All Chapters Test Bank Complete Answers

All Chapters Test Bank Complete Answers 1. The ratification of the Sixteenth Amendment to the U.S. Constitution was necessary to validate the Federal income tax on individuals. a. True b. False 2. Before the Sixteenth Amendment to the Constitution was ratified, there was no valid Federal income tax on individuals. a. True b. False 3. The first income tax on individuals (after the ratification of the Sixteenth Amendment to the Constitution) levied tax rates from a low of 2% to a high of 6%. a. True b. False 4. The Federal income tax on corporations generates more revenue than the Federal income tax on individuals. a. True b. False 5. The pay-as-you-go feature of the Federal income tax on individuals conforms to Adam Smith’s canon of convenience. a. True b. False 6. Although the law is complicated, most individual taxpayers are able to complete their Federal income tax returns without outside assistance. a. True b. False 7. The FICA tax (Medicare component) on wages is progressive since the tax due increases as wages increase. a. True b. False 8. The Federal estate and gift taxes are examples of progressive taxes. a. True b. False 9. The Federal excise tax on cigarettes is an example of a proportional tax. a. True b. False 10. Currently, the Federal income tax is more progressive than it ever has been in the past. a. True b. False 11. Mona inherits her mother’s personal residence, which she converts to a furnished rent house. These changes should affect the amount of ad valorem property taxes levied on the properties. a. True b. False 12. A fixture will be subject to the ad valorem tax on personalty rather than the ad valorem tax on realty. a. True b. False 13. Even if property tax rates are not changed, the ad valorem taxes imposed on realty may not remain the same. a. True b. False 14. The ad valorem tax on business use personalty is more often avoided by taxpayers than the ad valorem tax on personal use personalty. a. True b. False 15. Federal excise tax is no longer imposed on cosmetics. a. True b. False 16. The tax on hotel occupancy is subject to both Federal and state excise taxes. a. True b. False 17. The Federal gas-guzzler tax applies only to automobiles manufactured overseas and imported into the U.S. a. True b. False 18. Like the Federal counterpart, the amount of the state excise taxes on gasoline do not vary from state to state. a. True b. False 19. The states that impose a general sales tax also have a use tax. a. True b. False 20. Sales made by mail order are not exempt from the application of a general sales (or use) tax. a. True b. False 21. Two persons who live in the same state but in different counties may not be subject to the same general sales tax rate. a. True b. False 22. States impose either a state income tax or a general sales tax, but not both types of taxes. a. True b. False 23. A safe and easy way for a taxpayer to avoid local and state sales taxes is to have the purchase sent to an address in another state that levies no such taxes. a. True b. False 24. On transfers by death, the Federal government relies on an estate tax, while states use only an inheritance tax. a. True b. False 25. An inheritance tax is a tax on a decedent’s right to pass property at death. a. True b. False 26. One of the major reasons for the enactment of the Federal estate tax was to prevent large amounts of wealth from being accumulated within the family unit. a. True b. False 27. CHAPTER 1 AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE27 Under Clint’s will, all of his property passes to either the Lutheran Church or to his wife. No Federal estate tax will be due on Clint’s death in 2011. a. True b. False 28. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE28 Under a state inheritance tax, two heirs, a cousin and a son of the deceased, would be taxed at the same rate. a. True b. False 29. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE29 The annual exclusion, currently $13,000, is available for gift but not estate tax purposes. a. True b. False 30. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE30 In 2011, José, a widower, sells land (fair market value of $100,000) to his daughter, Linda, for $50,000. José has made a taxable gift of $37,000. a. True b. False 31. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE31 Julius, a married taxpayer, makes gifts to each of his six children. A maximum of six annual exclusions could be allowed as to these gifts. a. True b. False 32. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE32 One of the motivations for making a gift is to save on income taxes. a. True b. False 33. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE33 The formula for the Federal income tax on corporations is not the same as that applicable to individuals. a. True b. False 34. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE34 A state income tax can be imposed on nonresident taxpayers who earn income within the state or on an itinerant basis. a. True b. False 35. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE35 For state income tax purposes, all states allow a deduction for Federal income taxes. a. True b. False 36. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE36 Some states use their state income tax return as a means of collecting unpaid sales and use taxes. a. True b. False 37. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE37 No state has offered an income tax amnesty program more than once. a. True b. False 38. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE38 For Federal income tax purposes, there never has been a general amnesty period. a. True b. False 39. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE39 Under state amnesty programs, all delinquent and unpaid income taxes are forgiven. a. True b. False 40. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE40 When a state decouples from a Federal tax provision, it means that this provision will not apply for state income tax purposes. a. True b. False 41. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE41 The principal objective of the FICA tax is to provide some measure of retirement security. a. True b. False 42. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE42 Currently, the tax base for the Medicare component of the FICA is not limited to a dollar amount. a. True b. False 43. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE43 A parent employs his twin daughters, age 19, in his sole proprietorship. The daughters are not subject to FICA coverage. a. True b. False 44. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE44 Unlike FICA, FUTA requires that employers comply with state as well as Federal rules. a. True b. False 45. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE45 A major disadvantage of a flat tax type of income tax is its complexity. a. True b. False 46. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE46 The value added tax (VAT) has had wide acceptance in the international community. a. True b. False 47. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE47 Recently, more IRS audits are producing a greater number of no change results. This indicates increased compliance on the part of taxpayers. a. True b. False 48. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE48 The amount of a taxpayer’s itemized deductions will increase the chance of being audited by the IRS. a. True b. False 49. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE49 In a field audit, the audit by the IRS takes place at the office of the IRS. a. True b. False 50. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE50 The IRS agent auditing the return will issue an RAR even if the taxpayer owes no additional taxes. a. True b. False 51. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE51 If a “special agent” becomes involved in the audit of a return, this indicates that the IRS suspects that fraud is involved. a. True b. False 52. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE52 If a taxpayer files early (i.e., before the due date of the return), the statute of limitations on assessments begins on the date the return is filed. a. True b. False 53. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE53 For omissions from gross income in excess of 25% of that reported, there is no statute of limitations on additional income tax assessments by the IRS. a. True b. False 54. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE54 If an income tax return is not filed by a taxpayer, there is no statute of limitations on assessments of tax by the IRS. a. True b. False 55. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE55 If fraud is involved, there is no time limit on the assessment of a deficiency by the IRS. a. True b. False 56. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE56 The IRS is required to redetermine the interest rate on underpayments and overpayments once a year. a. True b. False 57. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE57 A calendar year taxpayer files his 2010 Federal income tax return on March 3, 2011. The return reflects an overpayment of $6,000, and the taxpayer requests a refund of this amount. The refund is paid on May 18, 2011. The refund must include interest. a. True b. False 58. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE58 For individual taxpayers, the interest rate for income tax refunds (overpayments) is not the same as that applicable to assessments (underpayments). a. True b. False 59. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE59 During any month in which both the failure to file penalty and the failure to pay penalty apply, the failure to file penalty is reduced by the amount of the failure to pay penalty. a. True b. False 60. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE60 When interest is charged on a deficiency, any part of a month counts as a full month. a. True b. False 61. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE61 For the negligence penalty to apply, the underpayment must be caused by intentional disregard of rules and regulations with intent to defraud. a. True b. False 62. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE62 Upon audit by the IRS, Faith is assessed a deficiency of $40,000 of which $25,000 is attributable to negligence. The 20% negligence penalty will apply to only $25,000. a. True b. False 63. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE63 If the tax deficiency is attributable to fraud, the negligence penalty will not be imposed. a. True b. False 64. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE64 The civil fraud penalty can entail large fines and possible incarceration. a. True b. False 65. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE65 Even though a client refuses to correct an error on a past return, it may be possible for a practitioner to continue to prepare returns for the client. a. True b. False 66. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE66 In preparing an income tax return, the use of a client’s estimates is permitted. a. True b. False 67. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE67 In preparing a tax return, all questions on the return must be answered. a. True b. False 68. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE68 A CPA firm in California sends many of its less complex tax returns to be prepared by a group of accountants in India. If certain procedures are followed, this outsourcing of tax return preparation is proper. a. True b. False 69. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE69 The objective of pay-as-you-go (paygo) is to achieve revenue neutrality. a. True b. False 70. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE70 When Congress enacts a tax cut that is phased in over a period of years, revenue neutrality is achieved. a. True b. False 71. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE71 A tax cut enacted by Congress that contains a sunset provision will make the tax cut permanent. a. True b. False 72. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE72 The tax law provides various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. These provisions can be justified on both economic and social grounds. a. True b. False 73. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE73 Various tax provisions encourage the creation of certain types of retirement plans. Such provisions can be justified on both economic and equity grounds. a. True b. False 74. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE74 To lessen, or eliminate, the effect of multiple taxation, a taxpayer who is subject to both foreign and U.S. income taxes on the same income is allowed either a deduction or a credit for the foreign tax paid. a. True b. False 75. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE75 To mitigate the effect of the annual accounting period concept, the tax law permits the carryback and carryforward to other years of the net operating loss of a particular year. a. True b. False 76. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE76 Jason’s business warehouse is destroyed by fire. As the insurance proceeds exceed the basis of the property, a gain results. If Jason shortly reinvests the proceeds in a new warehouse, no gain is recognized due to the application of the wherewithal to pay concept. a. True b. False 77. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE77 Congress has enacted a provision to allow a deduction for state and local sales taxes. Such a provision can be justified on social grounds. a. True b. False 78. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE78 As it is consistent with the wherewithal to pay concept, the tax law requires a seller to recognize gain in the year the installment sale took place. a. True b. False 79. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE79 Stealth taxes have the effect of generating additional taxes from higher income taxpayers. a. True b. False 80. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE80 A provision in the law that compels accrual basis taxpayers to pay a tax on prepaid income in the year received and not when earned is consistent with generally accepted accounting principles. a. True b. False 81. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE81 As a matter of administrative convenience, the IRS would prefer to have Congress increase (rather than decrease) the amount of the standard deduction allowed to individual taxpayers. a. True b. False 82. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE82 In cases of doubt, courts have held that tax relief provisions should be narrowly construed in against taxpayers. a. True b. False 83. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE83 On occasion, Congress has to enact legislation that clarifies the tax law in order to change a result reached by the U.S. Supreme Court. a. True b. False 84. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE84 Which, if any, of the following statements best describes the history of the Federal income tax? a. It existed during the Civil War. b. The Federal income tax on corporations was held by the U.S. Supreme Court to be contrary to the U.S. Constitution. c. The Federal income tax on individuals was held by the U.S. Supreme Court to be allowable under the U.S. Constitution. d. Both the Federal income tax on individuals and on corporations was held by the U.S. Supreme Court to be contrary to the U.S. Constitution. e. None of the above. 85. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE85 Which, if any, is not one of Adam Smith’s canons of taxation? a. Economy. b. Certainty. c. Simplicity. d. Convenience. e. Equality. 86. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE86 Which, if any, of the following taxes are proportional (rather than progressive)? a. Federal corporate income tax. b. Federal employment taxes (i.e., FICA, FUTA). c. Federal estate tax. d. Federal gift tax. e. All of the above. 87. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE87 Which, if any, of the following transactions will increase a taxing jurisdiction’s revenue from the ad valorem tax imposed on real estate? a. A resident dies and leaves his farm to his church. b. A large property owner issues a conservation easement as to some of her land. c. A tax holiday issued 10 years ago has expired. d. A bankrupt motel is acquired by the Red Cross and is to be used to provide housing for homeless persons. e. None of the above. 88. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE88 Which, if any, of the following transactions will decrease a taxing jurisdiction’s ad valorem tax revenue imposed on real estate? a. A tax holiday is denied to an out-of-state business that is searching for a new factory site. b. An abandoned church is converted to a restaurant. c. A public school is razed and turned into a city park. d. A local university buys an apartment building for use as a student dormitory. e. None of the above. 89. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE89 Which, if any, of the following is a typical characteristic of an ad valorem tax on personalty? a. Taxpayer compliance is greater for personal use property than for business use property. b. The tax on automobiles sometimes considers the age of the vehicle. c. Most states impose a tax on intangibles. d. The tax on intangibles generates considerable revenue since it is difficult for taxpayers to avoid. e. None of the above. 90. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE90 Federal excise taxes that are no longer imposed include: a. Tax on air travel. b. Tax on wagering. c. Tax on the manufacture of sporting equipment. d. Tax on jewelry. e. None of the above. 91. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE91 Taxes not imposed by the Federal government include: a. Tobacco excise tax. b. Car rental tax. c. Customs duties (tariffs on imports). d. Gas guzzler tax. e. None of the above. 92. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE92 Taxes levied by both states and the Federal government include: a. General sales tax. b. Custom duties. c. Hotel occupancy tax. d. Franchise tax. e. None of the above. 93. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE93 Taxes levied by all states include: a. Liquor excise tax. b. Individual income tax. c. Inheritance tax. d. General sales tax. e. None of the above. 94. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE94 A use tax is imposed by: a. The Federal government and all states. b. The Federal government and a majority of the states. c. All states and not the Federal government. d. Most of the states and not the Federal government. e. None of the above. 95. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE95 Burt and Lisa are married and live in a common law state. Burt wants to make gifts to their five children in 2011. What is the maximum amount of the annual exclusion they will be allowed for these gifts? a. $0. b. $13,000. c. $26,000. d. $65,000. e. $130,000. 96. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE96 Property can be transferred within the family group by gift or at death. One motivation for preferring the gift approach is: a. To take advantage of the per donee annual exclusion. b. To avoid a future decline in value of the property transferred. c. To take advantage of the higher unified transfer tax credit available under the gift tax. d. To shift income to higher bracket donees. e. None of the above. 97. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE97 Indicate which, if any, statement is incorrect. State income taxes: a. Can piggyback to the Federal version. b. Can decouple from the Federal version. c. Can apply to visiting nonresidents. d. Can provide occasional amnesty programs. e. None of the above. 98. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE98 State income taxes generally can be characterized by: a. A different date for filing than the Federal income tax. b. Provision for withholding procedures. c. Allowance of a deduction for Federal income taxes paid. d. Applying only to individuals and not applying to corporations. e. None of the above. 99. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FE99 A characteristic of FICA is that: a. It applies when one spouse works for the other spouse. b. It is imposed only on the employer. c. It provides a modest source of income in the event of loss of employment. d. It is administered by both state and Federal governments. e. None of the above. 100. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F100 A characteristic of FUTA is that: a. It is imposed on both employer and employee. b. It is imposed solely on the employee. c. Compliance requires following guidelines issued by both state and Federal regulatory authorities. d. It is applicable to spouses of employees but not to any children under age 18. e. None of the above. 101. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F101 The U.S. (either Federal, state, or local) does not impose: a. Franchise taxes. b. Severance taxes. c. Occupational fees. d. Export duties. e. Customs duties. 102. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F102 The proposed flat tax: a. Would eliminate the income tax. b. Would simplify the income tax. c. Would tax the increment in value as goods move through the production and manufacturing stages to the marketplace. d. Is a tax on consumption. e. None of the above. 103. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F103 A VAT (value added tax): a. Is regressive in its effect. b. Has not proved popular outside of the U.S. c. Is not a tax on consumption. d. Is used exclusively by third world (less developed) countries. e. None of the above. 104. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F104 Characteristics of the “Fair Tax” (i.e., national sales tax) include which, if any, of the following: a. Abolition of the Federal individual (but not the corporate) income tax. b. Abolition of all Federal income taxes but retention of payroll taxes (including the self-employment tax). c. Abolition of all Federal income taxes and payroll taxes but retention of the Federal estate and gift taxes. d. Abolition of all Federal income and payroll taxes as well as the Federal estate and gift taxes. e. None of the above. 105. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F105 In terms of probability, which of the following taxpayers would be least likely to be audited by the IRS? a. Taxpayer owns and operates a check-cashing service. b. Taxpayer is an employed electrician. c. Taxpayer just received a $3 million personal injury award as a result of a lawsuit. d. Taxpayer just won a $1 million slot machine jackpot at a Las Vegas casino. e. Taxpayer has been audited several times before. 106. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F106 Which of the following is a characteristic of the audit process? a. Most taxpayer audits involve “special” agents. b. Self-employed taxpayers are less likely to be selected for audit than employed taxpayers. c. Less important issues are handled by means of a correspondence audit. d. If a taxpayer disagrees with the IRS auditor’s finding, the only resort is to the courts. e. None of the above. 107. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F107 Scott files his tax return 65 days after the due date. Along with the return, Scott remits a check for $50,000 which is the balance of the tax owed. Disregarding the interest element, Scott’s total failure to file and to pay penalties are: a. $750. b. $6,000. c. $7,500. d. $8,250. e. None of the above. 108. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F108 A characteristic of the fraud penalties is: a. Civil fraud can result in a fine and a prison sentence. b. When negligence and civil fraud apply to a deficiency, the civil fraud penalty predominates. c. The criminal fraud penalty is 75% of the deficiency attributable to the fraud. d. The IRS has the same burden of proof in the case of criminal fraud than with civil fraud. e. None of the above. 109. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F109 Regarding proper ethical guidelines, which (if any) of the following is correct? a. The use of client estimates in preparing a return is not acceptable. b. Under no circumstances should a question on a tax return be left unanswered. c. If a client has made a mistake in a prior year’s return and refuses to correct it, you should withdraw from the engagement. d. If the exact amount of a deduction is not certain (e.g., around mid-$600s) , it should not be recorded as an odd amount (i.e., $649) so as to increase the appearance of greater certainty. e. None of the above. 110. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F110 Both economic and social considerations can be used to justify: a. Various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. b. Disallowance of any deduction for expenditures deemed to be contrary to public policy (e.g., fines, penalties, illegal kickbacks, bribes to government officials). c. Favorable tax treatment for accident and health plans provided for employees and financed by employers. d. Allowance of a deduction for state and local income taxes paid. e. None of the above. 111. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F111 Social considerations can be used to justify: a. Allowing a Federal income tax deduction for state and local sales taxes. b. Allowing excess capital losses to be carried over to other years. c. Allowing accelerated amortization for the cost of installing pollution control facilities. d. Allowance of a credit for child care expenses. e. None of the above. 112. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F112 Allowing a domestic production activities deduction for certain manufacturing income can be justified: a. As mitigating the effect of the annual accounting period concept. b. As promoting administrative feasibility. c. By economic considerations. d. Based on the wherewithal to pay concept. e. None of the above. 113. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F113 Provisions in the tax law that promote energy conservation and more use of alternative (non-fossil) fuels can be justified by: a. Political considerations. b. Economic and social considerations. c. Promoting administrative feasibility. d. Encouragement of small business. e. None of the above. 114. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F114 Which, if any, of the following provisions cannot be justified as mitigating the effect of the annual accounting period concept? a. Nonrecognition of gain allowed for involuntary conversions. b. Net operating loss carryback and carryover provisions. c. Carry over of excess charitable contributions. d. Use of the installment method to recognize gain. e. Carry over of excess capital losses. 115. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F115 Which, if any, of the following provisions of the tax law cannot be justified as promoting administrative feasibility (simplifying the task of the IRS)? a. Penalties are imposed for failure to file a return or pay a tax on time. b. Prepaid income is taxed in the year received and not in the year earned. c. Annual adjustments for indexation increases the amount of the standard deduction allowed. d. Casualty losses must exceed 10% of AGI to be deductible. e. A deduction is allowed for charitable contributions. 116. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F116 A landlord leases property upon which the tenant makes improvements. The improvements are significant and are not made in lieu of rent. At the end of the lease, the value of the improvements are not income to the landlord. This rule is an example of: a. A clear reflection of income result. b. The tax benefit rule. c. The arm’s length concept. d. The wherewithal to pay concept. e. None of the above. 117. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F117 Match the statements that relate to each other. Note: Choice k may be used more than once.Jock taxDecouplingDIFTax fraud suspectedRevenue neutralityRARWherewithal to pay conceptMitigation of the annual accounting period conceptTax on transfers at death (inheritance type)Excise tax on tobaccoUse taxIncome tax amnestyTax deficiency assessed in prior years“Pay-as-you-go” (paygo)Export taxesState income tax applied to visiting nonresident Undoing the “piggyback” result Criteria in the selection of tax returns for audit IRS special agent Ideal budget goal as to new tax legislation “No change” is one possible result Deferral of gains from involuntary conversions Carryback and carryforward of net operating losses. Imposed by some states but not the Federal government No correct match provided Every state that has a general sales tax has one Imposed by some states but not the Federal government Criteria in the selection of tax returns for audit Ideal budget goal as to new tax legislation No correct match provided [a] 1. Jock tax [b] 2. Decoupling [c] 3. DIF [d] 4. Tax fraud suspected [e] 5. Revenue neutrality [f] 6. RAR [g] 7. Wherewithal to pay concept [h] 8. Mitigation of the annual accounting period concept [i] 9. Tax on transfers at death (inheritance type) [j] 10. Excise tax on tobacco [k] 11. Use tax [l] 12. Income tax amnesty [m] 13. Tax deficiency assessed in prior years [n] 14. “Pay-as-you-go” (paygo) [o] 15. Export taxes a. State income tax applied to visiting nonresident b. Undoing the “piggyback” result c. Criteria in the selection of tax returns for audit d. IRS special agent e. Ideal budget goal as to new tax legislation f. “No change” is one possible result g. Deferral of gains from involuntary conversions h. Carryback and carryforward of net operating losses. i. Imposed by some states but not the Federal government j. No correct match provided k. Every state that has a general sales tax has one l. Imposed by some states but not the Federal government m. Criteria in the selection of tax returns for audit n. Ideal budget goal as to new tax legislation o. No correct match provided 118. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F118 Match the statements that relate to each other. Note: Some choices may be used more than once.Office auditField auditFailure to file penaltyFailure to pay penaltyNegligence penaltyCivil fraud penaltyFraud and statute of limitationsEarly filing and statute of limitations (deficiency situations)Late filing and statute limitations (deficiency situations)No return and statute limitationsMore than 25% gross income omission and statute of limitationsInterest due on refundConducted at IRS office Conducted at taxpayer’s office 5% per month (25% limit) 0.5% per month (25% limit) 20% of underpayment No correct match provided No statute of limitations (period remains open). 3 years from due date of return 3 years from date return is filed No statute of limitations (period remains open). 6 years 45-day grace period allowed to IRS [a] 1. Office audit [b] 2. Field audit [c] 3. Failure to file penalty [d] 4. Failure to pay penalty [e] 5. Negligence penalty [f] 6. Civil fraud penalty [g] 7. Fraud and statute of limitations [h] 8. Early filing and statute of limitations (deficiency situations) [i] 9. Late filing and statute limitations (deficiency situations) [j] 10. No return and statute limitations [k] 11. More than 25% gross income omission and statute of limitations [l] 12. Interest due on refund a. Conducted at IRS office b. Conducted at taxpayer’s office c. 5% per month (25% limit) d. 0.5% per month (25% limit) e. 20% of underpayment f. No correct match provided g. No statute of limitations (period remains open). h. 3 years from due date of return i. 3 years from date return is filed j. No statute of limitations (period remains open). k. 6 years l. 45-day grace period allowed to IRS 119. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F119 Using the choices provided below, show the justification for each provision of the tax law listed. Note: In some cases, more than one answer is appropriate.A tax credit for amounts spent to furnish care for children while the parent is at work.Additional depreciation deduction allowed for the year the asset is acquired.Tax brackets are increased for inflation.A small business corporation can elect to avoid the corporate income tax.A deduction for contributions by an employee to certain retirement plans.A deduction for qualified tuition paid to obtain higher education.A deduction for certain expenses (interest and taxes) incident to home ownership.A Federal deduction for state and local income taxes paid.A deduction for certain income from manufacturing activities.A bribe to the local sheriff, although business related, is not deductible.Contributions to charitable organizations are deductible.A Federal deduction for state and local sales taxes paid.Tax credits available for the purchase of a vehicle that uses alternative (non-fossil) fuels.Tax credits for home improvements that conserve energy.More rapid expensing for tax purposes of the costs of installing pollution control devicesSocial considerations Economic considerations Equity considerations Economic considerations Economic considerations Economic considerations Economic considerations Equity considerations Economic considerations Social considerations Social considerations Equity considerations Economic considerations Economic considerations Economic considerations [a] 1. A tax credit for amounts spent to furnish care for children while the parent is at work. [b] 2. Additional depreciation deduction allowed for the year the asset is acquired. ownership. [c] 3. Tax brackets are increased for inflation. [d] 4. A small business corporation can elect to avoid the corporate income tax. [e] 5. A deduction for contributions by an employee to certain retirement plans. [f] 6. A deduction for qualified tuition paid to obtain higher education. [g] 7. A deduction for certain expenses (interest and taxes) incident to home [h] 8. A Federal deduction for state and local income taxes paid. [i] 9. A deduction for certain income from manufacturing activities. [j] 10. A bribe to the local sheriff, although business related, is not deductible. [k] 11. Contributions to charitable organizations are deductible. [l] 12. A Federal deduction for state and local sales taxes paid. [m] 13. Tax credits available for the purchase of a vehicle that uses alternative (non-fossil) fuels. [n] 14. Tax credits for home improvements that conserve energy. [o] 15. More rapid expensing for tax purposes of the costs of installing pollution control devices a. Social considerations b. Economic considerations c. Equity considerations d. Economic considerations e. Economic considerations f. Economic considerations g. Economic considerations h. Equity considerations i. Economic considerations j. Social considerations k. Social considerations l. Equity considerations m. Economic considerations n. Economic considerations o. Economic considerations 120. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F120 Molly, a widow, makes cash gifts to her five married children (including their spouses) and to her eight grandchildren. a. What is the maximum amount Molly can give for calendar year 2011 without using her unified transfer tax credit? b. What is the maximum amount Molly can give for calendar year 2011 also using her unified transfer tax credit? [Note: Molly has never made any prior taxable gifts.] Correct Answer: a. $234,000. $13,000 (annual exclusion) ´ 18 donees = $234,000. b. $5,234,000. $13,000 (annual exclusion) ´ 18 donees = $234,000 + $5,000,000 (the exemption equivalent of a $1,730,800 credit) = $5,234,000. 121. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F121 For the tax year 2011, Sam reported gross income of $400,000 on his timely filed Federal income tax return. a. Presuming the general rule applies, when does the statute of limitations on assessments normally expire? b. Suppose Sam inadvertently omitted gross income of $101,000. When does the statute of limitations on assessments expire? c. Suppose the omission was deliberate and not inadvertent. When does the statute of limitations on assessments expire? Correct Answer: a. Three years from April 16, 2012 (April 15 is a Sunday). b. If more than 25% of gross income is omitted, a six-year statute applies (i.e., 6 years from April 16, 2012). Here, it does as $101,000 is more than $100,000 (25% ´ $400,000). c. If fraud is involved, the statute never expires. 122. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F122 Without obtaining an extension, Lisa files her income tax return 45 days after the due date. With her return, she pays an additional tax of $40,000. Disregarding any interest element, what is Lisa’s penalty for failure to pay and to file? Correct Answer: $7,500. Disregarding the interest element, Lisa’s total penalties are as follows: Failure to pay penalty (0.5% ´ $40,000 ´ 2 months) $ 400 Plus: Failure to file penalty (5% ´ $40,000 ´ 2 months) $4,000 Less failure to pay penalty for same period (400) 3,600 Total penalties $4,000 123. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F123 On his 2011 income tax return, James omitted income and overstated deductions to the extent that his income tax was understated by $300,000. Disregarding any interest element, what is James’ penalty if the understatement was due to: a. Negligence. b. Civil fraud. c. Criminal fraud. Correct Answer: a. $60,000 (20% ´ $300,000). b. $225,000 (75% ´ $300,000). c. Various fines and/or prison sentence. 124. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F124 Several years ago, Ted purchased extra grazing land for his ranch at a cost of $40,000. In 2011, the land is condemned by the state for development as a highway maintenance depot. Under the condemnation award, Ted receives $100,000 for the land. Within the same year, he replaces the property with other grazing land. What is Ted’s tax situation if the replacement land cost: a. $35,000? b. $60,000? c. $105,000? d. Why? Correct Answer: a. The full realized gain of $60,000 [$100,000 (condemnation proceeds) – $40,000 (cost of land)] must be recognized, as only $35,000 was reinvested. The condemnation proceeds of $100,000 exceed the amount reinvested by more than $60,000. b. As only $60,000 was reinvested in replacement property, $40,000 ($100,000 – $60,000) of the gain must be recognized. c. As the full $100,000 was reinvested, no realized gain need be recognized. d. If some of the gain is not reinvested, consistent with the wherewithal to pay concept there exists the ability to pay the tax. 125. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F125 Paige is the sole shareholder of Citron Corporation. During the year, Paige leases a building to Citron for a monthly rental of $80,000. If the fair rental value of the building is $60,000, what are the income tax consequences to the parties involved? Correct Answer: The rent charged by Paige is not “arms length”; as such, Citron Corporation’s rent deduction is $60,000 (not $80,000). The $20,000 difference is a nondeductible dividend distribution. For Paige, the change merely requires reclassification. Instead of $80,000 of rent income, she has $60,000 of rent income and $20,000 of dividend income. 126. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F126 In 1985, Roy leased real estate to Drab Corporation for 20 years. Drab Corporation made significant capital improvements to the property. In 2005, Roy decides not to renew the lease and vacates the property. At that time, the value of the improvements is $800,000. Roy sells the real estate in 2011 for $1,200,000 of which $900,000 is attributable to the improvements. How and when is Roy taxed on the improvements made by Drab Corporation? Correct Answer: Roy is not subject to taxation on the improvements until he disposes of the property (i.e., 2011). After a controversial Supreme Court decision years ago, Congress clarified the tax law to make it more consistent with the wherewithal to pay concept. 127. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F127 The Federal income tax is based on a pay-as-you-go system and has become a “mass tax.” Explain this statement. Correct Answer: The pay-as-you-go system is present in the wage and other withholding procedures. In the case of self-employed persons, it is manifested in the required quarterly payments for estimated taxes. The income tax became a mass tax during World War II when its coverage was extended to 74% of the population (from less than 6% in 1939). 128. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F128 In terms of Adam Smith’s canons of taxation, how does the Federal income tax fare as far as economy is concerned? Correct Answer: Economy is present only if the collection procedure of the IRS is considered. Economy is not present, however, if the focus is on taxpayer compliance efforts. 129. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F129 Timothy recently converted a warehouse into apartment lofts, which he is renting to single professionals. In making the conversion, he emphasized improvements that were portable in nature. Thus, the sprinkler system, heating and cooling units, and room dividers are all removable from the building. In terms of ad valorem property taxes, what was Timothy trying to accomplish? Correct Answer: When personalty is permanently attached to real estate so that its removal will cause irreparable damage, it becomes a fixture. Consequently, it ceases to be personalty and is now regarded as realty. The classification of an asset is important because different ad valorem taxes apply to realty than to personalty. For one thing, the ad valorem tax on realty is less easily avoided. Also to be considered is the possibility that the ad valorem tax on personalty (even if it cannot be avoided) could be lower than that applicable to realty. 130. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F130 Due to the population change, the Goose Creek School District has decided to close one of its high schools. Since it has no further need of the property, the school is listed for sale. The two bids it receives are as follows: United Methodist Church $1,700,000 Planet Motors 1,600,000 The United Methodist Church would use the property to establish a sectarian middle school. Planet, a well-known car dealership, would revamp the property and operate it as a branch location. If you were a member of the School District board, what factors would you consider in evaluating the two bids? Correct Answer: Although the bid from the United Methodist Church is higher, several other factors need to be considered. Does, for example, Goose Creek School district exempt property owned by churches from its ad valorem taxes? If so, losing this property from the tax base could prove very costly over the long run. Also, it is probable that income-producing property (such as a car dealership) would be taxed at a higher rate than that owned by a nonprofit organization (a school operated by a church). This assumes, of course, that the school would not be taxed at all. The auto dealership also would generate sales tax. 131. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F131 Morgan inherits her father’s personal residence including all of the furnishings. She plans to add a swimming pool and sauna to the property and rent it as a furnished house. What are some of the ad valorem property tax problems Morgan can anticipate? Correct Answer: The real estate taxes probably will increase for several reasons. The capital improvements and the conversion from residential to rental will trigger the increase. Furthermore, the furnishings may generate an ad valorem tax on personalty. (Depending on applicable law, furniture might not be subject to tax unless used for business purposes—such as in this case.) 132. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F132 In 2009, Deborah became 65 years old. In 2010 she added a swimming pool, and in 2011 she converted the residence to rental property and moved into an assisted living facility. Since 2008, Deborah’s ad valorem property taxes have decreased once and increased twice. Explain. Correct Answer: The decrease probably came in 2009 when Deborah reached age 65. The increases probably occurred in 2010 when she added the pool and in 2011 when the residence was converted to rental property. 133. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F133 A lack of compliance in the payment of use taxes can be eased by several means. In this regard, comment on the following: a. Registration of automobiles. b. Reporting of Internet purchases on state income tax returns. Correct Answer: a. As reflected in Example 5 in the text, re-registration of a car purchased out-of-state is the occasion for the owner’s home state to collect the use tax. b. Completing the state income tax return reminds (or forces) the taxpayer to pay use tax on out-of-state-purchases. 134. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F134 What are the pros and cons of the following state and local tax provisions? a. An ad valorem property tax holiday made available to a manufacturing plant that is relocating. b. Hotel occupancy tax and a rental car surcharge. c. A back-to-school sales tax holiday. Correct Answer: a. Such a holiday is designed to attract new industry to the area. This means more jobs and growth in consumption. On the other hand, if the tax holiday is too generous, this places a strain on available public revenue. The result could be that schools and capital maintenance (roads, public services) will suffer. b. The hotel occupancy tax and car rental surcharges are popular because they mainly impact visitors. Also, they can generate considerable revenue to finance major capital improvements. If these taxes become excessive, however, they could discourage major events (such as conventions). c. Such holidays are very popular with both merchants and consumers and serve the social need of defraying some of the costs of sending children to school. Once established, however, they are difficult to get rid of. Thus, they become an annual drain on sales tax revenue. 135. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F135 With regard to state income taxes, explain what is meant by the “jock tax”? Correct Answer: Although states have a right to levy an income tax on all nonresidents who earn income within the state, they usually do so only on highly paid visitors. Such persons are often athletes, hence the designation of “jock tax.” 136. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F136 Virtually all state income tax returns contain checkoff boxes for donations to various causes. On what grounds has this procedure been criticized? Correct Answer: In many cases the procedure is overused (i.e., a multiplicity of boxes). This overuse adds complexity to the return. Also, in most cases the donation is being drawn from any income tax refund that might be due. Thus, taxpayers may not fully appreciate that they are paying for such checkoffs. 137. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F137 State and local governments are sometimes forced to find ways to generate additional revenue. Comment on the pros and cons of the following procedures: a. Decouple what would be part of the piggyback format of the state income tax. b. Tax amnesty provisions. c. Internet shaming. Correct Answer: a. The decoupling process is easily accomplished as to new Federal tax changes that have never taken effect at the state level. Taxpayers are not apt to miss what they never have enjoyed. b. Tax amnesty provisions generate considerable revenue. It also unmasks many taxpayers who have not previously paid taxes. Now that the taxing jurisdiction is aware of their existence, they will tend to pay taxes in the future. c. By use of a public Web site, the taxing authority posts the names of those taxpayers that are delinquent as to various taxes (e.g., sales, income). This public humiliation (or threat of) very often results in compliance. 138. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F138 Briana lives in one state and works in the adjoining state. Both states tax the income she earns from her job. Does Briana have any relief from this apparent double taxation of the same income? Correct Answer: Most states allow their residents some form of tax credit for the income taxes paid to other states. In Briana’s case, the credit would be allowed by the state where she lives for the taxes paid to the state where she works. 139. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F139 In early July 2011, Gavin is audited by the IRS and a large deficiency is assessed. In October of the same year, his income tax return for the state is audited. What has probably happened? Correct Answer: The state has been notified by the IRS concerning the results of the July audit. 140. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F140 Two months after the burglary of his personal residence, Eric is audited by the IRS. Among the items taken in the burglary was a shoe box containing approximately $50,000 in cash. Eric is the owner and operator of a cash-and-carry liquor store. Eric wonders why he was audited. Can you help explain? Correct Answer: Although Eric’s audit by the IRS could be the result of sheer chance, this appears unlikely. Press coverage of the burglary, particularly if the items stolen were enumerated, could have put the IRS on notice. Why would anyone keep such a large amount of cash at his personal residence? Also, Eric is in a business where tax evasion is easily accomplished. 141. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F141 Comment on the following items relating to IRS audit situations: a. Taxpayer was audited and the matter resolved, but no IRS agent was ever physically present. b. The regular IRS agent is accompanied by a special agent. Correct Answer: a. The facts describe what usually occurs in a correspondence audit. b. The presence of a special agent indicates that the IRS suspects fraud. Thus, the taxpayer should retain an attorney. 142. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F142 Tracy has just been audited and the IRS agent has issued an RAR that assesses a large deficiency. Since Tracy disagrees with the result, her next step is to go to court. Do you agree? Correct Answer: Tracy might save herself time and expense by going to the Appeals Division of the IRS. Here, the IRS has the authority to negotiate a settlement based on the “hazards of litigation” (i.e., the probabilities of winning or losing). If a settlement is reached, resort to the courts is avoided. 143. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F143 Tom, a calendar year taxpayer, filed his 2006 Federal income tax return on April 3, 2007. In 2011, the IRS audits this return and assesses an income tax deficiency against Tom. On the grounds that the statute of limitations has run, Tom disputes the assessment. Is Tom correct? Why? Correct Answer: Tom is correct as to the usual three-year statute of limitations. This would have expired on April 15, 2010, which is three years from the due date of the return. Tom is not correct if the six-year statute applies. The six-year statute applies if there has been a more-than-25% omission from gross income. Lastly, there is no statute of limitations if Tom has acted fraudulently. 144. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F144 Can a taxpayer start the 3-year statute of limitations on additional assessments by the IRS by filing his income tax return early (i.e., before the due date)? Can the period be shortened by filing late (i.e., after the due date)? Correct Answer: The answer is no in both cases. When filing early, the statute starts to run on the due date of the return. When filing late however, the filing date controls. 145. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F145 Brayden files his Federal income tax return by April 15, but does not pay the tax. Although he expects to pay interest on the large amount of tax he still owes, he feels that the timely filing has avoided any penalties. Is Brayden’s assumption correct? Correct Answer: Although Brayden has avoided the failure to file penalty, the failure to pay penalty will apply. It is 0.5% per month up to a maximum of 25% of the tax due as shown on the return. 146. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F146 Compare civil fraud with criminal fraud with regard to the following: a. Penalties imposed. b. Degree of proof. Correct Answer: a. Civil fraud results in a penalty of 75% of the deficiency attributable to fraud. Criminal fraud involves various fines and a possible prison sentence. b. In both cases, the burden of proof is on the IRS. In the case of criminal fraud, the IRS must show a degree of willfulness on the part of the taxpayer. 147. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F147 Melinda has been referred to you by one of your clients. In the past, she has prepared her own income tax returns, but she has become overwhelmed by the increased complexity of the tax law. Consequently, Melinda wants you to prepare her return for calendar year 2011. In reviewing her 2010 return, you note that she has claimed as a deduction the entire cost of a business building that should have been capitalized and depreciated. What course of action should you follow? Correct Answer: You should recommend to Melinda that an amended return be filed for 2010 correcting the error. If she refuses, you should assess the gravity of the error and how it impacts on your ability to file an accurate return for 2011. If you cannot do so, then you must decline the engagement. 148. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F148 Your client, Connie, won $12,000 in a football office pool. She sees no reason to include it in her income for several reasons. First, the amount won will not be reported to the IRS. Second, as an average income employee, she is unlikely to be audited by the IRS. Third, she feels that she has probably lost this much in other past office pools. How do you respond? Correct Answer: As a practitioner, you cannot play the audit lottery. You must presume she will be audited irrespective of the probabilities. Although the use of estimates is allowed, Connie’s assumptions as to her losses are not realistic. Even if they were reliable, gambling losses cannot be offset against gambling winnings but must be separately deducted. Thus, the $12,000 must be reported as income or you cannot prepare Connie’ return. 149. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F149 Under what conditions is it permissible, from an ethical standpoint, for a CPA firm to outsource tax return preparation to a third party? Correct Answer: First, the clients’ confidentiality must be preserved. Second, the CPA firm must verify the accuracy of the work. Third, the clients must be advised as to the practice. 150. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F150 In terms of revenue neutrality, comment on a tax cut enacted by Congress that: a. contains revenue offsets. b. is phased in over a period of years. c. contains a sunset provision. Correct Answer: a. Ideally, to achieve revenue neutrality all tax cuts should be accompanied by revenue offsets. b. The phase-in approach to a tax cut was taken by Congress in the Tax Relief Reconciliation Act of 2001 (e.g., the phase-in of the repeal of the Federal estate tax) and reduces the short-run revenue loss. c. A sunset provision does not account for the immediate revenue losses generated by a tax cut. It merely provides that such losses will not continue beyond a specified date when the tax cut expires and the former tax law is reinstated. 151. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F151 The tax law contains various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. On what grounds can these provisions be justified? Correct Answer: Social and economic considerations. As to the latter, a better educated workforce carries a positive economic impact. 152. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F152 The tax law contains various provisions that encourage home ownership. a. On what basis can this objective be justified? b. Are there any negative considerations? Explain. Correct Answer: a. Home ownership can be justified on economic and social grounds. b. Granting tax advantages to persons who are purchasing their homes places the taxpayers who rent at a disadvantage. The result is inequality in treatment. 153. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F153 The tax law allows an income tax deduction for state and local income taxes or state and local sales taxes paid. Explain the justification for each. Correct Answer: The deduction for state and local income taxes can be justified on the grounds that it mitigates the double tax imposed on the same income. The deduction for sales taxes paid cannot be similarly justified. Here, the rationale was to place those states that rely on a general sales tax on a parity with those that emphasize an income tax. Thus, if a resident of Montana (which imposes an income tax but no sales tax) can deduct the state income tax, should not a resident of Wyoming (which imposes a general sales tax but no income tax) be able to deduct the sales tax? 154. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F154 The tax law allows, under certain conditions, deferral of gain recognition for involuntary conversions. a. What is the justification for this relief measure? b. What happens if the proceeds are not entirely reinvested? Correct Answer: a. By recognizing that the taxpayer’s relative economic situation has not changed and that he or she lacks the wherewithal to pay a tax, any recognition of realized gain is deferred. b. If the proceeds from an involuntary conversion are not fully reinvested in property that is similar or related in service or use, recognized gain results. Such recognized gain cannot exceed realized gain and will be limited to the amount of the proceeds not reinvested. Recognition is based on the notion that the taxpayer now has the wherewithal to pay the tax that results. 155. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F155 How do the net operating loss provisions in the tax law mitigate the effect of the annual accounting concept? Correct Answer: Without the allowance of carryback and/or carryover provisions that apply the excess losses to profitable years, the losses would disappear. As shown by Example 25, this result places a business with profit and loss fluctuations on a more level playing field with one that maintains a stable income pattern. 156. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F156 How are “stealth taxes” justified and how are they structured? Correct Answer: “Stealth taxes” can be justified on the basis of political expediency. They are structured to phase out (or eliminate) certain tax benefits (e.g., deductions, credits) as income rises. Thus, they generate revenue without the unpopular stigma of being labeled as a tax. 157. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F157 In connection with facilitating the function of the IRS in the administration of the tax laws, comment on the utility of the following: a. An increase in the amount of the standard deduction. b. Dollar and percentage limitations on the deduction of personal casualty losses. c. Power to make adjustments to properly reflect a taxpayer’s income. d. Availability of interest and penalties for taxpayer noncompliance. e. Arm’s length standard. Correct Answer: a. An increase in the amount of the standard deduction reduces the number of taxpayers who choose to itemize their personal deductions. This, in turn, cuts down on the deductions the IRS has to check. b. Limitations placed on casualty and theft losses curtail the number of taxpayers who can claim the deduction. c. This power is particularly useful to prevent taxpayers from manipulating accounting procedures. Such was the case in Example 27 (page 1-34 of the text). d. The imposition of extra penalties, in addition to the tax owed, definitely deters taxpayer noncompliance. e. If the parties are related, taxpayer manipulation is facilitated. The arm’s length standard furnishes the IRS with a means of combating such manipulation. 158. CHAPTER 1AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE F158 Congress reacts to judicial decisions that interpret the tax law in different ways. When it approves of a decision, Congress may act to amend the Code to incorporate the holding. When it disapproves, Congress may amend the Code to nullify its effect. Give an example of each one of these congressional reactions. Correct Answer: Congress approved of the judicial conclusion that most stock dividends should be nontaxable and amended the Code to this effect. However, it disagreed as to when leasehold improvements should be taxed to a lessor. Consistent with the wherewithal to pay concept, the improvements are to be taxed on the termination of the lease. Thus, Congress overturned a judicial holding that would have taxed such improvements in the year they are made by the lessee. 159. CHAPTER 2WORKING WITH THE TAX LAW Question TF #1 A professional must understand the relative weight of authority within the sources of tax law. a. True b. False 160. CHAP