting rules.Under GAAP, businesses generally include in inventory only those costs incurredwithin their production facility. In contrast, the UNICAP rules require businessesto allocate to inventory the costs they incurnot onlyinside the production facilitybut alsothe costs they incur outside the facility to support production (or inventoryacquisition) activities.Uniform capitalization requires that both direct and certainindirect costs be capitalized into inventories (full absorption costing). Hence,businesses generally capitalize more costs to inventory for tax purposes than theycapitalize under financial accounting rules.33.[LO5]Compare and contrast the tests for accruing income and those for accruingdeductions for tax purposes.To record an expense and the corresponding deduction for tax purposes, thebusiness must meet (1) an all-events test for the liability and (2) an economicperformance test with respect to the liability. While the all-events test forrecognizing deductionsis similar to the all-events test for recognizing income, theadditional economic performance requirement makes the deduction recognitionrules more stringent than the income recognition rules. The deduction rulesgenerally preclude businesses from deducting estimated expenses or reserves.

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 11 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.34.[LO 5] Compare and contrast when taxpayers are allowed to deductthe cost ofwarranties provided by others to the taxpayer (i.e., purchased by the taxpayer) andwhen taxpayers are allowed to deduct the costs associated with warranties theyprovide (sell) toothers.Insurance, warranties, and service contracts providedtothetaxpayer are paymentliabilities and accrual method taxpayers that prepay business expenses for paymentliabilities (insurance contracts, warranties, and product service contracts providedto the taxpayer) are allowed to immediately deduct the prepayments subject to the12-month rule for prepaid expenses.Awarrantyprovidedbythe taxpayer to othersisdeductibleas the taxpayer incurs costs associated with these liabilities.35.[LO 5] Describe when economic performance occurs for the following expenses:a)Workers’compensation,b)Rebates and refundsc)Insurance, warranties, and service contracts providedtothe businessd)TaxesWorkers’compensation, rebates, refunds, and service contracts are paymentliabilities and economic performance occurs upon payment regardless of actualperformance. Taxes are also payment liabilities, but under§461 accrual-methodtaxpayers that paycertain real estate taxesare allowed toelect todeducttaxpaymentsratably over the tax accrual period.36.[LO 5] On December 31 of the current year, a taxpayer prepays an advertisingcompany to provide advertising services for the next 10 months. Using the 12-month rule and the economic performance rules, contrast when the taxpayer wouldbe able to deduct the expenditure if the taxpayer uses the cash method ofaccounting versus if the taxpayer uses the accrual method of accounting.Undereconomic performance an accrual-method taxpayer can deduct the cost ofadvertising as theservicesareprovided to the taxpayer or with payment if thetaxpayer reasonably expects actual performance within 3 ½ months.Acash-methodbusiness that prepays businesses expenses may immediately deduct theprepayment if thecontract period(1) doesnot last more than a yearand (2) doesnot extend beyond the end of the taxable year following the tax year in which thetaxpayer makes the payment.37.[LO 5]Compare and contrast how bad debt expenseis determinedfor financialaccounting purposes andhow the deduction for bad debts isdeterminedforaccrual-method taxpayers. How do cash-method taxpayers determine their bad debtexpensefor accounts receivable?For financial reporting purposes, the business estimates the amount of the baddebt, debits bad debt expense, and credits an allowance for doubtful accounts.However, for tax purposes,accrual-method taxpayersareonlyallowed to deductbad debt expensein the tax year when an account receivable ordebt becomes

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 12 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.thless. Cash-method taxpayers do not create accounts receivable for sales oncredit so no bad debt deductions are ever claimed.38.[LO 5] Describe the related-person limitation on accrued deductions. What taxsavings strategy is this limitation designed to thwart?An accrual-method business is not allowed to deduct amounts they accrue forexpenses payable to related persons until the related person includes the paymentin income. When a business accrues an expense payable to a related person atyear end, and the related person is a cash-method taxpayer, the business is notallowed to deduct the expense until the next year when the related person receivesthe payment and includes it in income. This limit prevents businesses and relatedpersons from working to accelerate a tax deduction into the earlier year and therelated person from deferring the income until the later year.39.[LO 5] What are the relative advantages of the cash and accrual methods ofaccounting?The two primary advantages of the cash method over the accrual method are that(1) the cash method provides the business with more flexibility to time income anddeductions by accelerating or deferring payments and (2) the ease of bookkeeping.The primary advantage of the accrual method over the cash method is that it bettermatches revenues and expenses.40.[LO 5] Describe how a business adopts a permissible accounting method. Explainwhether a taxpayer can adopt an impermissible accounting method.A business adopts a permissible accounting method by using and reporting theresults of the method for at least one year. A business adopts an impermissiblemethod by using and reporting the results of the method for two consecutive years.41.[LO 5] Describe why the IRS might be skeptical of permitting requests for changesin accounting method without a good business purpose?The reluctance of the IRS probably stems from the possibility that taxpayers willmanipulate accounting methods to defer taxable income. For example, a taxpayermight use LIFO in a period of rising costs, but want to switch to FIFO in a periodof stable or declining costs.42.[LO 5] What is a §481 adjustment, and what is the purpose of this adjustment?When a business changes an accounting method, the business is required to make a§481 adjustment that represents the cumulative difference between the accountingmethod the business was using and the accounting method the taxpayer is changingto. The adjustment prevents the duplication or omission of items of income ordeduction due to a change in accounting method. If the adjustment increasesincome, the taxpayer includes 25 percent of the adjustment (beginning in the yearof adjustment) in income for four years. If the adjustment reduces taxable income,the taxpayer recognizes the entire adjustment in the year of change.

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 13 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.Problems43.[LO 1] Mannyhired his brother’s firm to provide accounting services to hisbusiness. During the current year,Mannypaid his brother’s firm $82,000 forservices even though other firms were willing to provide the same services for$40,000.How much of this expenditure, if any, is deductible as an ordinary andnecessary business expenditure?Only reasonable amounts of compensation are deductible ($40,000), and theremainder would be reclassified probably as a gift to his brother.44.[LO 1,LO2]Michelle operates a food truck.Indicatethe amount (if any) thatshecan deduct asanordinary andnecessary business deductions in each of thefollowingsituations and explain your solution.a)Michelle moves her food truck between various locationson a dailyrotation.Last week, Michelle was stopped for speeding. She paid a fine of $125 forspeeding including $80 for legal advice in connection with the ticket.b)Michelle paid $750 to reserve a parking place for her food truck for the fallfootball season outside the local football arena.Michelle also paid $95 fortickets to a game for her children.c)Michelle provided a candidate with free advertising painted on her truckduring the candidate's campaign for city council. Michelle paid $500 to havethe ad prepared and an additional $200 to have the ad removed from the truckafter the candidate lost theelection.a)No deduction forthefine, but the legal advice is fully deductible.b)The cost of the reserve parking($750)is deductible, but the cost of the ticketsis likely personal and not deductible.c)No deduction forexpenditures forpoliticalpurposes(in cash or in kind).45.[LO 1,LO2]Indicate the amount (if any) thatJoshcan deduct asanordinary andnecessary business deduction in each of the followingsituationsand explain yoursolution.a)Josh borrowed $50,000 from the First State Bank using his business assets ascollateral. He used the money to buy City of Blanksville bonds. Over thecourse of a year,Josh paid interest of $4,200 on the borrowed funds, but hereceived $3,500 of interest on the bonds.b)Josh purchased a piece of land for $45,000 in order to get a location toexpand his business. He also paid $3,200 to construct a new driveway foraccess to the property.

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 14 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.c)This year Josh paid $15,000 to employthe mayor’sson in the business. Joshwould typically pay an employee withtheseresponsibilities about $10,000but the mayor assured Josh that after his son was hired, some city businesswould be coming his way.d)Josh paid his brother, a mechanic, $3,000 to install a robotic machine forJosh’s business. The amount he paid to his brother is comparable to what hewould have paid to an unrelatedpersonto do the same work. Once theinstallation was completed by his brother, Josh began calibrating the machinefor operation.However, by the end of the year, he had not started using themachine in his business.a)$0.The interest expense is not deductible (expense associated with tax-exempt income).b)$0.Capital expenditures are not deductible.c)Only $10,000 is deductible and the remaining $5,000 is either unreasonablein amount or against public policy (as a bribe).d)$0. The amountpaid to install a machine is capitalized because the costbenefits the useful life of the machine.46.[LO 2] {Research} Ralph operates abusinessthat acts as a sales representative forfirmsthat produce and sell precious metals to electronic manufacturers. Ralphcontacts manufacturers and convinces them to sign contracts for delivery of metals.Ralphearns a commission on the sales. This year, Ralph contacted a jeweler toengrave small lapel buttons for each ofhis clients. Ralph paid $20 each for thelapel buttons and the jeweler charged Ralph an additional $7for engraving. Theelectronicmanufacturers, however, prohibit theiremployeesfrom accepting giftsrelated to sales contracts.CanRalphdeduct the cost of the lapel buttons asbusiness gifts?§274(b) denies business deductions for gifts that exceed $25 in amount, but Reg.§1.274-3(c)indicates that “the term expense for a gift means the cost of the gift tothe taxpayer, other than incidental costs such as for customary engraving onjewelry.” Hence, it would appear that the amount of the gift ($27) is likelydeductible. It might also be argued that the expenditure is not deductible because itviolates the §162(c) prohibition against deducting expense against illegal bribesand kickbacks. However, inArthur E. Bondy, TC Memo 1991-545,the Tax Courtfound similar gifts deductible as business expenses as long as the payments werenot illegal under state or federal law.47.[LO2]Melissa recently paid $400 for round-trip airfare to San Francisco to attenda business conference for three days. Melissa also paid the following expenses:$250 fee to register for the conference, $300 per night for three nightslodging,$200 for meals, and$150for cab fare.

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 15 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.a)What amount of the travel costs can Melissa deduct as business expenses?b)Suppose that while Melissa was on the coast, she also spent two dayssightseeing the national parks in the area. To do the sightseeing, she paid$1,000 for transportation, $800 for lodging, and $450 for meals during thispart of her trip, which she considers personal in nature. What amount of thetravel costs can Melissa deduct as business expenses?c)Suppose that Melissa made the trip to San Francisco primarily to visit thenational parks and only attended the business conference as an incidentalbenefit of being present on the coast at that time. What amount of the airfarecan Melissa deduct as a business expense?d)Suppose that Melissa’s permanent residence and business was located in SanFrancisco. She attended the conference in San Francisco and paid $250 forthe registration fee. She drove100 miles overthe course of three days andpaid $90 for parking at the conference hotel. In addition, she spent $150 forbreakfast and dinner over the three days of the conference. She boughtbreakfast on the way to the conference hotel and she bought dinner on herway home each night from the conference. What amount ofthese costs canMelissa deduct as business expenses?a)Since business was the primary reason for the trip, Melissa can deduct$1,800of travel costs [$250 registration +$400airfare+ $900lodging+(50%*$200)meals+ $150cab fare]b)None of the costs ofsightseeingis deductible. However, because her primarypurpose for the trip appears to be business (3 days business vs. 2 dayspersonal) she is allowed to deduct her airfare to San Francisco and her otherexpenses in part(a)relating to the business portion of the trip.c)If the purpose of the trip is primarily personal, then none of the air fare isdeductible and only those direct costs associated with the conference($1,400) can be deducted (the registration, lodging, 50 percent of the meals,and cab fare).d)Melissa would be allowed to deduct the registration fee for the conference of$250 and shecould deduct$58(in 2019)for the 100 miles she drove to andfrom the conference (58cents per mile x 100 miles) and the parking fee of$90. However, because her travel did not require her to be away from homeovernight, she is not allowed to deduct the cost of her meals going to andcoming from the conference each day.48.[LO 2] Kimberly is a self-employed taxpayer. She recently spent $1,000 forairfare to travel to Italy. What amount of the airfare is deductiblein each of thefollowing alternative scenarios?a)Her trip was entirely for personal purposes.

Solution Manual For McGraw-Hill's Taxation of Business Entities 2020 Edition, 11th Edition - Page 16 preview image

Loading page ...

Solutions Manual–Taxationof Business Entities,by Spilker et al.b)On the trip, she spent eight days on personal activities and two days onbusiness activities.c)Onthe trip, she spent seven days on business activities and three days onpersonal activities.d)Her trip was entirely for business purposes.a)$0 since thesolepurpose of the trip was for personal purposes.b)$0 sincethe primarypurpose of the tripappears to be personal.c)$700 ($1,000 x7/10). Since the primary purpose of the trip appears to bebusiness, she may deduct the portion of the airfare allocated to the businesstrip(prorated because this is foreign travel). Using the number of days ofbusiness activities to total days of travel, she may deduct70percent(7/10ths)of the cost (conversely, she may not deduct30percent(3/10ths) of the cost.d)$1,000since the sole purpose of the trip is business, she may deduct theentire airfare.49.[LO2]Ryan is self-employed.This year Ryan used his personal auto for severallong business trips. Ryan paid $1,500 for gasoline on these trips. Hisdepreciationon the car if he was using it fully for business purposes would be $3,000. Duringthe year, he drove his car a total of 12,000 miles (combination of business andpersonaltravel).a)Ryan can provide written documentation of the business purpose for tripstotaling 3,000 miles. What business expense amount can Ryan deduct (ifany) for these trips?b)Ryan estimates that he drove approximately 1,300 miles on business trips, buthe can only provide written documentation of the business purpose for tripstotaling 820 miles. What business expense amount can Ryan deduct (if any)for these trips?a)Ryan can claim the direct cost of these trips,including gas ($1,500) anddepreciation on the auto. However,thededuction for auto use is limited todirect costs (such as gas and oil) and the pro-rata portion of indirect costs(such as depreciation).The pro rata portion would be calculated as thebusinesspercentage of total mileage ($3,000 x [3,000/12,000]) or $750.Hence, Ryan could deduct $2,250.Alternatively, Ryan can claim a standardmileage rate, and based on the standard mileage rate of58¢per mile(in2019), he can deduct $1,740(i.e., 3,000 x58¢).b)Ryan is allowed to deduct the cost of using his personal auto in his businessactivitiesonly if he cansubstantiate the business use.If he has records tosubstantiate the business use,Ryan can claim the direct cost of these tripsincluding depreciation on the auto (for the business portion of the totalmileage).Ryan’s total expense deduction wouldconsist of depreciation and

Preview Mode

This document has 659 pages. Sign in to access the full document!

Report

Study Now!

Document Details

Related Documents

Analyzing Tax-Exempt Status: Requirements and Case Study of Mutual Insurance Companies

Exploring International Taxation Benefits and Strategies for U.S. Corporations

The Impact of IRC Section 199 and Related Corporate Tax Provisions on U.S. Businesses

Corporate Taxation: Charitable Contributions, Accounting Methods, and Taxable Income Calculations

Taxation for Decision Makers Test Bank

Test Bank for Pearson's Federal Taxation 2020 Comprehensive, 33rd Edition

Pearson�s Federal Taxation 2020 Comprehensive 33rd Edition Test Bank

Tax Implications Of The Sale Of Rental Property: A Case Study On T. Terri's Apartment Sale

Tax Implications And Calculation Of Realized, Recognized, And Characterized Gain In The Sale Of a Residential Rental Property

Test Bank for Pearson's Federal Taxation 2020 Individuals, 33rd Edition

Company

Explore

Study Tools