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Taxation For Decision Makers, 2016 6th Edition Solution Manual

Taxation For Decision Makers, 2016 6th Edition Solution Manual provides step-by-step solutions and explanations for better comprehension.

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    Solutions to Chapter 1 Problem Assignments Check Your Understanding 1. [LO 1.1] Consumption Taxes Solution: Consumption taxes are “spending” taxes. They are taxes that are not levied until a person decides to expend funds (whether from income or from savings) for goods or services. The most common consumption tax is the sales tax. Other consumption taxes include excise taxes, value added taxes, and use taxes. 2. [LO 1.4] Horizontal vs. Vertical Equity Solution: Horizontal equity is the concept that argues that persons in the same economic situation should pay equivalent amounts of taxes. The concept of vertical equity states that persons with greater economic wealth should pay a greater amount of taxes and is the foundation for a progressive rate system; conversely, a person with less wealth would pay less tax. 3. [LO 1.4] Constitutional Authority Solution: The 16th amendment to the United States Constitution was passed in 1913. 4. [LO 1.4] Type of Tax Solution: A tax that is designed to discourage the use of a good or service considered undesirable is called a sin tax. 5. [LO 1.5] Objectives of Taxation Solution: There are numerous objectives of taxation; some of the more common goals besides raising revenue to support the functions of government are to promote wealth redistribution, price stability, economic growth, full employment, and desirable social goals. 6. [LO 1.5] Taxable Persons Solution: Only individuals, regular (or C) corporations, and fiduciaries (estates and trusts) pay income taxes. 7. [LO 1.5.] Gross Revenue vs. Gross Income Solution: A business’s gross revenue includes all of its receipts from the sale of goods or services; a business’s gross income is its gross receipts from sales less the cost of goods sold. 8 [LO 1.5] Tax Models Solution: The individual tax model includes an intermediate income concept called adjusted gross income. As a result, an individual can have deductions both for and from adjusted gross income. Deductions from adjusted gross income include personal and dependency exemptions and either a standard deduction or itemized deductions. None of these items appear in the corporate tax model. The corporate and individual tax models both include gross income; they are both permitted deductions from gross income to determine taxable income; they both may have additions to tax and

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    2 Solutions Manual for Taxation for Decision Makers tax credits applied before the final tax liability is determined. Both taxpayers are generally required to make tax prepayments. 9. [LO 1.5] Adjusted Gross Income Solution: Adjusted gross income is used to provide either a threshold or limitation for most of an individual’s itemized deductions. It is also used to determine at what point an individual’s exemptions and itemized deductions will begin to be phased out. 10. [LO 1.5] Filing Status Solution: The four filing statuses are single, married filing jointly, married filing separately, and head of household. (The surviving spouse category included within the married filing jointly category is discussed in Chapter 11.) The standard deduction for a dependent is subject to limitation although there is no separate filing status for the dependent. 11. [LO 1.5] Exemptions Solution: The personal exemption is the deduction a self-supporting person takes for him or herself on his or her own tax return. The dependency exemption is the deduction an individual takes for another person, a dependent, whose support is provided by that individual. 12. [LO 1.5] Property Dispositions Solution: To determine the gain or loss on business or investment property, the taxpayer subtracts the adjusted basis of the property sold from the amount received on the sale. If the result is positive, there is a gain. If the adjusted basis exceeds the amount received, there is a loss. 13. [LO 1.5] Deductions vs. Credits Solution: A tax credit is a dollar for dollar reduction in a tax liability. A tax deduction only reduces a person’s tax in an amount equal to the deduction times the marginal tax rate. Compare a $1,000 deduction with a $1,000 credit for a person with a $20,000 tax liability whose marginal tax rate is 28 percent. The $1,000 credit reduces the person’s tax to $19,000. The $1,000 deduction, however, will only reduce the person’s tax by $280 ($1,000 x 28%) to $19,720. The value of a tax deduction is dependent upon the person’s marginal tax rate; the value of a tax credit is independent of the marginal tax rate and benefits all taxpayers equally. 14. [LO 1.6] Sole Proprietorship Solution: Only one taxable person, who must be an individual, can own a sole proprietorship. The sole proprietor is personally liable for all debts of the business. The sole proprietor cannot be an employee of the business. The results of operations of the sole proprietorship are reported on the Schedule C and these are then included in the owner’s personal tax return. A partnership must have more than one owner. A general partner is liable for partnership debts but limited partners are only liable for their investment in the partnership. Like sole proprietors, partners cannot be employees of the partnership. Although partnerships

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    Chapter 1: An Introduction to Taxation 3 do not pay taxes directly, they must file information tax returns. The income/loss from the partnership flows through to the partners and is reported on their own tax returns. If the partners are individuals, these results are reported on Schedule E (included in the personal tax return) and they pay any taxes owing on the income items. Partnerships and limited liability companies differ in a number of ways. Owners of partnerships are partners while owners of limited liability companies are called members. There are no legal requirements to set up a partnership but a limited liability company must be established according to the laws of the state of domicile. Limited liability companies can elect to be taxed as corporations while partnerships do not have that option. In some states, a limited liability company may have only one owner but a partnership must have two or more owners. General partners are normally required to pay self-employment taxes while only the managing member of a limited liability company may be subject to self- employment taxes. Other items of comparison could be drawn from the table in the text comparing business entity attributes. 15. [LO 1.6] Corporations Solution: The principal difference between a C corporation and an S corporation is in the method of taxation. A corporation pays a tax directly on its income. Any net after- tax income that is distributed to its shareholders as dividends is subject to a second level of tax. Thus, these corporate earnings are said to be subject to double taxation. An S corporation’s income flows directly through to its shareholders (whether there is an actual distribution of this income in cash or not) undiminished by taxes at the corporate level. The income is then taxed once only at the shareholder level. The corporation can then make actual distributions of this previously-taxed income to the S corporation shareholders without any additional taxes due. There are a number of other differences in that the number and type of S corporation shareholders is limited; it can only have one class of stock outstanding, and its choice of tax year is restricted. None of these restrictions apply to a C corporation. Other items of comparison could be drawn from the table in the text comparing business entity attributes. Crunch the Numbers 16. [LO1.1] Property Taxes Solution: He will pay $750. $20,000,000 / $4,000,000,000 = .005 or 5 mills per $1 of valuation. $150,000 x .005 = $750 in tax 17. [LO 1.2] FICA Taxes Solution: 2015: $40,000 x 7.65% = $3,060 No change for 2014: $40,000 x 7.65% = $3,060 18. [LO 1.2] FICA Taxes Solution: 9,377.00 is withheld for FICA taxes in 2015. $118,500 x 6.2% = $7,347.00 $140,000 x 1.45% = 2,030.00

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    4 Solutions Manual for Taxation for Decision Makers Total $9,377.00 $9,284 is withheld for FICA taxes in 2014. $117,000 x 6.2% = $7,254.00 $140,000 x 1.45% = 2,030.00 Total $9,284.00 In 2014, the taxpayer would have paid $93 less in Social Security taxes than in 2015 due to the $1,500 lower wage base on which the tax was levied. 19. [LO 1.5] Taxable Income Solution: Taxable income = $29,700 $40,000 Salary minus 6,300 Standard deduction minus 4,000 Personal exemption equals $29,700 Taxable income 20. [LO 1.5] Taxable Income Solution: Taxable income = $47,250 $71,000 Salary Plus 1,500 Interest income minus 9,250 Standard deduction minus 16,000 Personal and dependency exemptions ($4,000 x 4) equals $47,250 Taxable income 21. [LO 1.5] Taxable Income Solution: Taxable income = $49,000 $450,000 Gross receipts minus 145,000 Cost of goods sold equals $305,000 Gross income plus 20,000 Gain on sale minus 276,000 Expenses equals $49,000 Taxable income The $500 interest on State of New York bonds is tax-exempt. 22. [LO 1.5] Taxable Income Solution: Taxable income = $237,500 $560,000 Gross income plus 2,500 Interest income minus 325,000 Expenses equals $237,500 Taxable income The $20,000 capital loss is not deductible currently.

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    Chapter 1: An Introduction to Taxation 5 23. [LO 1.5] Taxable Income Solution : Taxable income = $74,000 George's salary $65,000 plus Mary's salary 45,000 equals AGI $110,000 minus Itemized deductions 20,000 minus Standard deduction 0 minus Personal & dependency exemptions ($4,000 x 4) 16,000 equals Taxable income $74,000 24. [LO 1.5] Determining Tax Liability Solution: Taxable income = $29,700; income tax = $3,993.75 Income Tax: ($9,225 x 10%) + ($20,475 x 15%) = $3,993.75. 25. [LO 1.5] Determining Tax Liability Solution: Taxable income = $47,250; income tax = 6,430. Income Tax: ($13,150 x 10%) + ($34,100 x 15%) = $6,430 26. [LO 1.5] Determining Tax Liability Solution: Taxable income = $49,000; income tax = $7,350. Income Tax: $49,000 x 15% = $7,350. 27. [LO 1.5] Determining Tax Liability Solution: Taxable income = $237,500; Income tax = $75,875 $50,000 x 15% = $7,500 $25,000 x 25% = 6,250 $25,000 x 34% = 8,500 $137,500 x 39% = 53,625 Total tax $75,875 28. [LO 1.5] Determining Tax Liability Solution: They save $1,760 ($11,937.50 - $10,177.50) by itemizing their deductions. Taxable income with itemizing = $74,000; Taxable income taking standard deduction = $81,400 ($110,000 in salaries - $12,600 standard deduction - $16,000 exemptions). Income Tax Calculation: Itemizing Standard Deduction $18,450 x 10% = $1,845.00 $18,450 x 10% = $1,845.00 $55,550 x 15% = $8,332.50 $56,450 x 15% = $8,467.50 ------------- $ 6,500 x 25% = $1,625.00 $10,177.50 $11,937.50

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    6 Solutions Manual for Taxation for Decision Makers 29. [LO 1.5] Marriage Penalty Solution: They have a marriage penalty of $264 ($31,851.50 - $31,587.50). Tax on $160,000 (MFJ) Tax on $80,000 (Single) $18,450 x 10% = $ 1,845.00 $ 9,225 x 10% = $ 922.50 $56,450 x 15% = 8,467.50 $28,225 x 15% = 4,233.75 $76,300 x 25% = 19,075.00 $42,550 x 25% = 10,637.50 $8,800 x 28% = 2,464.00 Total = $15,793.75 Total = $31,851.50 Total x 2 = $31,587.50 30. [LO 1.5] Joint vs. Single Filing Solution: a. It will be to their advantage to marry in 2015. b. By marrying before the end of 2015 and filing jointly, they save $6,019.75 ($43,471.25 - $37,451.50) in taxes. Tax on $180,000 (MFJ) Tax on $180,000 (Single-Conrad) $18,450 x 10% = $ 1,845.00 $9,225 x 10% = $ 922.50 $56,450 x 15% = 8,467.50 $28,225 x 15% = 4,233.75 $75,300 x 25% = 19,075.00 $53,350 x 25% = 13,325.00 $28,800 x 28% = 8,064.00 $89,250 x 28% = 24,990.00 Total = $37,451.50 Total = $43,471.25 c. If they each have $90,000 of income, they would each pay $18,293.75 in taxes and they would then have a marriage penalty of $864 ($37,451.50 - $36,587.50). In this case, they would be slightly better off by postponing their wedding until 2016. Tax on $90,000 (Single) $ 9,225 x 10% = $ 922.50 $28,225 x 15% = 4,233.75 $52,550 x 25% = 13,137.50 -------------- Total = $18,293.75 Total x 2 = $36,587.50 31. [LO 1.5] Tax Liability Solution: William’s income is twice John’s, but his taxes are 2.67 ($10,793.75/$4,038.75) times John’s. This illustrates the progressive nature of the tax system as well as vertical equity. John’s tax on $30,000 William’s tax on $60,000 $9,225 x 10% = $ 922.50 $ 9,225 x 10% = $ 922.50 $20,775 x 15% = 3,116.25 $28,225 x 15% = 4,233.75 _______ $22,550 x 25% = 5,637.50 Total = $4,038.75 Total = $10,793.75 32. [LO 1.5] Tax Liability Solution: Lilikoi paid $6,000 tax for 2013 and $30,050 tax for 2014. Lilikoi will have a refund of $9,900 from carrying back $40,000 of the 2015 loss to 2013 and $10,000 of the loss to 2014. (Note that Lilikoi cannot carry the loss back to only 2014 without first carrying it back to 2013.) Tax paid for 2013 on $40,000 was $40,000 x 15% = $6,000

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    Chapter 1: An Introduction to Taxation 7 Tax paid for 2014 on $120,000 was ($50,000 x 15%) + ($25,000 x 25%) + ($25,000 x 34%) + ($20,000 x 39%) = $30,050. The $10,000 loss that is carried back to 2014 reduces the taxable income for that year from $120,000 to $110,000 saving tax at the 39% rate that applies to income between $110,000 and $120,000. Tax refund from 2015 loss is ($40,000 x 15%) + ($10,000 x 39%) = $9,900 33. [LO 1.5] Tax Liability Solution: The net tax liability is $20,000. $250,000 gross income - $125,000 expenses = $125,000 taxable income. The income tax liability is: $50,000 x 15% = $7,500 $25,000 x 25% = 6,250 $25,000 x 34% = 8,500 $25,000 x 39% = 9,750 Gross tax = $32,000 Less tax credit 12,000 Net tax = $20,000 34. [LO 1.5] Tax Liability Solution: Taxable income = $49,000 and the net tax liability = $6,187.50. $76,000 salary and wages - $15,000 itemized deductions - $12,000 ($4,000 x 3) personal and dependency exemptions = $49,000 taxable income. Income tax liability is: $18,450 x 10% = $1,845.00 $31,550 x 15% = 4,582.50 Tax before credit = $6,427.50 Less tax credit 240.00 Net tax = $6,187.50 35. [LO 1.5] Alternative Minimum Tax Solution: The regular tax is $153,000 and the alternative minimum tax is $27,400. Regular tax: $450,000 x 34% = $153,000. Note that this $153,000 is the same tax that would be computed by going through all of the tax brackets as follows: ($50,000 x 15%) + ($25,000 x 25%) + ($25,000 x 34%) + ($235,000 x 39%) + ($115,000 x 34%) = $153,000. This illustrates that for corporations with taxable income between $335,000 and $10,000,000, the benefit of the lower tax brackets is completely eliminated by the 5% surtax on income between $100,000 and $335,000. Tentative alternative tax: $902,000 x 20% = $180,400 Alternative minimum tax: $180,400 - $153,000 = $27,400 The corporation will pay a total tax of $180,400 ($153,000 regular tax + $27,400 AMT)

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    8 Solutions Manual for Taxation for Decision Makers 36. [LO 1.5] Alternative Minimum Tax Solution: The alternative minimum tax would be $21,420.75 Regular tax on $140,000: $ 9,225 x 10% = $922.50 $28,225 x 15% = 4,233.75 $5,300 x 25% = 13,325.00 $49,250 x 28% = 13,790.00 $32,271.25 Tentative alternative minimum tax on $205,000: ($185,400 x 26%) + ([$205,000 - $185,400] 28%) = $48,204 + $5,488 = $53,692. The alternative minimum tax: $53,692 - $32,271.25 = $21,420.75 Betty will pay a total tax of $53,692 ($32,271.25 regular tax + $21,420.75 AMT) 37. [LO 1.5] Estate Income Tax Solution: The estate will pay $6,228.70. $2,500 x 15% = $375.00 $3,400 x 25% = 850.00 $3,150 x 28% = 882.00 $3,250 x 33% = 1,072.50 $7,300 x 39.6 = 3,049.20 Total tax $6,228.70 38. [LO 1.1 & 1.5] Differing Types of Taxes Solution: a. Wealth taxes are levied on assets owned by an individual or a business; the most common wealth tax is the property tax which comes in several forms such as real property taxes, inventory taxes, or taxes on plant and equipment. Wealth transfer taxes are only levied when the goods owned by one person are passed gratuitously to another as a gift or a bequest. Estate and inheritance taxes are wealth transfer taxes. b. The most common consumption tax is the sales tax which is based on the purchase price of goods or services when they are acquired by the spending of one’s income or savings. An income tax is levied on the increase in wealth as it is earned regardless of whether that income is actually spent or saved. If a single individual has $37,450 of taxable income in 2015, he will pay taxes of $5,156.25 on this amount even if he saves all or part of the after-tax income. In addition, any income on savings would also be taxed when earned. If this same individual were able to save all of the $37,450, under a consumption tax he would pay no taxes until he actually spent that income. The money saved would be available for investment and that income would not be taxed until it was spent. c. The 25% tax bracket for a married couple extends to $151,200 in 2015. This would be equivalent to two single individuals with equal incomes earning $75,600 each. Beyond $151,200, the married filing jointly rate increases to 28% and they begin to be subject to the marriage penalty. Single individuals remain in the 25% tax bracket until their income exceeds $90,750.

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    Chapter 1: An Introduction to Taxation 9 39. [LO 1.6] Tax Liability Solution: Taxable income = $28,700 and the tax liability is $3,843.75 $46,000 Salary minus 7,000 Partnership loss (50% x $14,000) equals $39,000 Gross income minus 6,300 Standard deduction minus 4,000 Personal exemption equals $28,700 Taxable income Tax calculation $922.50 $9,225 x 10% 2,921.25 $19,475 x 15% $3,843.75 Note that this solution assumes that Carolyn has at least $7,000 basis in her partnership interest so that she can deduct her full loss this year. 40. [LO 1.6] Tax Liability Comparisons Solution: Partnership: Pays no tax. June and John are each taxed on the $32,000 passed through to them at their marginal tax rates. To determine their marginal tax rates, find the tax bracket in which their other taxable income falls. (Note that the “other ordinary taxable income” is provided; either the standard or their itemized deductions and the personal exemptions have already been subtracted.) June’s $475,000 of other ordinary taxable income puts her in the 39.6% marginal tax bracket because she is a head of household with taxable income over $439,000. John’s $32,000 straddles the 25% and 28% marginal tax brackets because his $130,000 of taxable income plus the additional $32,000 exceeds $151,200 – the 25% tax bracket. Thus, $21,200 is taxed at 25% and $10,800 ($162,000 - $151,200) is taxed at 28% for a married taxpayer filing a joint return. June’s tax = $32,000 x 39.6% = $12,672. John’s tax = [$21,200 x 25% = $5,300] + [10,800 x .28 = $3,024] = $8,324. Together they pay a total of $20,996 in taxes. S Corporation: Pays no tax. June and John are each taxed on the $32,000 passed through to them at their marginal tax rates as shown above for the partnership and together they pay $20,996 in taxes. C Corporation: The corporation pays a tax of $11,000 [($50,000 x 15%) + ($14,000 x 25%)]. Neither June nor John pay any taxes as they received no distributions from the corporation. Note the problem specified only income taxes; employment taxes are not included in the solution to this problem. 41. [LO 1.6] Tax Liability Comparisons Solution: Partnership: The answer does not change because June and John are taxed fully on their shares of income whether they are distributed or not and the partnership pays

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    10 Solutions Manual for Taxation for Decision Makers no tax. Thus, June’s tax is still $12,672 and John’s tax is $8,324 for a total of $20,996 in taxes. They pay no additional tax on the $28,000 distribution. S Corporation: The answer does not change because June and John are taxed fully on their shares of income whether they are distributed or not and the S corporation pays no tax. Thus, June’s tax is still $12,672 and John’s tax is $8,324 for a total of $20,996 in taxes. They pay no additional tax on the $28,000 distribution. C Corporation: The corporation pays the same tax of $11,000 [($50,000 x 15%) + ($14,000 x 25%)]. June and John, however, will now have to recognize $28,000 of dividend income; John will be taxed at the 15% dividend rate but June will be taxed at 20% (the dividend rate for taxpayers in the 39.6% marginal tax bracket). June’s tax = $28,000 x 20% = $5,600. John’s tax = $28,000 x 15% = $4,200. The total tax for the corporation, June, and John is $20,800 ($11,000 + $5,600 + $4,200). Note the problem specified only income taxes; Medicare surtaxes and employment taxes are not included in the solution to this problem. 42. [LO 1.6] Tax Liability Comparisons Solution: Partnership: The partnership does not benefit from the loss. June and John are each allocated $22,000 of loss and can deduct the loss against their other income because they have sufficient basis in the partnership [$15,000 invested + ($30,000 bank loan x 50%) = $30,000 basis before loss - $22,000 loss = $8,000 ending basis]. June’s and John’s incomes are high enough for them to remain fully in their respective marginal tax rates of 39.6% and 25%. June benefits from a reduction in taxes of $8,712 ($22,000 x 39.6%) and John saves $5,500 ($22,000 x 25%) in taxes at his marginal tax rate. The total tax savings for both are $14,212 ($8,712 + $5,500). S Corporation: The S corporation does not benefit from the loss. June and John are each allocated $22,000 of the loss but they can only deduct $15,000 of this loss against their other income because their deduction is limited to their basis in their S corporation stock (which does not include any of the corporation’s liabilities). Thus, June benefits from a reduction in taxes of $5,940 ($15,000 x 39.6) at her marginal tax rate. John reduces his taxes by $3,750 ($15,000 x 25%) at his marginal tax rate. They will each carry their excess $7,000 loss forward; these losses can be deducted in a future year when they have sufficient basis. The total tax savings for the current year is $9,690 ($5,940 + $3,750). C Corporation: Neither June nor John have any current tax savings from the $44,000 loss. As a new corporation, it can only carry its loss forward to offset income (and realize tax savings) in a future year. Losses of a C corporation do not pass through to shareholders. Note the problem specified only income taxes; Medicare surtaxes and employment taxes were not included in the solution. 43. [LO 1.6] Choice of Business Entity Solution: a. (1) The partnership does not pay any tax in years 1 or 2. (2) The S corporation does not pay any tax in years 1 or 2.

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    Chapter 1: An Introduction to Taxation 11 (3) The C corporation pays no tax in year 1 but its year-1 loss can be carried forward to year 2 to offset $54,000 of its year-2 $60,000 income; it will pay a tax of $900 ($6,000 x 15%) on this remaining $6,000 income in year 2. b . (1) Tax savings for first year of partnership: Clara and Charles are each allocated $27,000 of loss and each can deduct loss to the extent of his or her basis of $25,000 [$15,000 investment + (50% x $20,000 loan)]. Clara’s tax savings will be $7,000 ($25,000 deductible loss x 28%) and Charles’s tax savings will be $6,250 ($25,000 deductible loss x 25%). The excess loss is carried forward to the next year. Partner’s basis computations: $15,000 Partner’s original investment +10,000 Partner’s share of liabilities ($20,000 loan x 50%) $25,000 Basis before deducting loss - 25,000 Deductible loss ($54,000 loss x 50% = $27,000 but limited to basis and $2,000 excess loss carried forward) 0 Basis at end of first year (2) Tax savings for first year of S corporation: Clara and Charles are each allocated $27,000 of loss and can deduct loss to the extent of his or her basis of $15,000 in the S corporation stock. Clara’s tax savings will be $4,200 ($15,000 deductible loss x 28%) and Charles’s savings will be $3,750 ($15,000 deductible loss x 25%). S corporation shareholder’s stock basis computations: $15,000 Shareholder’s original investment -15,000 Deductible loss ($54,000 loss x 50% = $27,000 but limited to basis and $12,000 excess loss carried forward) 0 Basis at end of first year Note that an S corporation shareholder does not increase stock basis for any corporate liabilities. (3) First year of C corporation: No effect on Clara or Charles. Their basis in stock remains $15,000 each. c. (1) Income tax for second year of partnership: Clara pays $7,840 income tax [($30,000 profit - $2,000 loss carried forward) x 28%] and Charles pays $7,000 income tax [($30,000 profit - $2,000 loss carried forward) x 25%]. The cash distribution is not taxed but is a reduction of basis. Partner’s basis computations: 0 Basis at end of first year $30,000 Year 2 profit ($60,000 x 50%) - 5,000 Cash distribution $25,000 Subtotal - 2,000 Deduct loss carried forward from previous year $23,000 Basis at end of second year (2) Income tax for second year of S corporation: Clara pays $5,040 in tax [($30,000 profit - $12,000 loss carried forward) x 28%] and Charles pays $4,500 tax [($30,000 profit - $12,000 loss carried forward) x 25%]. The cash distribution is not taxed but is a reduction of basis.

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    12 Solutions Manual for Taxation for Decision Makers S corporation shareholder’s stock basis computations: 0 Basis at end of first year $30,000 Year 2 profit ($60,000 x 50%) - 5,000 Cash distribution $25,000 Subtotal - 12,000 Deduct loss carried forward from previous year $13,000 Basis at end of second year (3) Income tax for second year of C corporation: Clara and Charles each pay $750 tax on their dividend income ($5,000 dividend income x 15% dividend rate = $750 tax). Their basis in the corporate stock remains $15,000. 44. [LO 1.6] Partnership Basis Solution: His basis is $5,200. $4,000 beginning basis + (30% x $7,000 partnership income) – (30% x $3,000 distribution) = $4,000 + $2,100 - $900 = $5,200 45. [LO 1.6] Tax Rates Solution: .05 x ($335,000 - $100,000) = $11,750 $50,000 (.34 - .15) = $9,500 ($75,000 - $50,000)(.34 - .25) = $2,250. $9,500 + $2,250 = $11,750 46. [LO 1.6] Tax Rates Solution: .03 ($18,333,333 - $15,000,000) = $100,000 (.35 - .34)($10,000,000) = $100,000 Develop Planning Skills 47. [LO 1.6] Single vs. Married Filing Status Solution: Married Filing Separately Married Filing Jointly Single Gross Income $100,000 $200,000 $100,000 Personal exemptions -4,000 -8,000 -4,000 Standard deduction -6,300 -12,600 -6,300 Taxable income $89,700 $179,400 $89,700 Tax Rates Tax for MFS Tax for MFJ Tax for Single 10% x $ 9,225 = $ 922.50 $18,450 = $1,845.00 $9,225 = $ 922.50 15% x 28,225 = 4,233.75 56,450 = 8,467.50 28,225 = 4,233.75 25% x 38,150 = 9,537.50 76,300 = 19,075.00 52,250 = 13,062.50 28% x 14,100 = 3,948.00 28,200 = 7,896.00 ----------- Total Tax 18,641.75 $37,283.50 $18,218.75 x 2 $37,283.50 $36,437.50 It makes no difference if they marry this year and file either as married filing jointly or separately. If they postpone the wedding until next year, they will save $846.00 ($37,283.50 - $36,437.50) in taxes filing as single individuals this year.

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    Chapter 1: An Introduction to Taxation 13 48. [LO 1.7] Total Tax Comparisons Solution: Sole Proprietorship: Jeremy will be taxed on the entire net income from the sole proprietorship of $48,000 ($60,000 – $12,000) regardless of the “salary.” $48,000 - $4,000 personal exemption - $6,300 standard deduction = $37,700 taxable income; (10% x $9,225) + (15% x $28,225) + ($250 x 25%) = $922.50 + $4,233.75 + $62.50 = $5,218.75 income tax. Corporation: $60,000 - $12,000 - $30,000 = $18,000 taxable income; $18,000 x 15% = $2,700 income tax. Income tax on Jeremy’s $30,000 salary: Jeremy’s taxable income = $30,000 - $6,300 standard deduction - $4,000 personal exemption = $19,700. Tax on $19,700 = ($9,225 x 10%) + ($10,475 x 15%) = $922.50 + $1,571.25 = $2,493.75. Total taxes as a corporation = $2,700 + $2,493.75 = $5,193.75 Based solely on income taxes, Jeremy should incorporate because his taxes will be $25 ($5,218.75 - $5,193.75) less than operating as a sole proprietorship. 49. [LO 1.6] Charitable Deduction Solution: As a married couple, their standard deduction is $12,600 in 2015 and estimated at $12,800 for 2016. The 10 percent they plan to give to charity is $13,500 in 2015 and is expected to be $14,000 in 2016. Their total planned contribution is $27,500 ($13,500 + $14,000) over the two years and they have saved sufficient funds to contribute the entire amount in one year. If they contribute the entire $27,500 in 2015, their taxable income would be $99,500 ($135,000 - $8,000 personal exemptions - $27,500 contribution) which is $14,900 less than their $114,400 taxable income if they claim the standard deduction ($135,000 - $8,000 personal exemptions - $12,600 standard deduction). This $14,900 savings in taxable income is within the 25% tax bracket. Their tax savings for 2015 are $3,725 [($14,900 x 25%) by doubling up their donations at the end of this year Under the assumption of no change in tax rates and only a $200 increase in the standard deduction, however, they would have reduced tax savings of $50 ($200 x 25%) in 2016, but one year later; in the meantime they could benefit from any income earned on the contribution until made in 2016. This would have to be compared to the additional income on their savings, however, if the contribution were postponed. 50. [LO 1.7] After-Tax Return Solution: The after-tax interest on the taxable bonds equals 6% (1 - .34) = 3.96%. The 4.5 percent interest rate on the tax-exempt bonds provides the better return. 51. [LO 1.7] Tax Liability Comparison Solution: Regular C Corporation: FICA tax on Carol’s $60,000 salary is $4,590 ($60,000 x 7.65%). FUTA = $420 ($7,000 x 6%) Corporate taxable income = $200,000 - $75,000 - $60,000 salary - $4,590 FICA - $420 FUTA= $59,990. Income tax on $59,990 = ($50,000 x 15%) + ($9,990 x 25%) = $7,500 + $2,497.50 = $9,997.50. Total corporate taxes = $4,590 + $420 +$9,997.50 = $15,007.50.

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    14 Solutions Manual for Taxation for Decision Makers Carol’s taxes: Carol also pays $4,590 ($60,000 x 7.65%) in FICA taxes on her salary but she cannot deduct these taxes. Carol’s taxable income = $60,000 - $6,300 standard deduction - $4,000 personal exemption = $49,700. Income tax on $49,700 = ($9,225 x 10%) + ($28,225 x 15%) + ($12,250 x 25%) = $922.50 + $4,233.75 + $3,062.50 = $8,218.75. Carol’s total taxes = $8,218.75 + $4,590 = $12,808.75. Total taxes = $15,007.50 + $12,808.75 = $27,816.25 S Corporation: FICA tax on Carol’s $60,000 salary is $4,590 ($60,000 x 7.65%). FUTA = $420 ($7,000 x 6%). The net S corporation income of $59,990 (same as the regular corporation) is passed through to Carol for taxation along with her salary income. Carol’s taxable income = $60,000 salary + $59,990 corporation income - $6,300 standard deduction - $4,000 exemption = $109,690. Tax on Carol’s $109,690 taxable income = ($9,225 x 10%) + ($28,225 x 15%) + ($53,300 x 25%) + ($18,940 x 28%) = $922.50 + $4,233.75 + $13,325 + $5,303.20 = $23,784.45 Carol’s total tax = $23,784.45 + $4,590 = $28,374.45 Total taxes = $28,374.45 + $4,590 +$420 = $33,384.45 Based on 2015 total taxes only, Carol should not make the S corporation election because the total taxes will be $5,568.20 ($33,384.45 - $27,816.25) less operating as a regular C corporation. Think Outside the Text These questions require answers that are beyond the material that is covered in this chapter. 52. [LO 1.2] Tax Rates Solution: Income Tax Rate on salary Employment Tax Rate Capital Gains Tax Rate 15% 7.65% 0% 28% 6.2% up to $118,500 and 1.45% on $132,000 15% 28% 6.2% up to $118,500 and 1.45% on $176,000 salary 15% on the first $24,000 and 18.6% on the remaining $115,000 33% 6.2% up to $118,500; 1.45% to $200,000; 2.35% above $200,000 18.6% on the first $128,200 (up to AGI of $413,200) and 23.6% on remaining $119,800 53. [LO .3] Tax Fairness Solution: No answer is suggested here as the purpose of this question is to require the student to select an alternative and construct an argument to support that position.

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    Chapter 1: An Introduction to Taxation 15 54. [LO 1.3] Property Tax Solution: As an ad valorem tax, a property tax is proportional. If you look at any other taxing base except the value of the property, the tax may be progressive for some group of citizens and regressive for others. For example, senior citizens generally have lower incomes than working persons. They may live in equivalently valued houses because they have lived there a long time and have no mortgage, however. In this case, based on a percentage of income, the property tax would be regressive. Alternatively, a lower income person may spend only 25 percent of his or her income on housing because of other necessities. A high-income person may be able to spend 40 percent of his or her income on housing. The latter’s property taxes will be much higher as a percent of income than the former. In this situation, the tax is progressive when based on income. Thus, for a wealth tax such as a property tax, wealth is the only base on which it is practical to evaluate it. It is generally proportional, although a certain base amount may be excluded from the tax (for example, a $25,000 homestead exemption for persons who own their own home and this would make it somewhat progressive). 55. [LO 1.3] Canons of Taxation Solution: The four canons of taxation are equity, economy, certainty, and convenience. In general, with the exception of an evaluation based on equity, many persons believe the sales tax that most states levy is superior to the income tax. The costs to collect and comply with the sales tax are relatively small compared to the amounts collected (although internet sales are a significant problem now); most persons know that when they purchase certain items they are required to pay sales taxes; and they pay at the point of sale without having to file end-of-year returns. Sales taxes are considered regressive, however, and therefore not considered equitable. As a percentage of income, lower income persons pay more sales tax than higher income persons do because they are obliged to spend more of their income. As an absolute amount, however, most wealthy persons spend more overall than poor persons, and, as a result pay more sales taxes (vertical equity). Two persons with equal incomes can pay different amounts of sales taxes, however, if one party chooses to save money while the other spends; this would violate horizontal equity. The income tax has far higher costs of collections and administration but its tax rates are progressive and it contains provisions that exempt low-income taxpayers from paying any taxes. Thus, it is generally seen as more equitable than a sales tax. It fails, however, on convenience and certainty because of the annual filing requirements and constant changing of the laws. 56. [LO 1.3] Flat Tax Solution: Most students will agree that there will have to be some basic exclusions or deductions to enact a viable flat tax. Comparisons can be drawn, however, to the FICA taxes, which have been flat over incomes up to the Social Security base amount ($118,500 for 2014), but only the Medicare portion applies above this base amount; an income flat tax, on the contrary, could be structured to exempt a certain base amount from tax with the tax applying on all income above that minimum

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