Chapter 1 Flashcards
The federal income tax is the dominant form of taxation by the federal government.
TRUE
The federal income tax provides more revenues than any other tax.
The Sixteenth Amendment to the U.S. Constitution permits the passage of a federal income tax law.
TRUE
The Sixteenth Amendment amended the Constitution to permit the imposition of an income tax.
When a change in the tax law is deemed necessary by Congress, the entire Internal Revenue Code must be revised.
FALSE
The federal income tax law is changed on an incremental basis.
The largest source of federal revenues is the
corporate income tax.
FALSE
The largest source is the individual income tax.
Until about 100 years ago, attempts to impose a federal income tax were ruled unconstitutional. The amendment to the U.S. Constitution allowing the imposition of a federal income tax is the
A) Second Amendment.
B) Thirteenth Amendment.
C) Sixteenth Amendment.
D) Nineteenth Amendment.
Sixteenth Amendment
The Sixteenth Amendment, ratified in 1913, gave Congress the power to impose a federal income tax.
The largest source of revenues for the federal government comes from
A) individual income taxes.
B) corporate income taxes.
C) Social Security and Medicare taxes (FICA).
D) estate and gift taxes.
individual income taxes
The individual income tax has provided the largest source of revenues for many years.
A progressive tax rate structure is one where the rate of tax increases as the tax base increases.
True or False
TRUE
Under a progressive tax system, the rate increases as the tax base increases.
The terms “progressive tax” and “flat tax” are synonymous.
True or False
FALSE
A proportional, not progressive, tax and flat tax are synonymous.
A proportional tax rate is one where the rate of the tax is the same for all taxpayers, regardless of income levels.
TRUE
proportional tax = flat tax.
Regressive tax rates decrease as the tax base increases.
TRUE
Regressive rates increase as the base decreases.
The marginal tax rate is useful in tax planning because it measures the tax effect of a proposed transaction.
TRUE
The marginal rate applies to the planned addition to income or reduction to income.
A taxpayer’s average tax rate is the tax rate applied to an incremental amount of taxable income that is added to the tax base.
True or False
FALSE
The marginal tax rate = tax rate applied to an incremental amount of taxable income.
If a taxpayer’s total tax liability is $30,000, taxable income is $100,000, and economic income is $120,000, the average tax rate is 30 percent.
True or False
TRUE
The average rate = the tax liability / by the taxable income.
If a taxpayer’s total tax liability is $4,000, taxable income is $20,000, and total economic income is $40,000, then the effective tax rate is 20 percent.
FALSE
The effective rate would be
$4,000/$40,000 = 10 percent.
Arthur pays tax of $5,000 on taxable income of $50,000 while taxpayer Barbara pays tax of $12,000 on $120,000. The tax is a
A) progressive tax.
B) proportional tax.
C) regressive tax.
D) None of the above.
Proportional tax
The tax rate is proportional because the 10% tax rate applies to both taxpayers regardless of their income level.
Which of the following taxes is progressive?
A) sales tax
B) excise tax
C) property tax
D) federal income tax
Federal income tax
Federal income tax rates increase as a taxpayer’s taxable income rises.
Which of the following taxes is proportional?
A) gift tax
B) income tax
C) sales tax
D) Federal Insurance Contributions Act (FICA)
Sales tax
A sales tax is assessed at a fixed rate of the purchase amount, based on state and local law.
Which of the following taxes is regressive?
A) Federal Insurance Contributions Act (FICA)
B) excise tax
C) property tax
D) gift tax
Federal Insurance Contributions Act (FICA)
For upper-income wage earners, the Social Security tax ceases at a maximum wage base. For 2019, wages over $132,900 are not subject to the Social Security tax.
The corporate tax rate is
A) progressive.
B) regressive.
C) proportional.
D) none of the above.
Proportional
The corporate tax rate is a flat 21 percent.
Sarah contributes $25,000 to a church. Sarah’s marginal tax rate is 35% while her average tax rate is 25%. After considering her tax savings, Sarah’s contribution costs
A) $6,250.
B) $8,750.
C) $16,250.
D) $18,750.
$16,250
[$25,000 × (100% - 35%)] = $16,250
Helen, who is single, is considering purchasing a residence that will provide an $18,000 tax deduction for property taxes and mortgage interest. If her marginal tax rate is 24% and her effective tax rate is 20%, what is the amount of Helen’s tax savings from purchasing the residence?
A) $3,600
B) $4,320
C) $3,200
D) $18,000
$4,320
$18,000 × .24 marginal rate = $4,320 tax savings.
Charlotte pays $8,000 in tax deductible property taxes. Charlotte’s marginal tax rate is 24%, effective tax rate is 20% and average rate is 22%. Charlotte’s tax savings from paying the property tax is
A) $1,600.
B) $1,760.
C) $1,920.
D) $8,000.
$1,920
$8,000 × 0.24 = $1,920
Briana, who is single, has taxable income for 2019 of $90,000, resulting in a total tax of $15,775. Her total economic income is $100,000. Briana’s average tax rate and effective tax rate are, respectively,
A) 17.53% and 15.78%.
B) 17.53% and 24%.
C) 15.78% and 24%.
D) 15.78% and 17.53%.
17.53% and 15.78%
Average tax rate: $15,775 ÷ $90,000 = 17.53%
Effective tax rate: $15,775 ÷ $100,000 = 15.78%
Larry and Ally are married and file a joint return. They are considering purchasing a personal residence that will generate two deductions: $10,000 in home mortgage interest and $8,000 in real estate taxes. Their marginal tax rate is 24%. What is the total tax savings if Larry and Ally purchase the residence?
($10,000 + $8,000) × .24 = $4,320
Larry and Ally are married and file a joint return. They are considering purchasing a personal residence that will generate two deductions: $10,000 in home mortgage interest and $8,000 in real estate taxes. Their marginal tax rate is 24%. If Larry and Ally purchase the residence, what will be the after-tax cost of the additional $18,000 in expenditures?
Tax savings of expenditures: ($10,000 + $8,000) × .24 = $4,320
After-tax cost:: $18,000 - $4,320 = $13,680.
All states impose a state income tax which is generally based on an individual’s federal adjusted gross income (AGI) with minor adjustments.
True or False
FALSE
While many states impose a state income tax, not all states do. In those states that do impose tax, the taxes vary greatly in both form and rates.
The unified transfer tax system, comprised of the gift and estate taxes, is based upon the total property transfers an individual makes during lifetime and at death.
True or False
TRUE
Gift and estate taxes, which comprise a unified transfer tax system, are based on cumulative transfers.
Gifts between spouses are generally exempt
from transfer taxes.
TRUE
The tax law allows for unlimited transfers between spouses.
The primary liability for payment of the gift tax is
imposed upon the donee.
FALSE
The gift tax is imposed on the donor.
For gift tax purposes, a $15,000 annual exclusion
per donee is permitted.
TRUE
Donors are allowed to exclude $15,000 per donee per year for gift tax purposes.
An individual will be subject to gift tax on gifts made to a charity greater than $15,000.
FALSE
Contributions to charity are not limited by the
$15,000 gift tax exclusion.
Property is generally included on an estate tax return at its historical cost basis.
True or False
FALSE
Property is generally valued at fair market value at date of death or the alternate valuation date.
Property transferred to the decedent’s spouse is exempt from the estate tax because of the estate tax marital deduction provision.
TRUE
The estate and gift tax law allows tax-exempt
transfers to spouses.
Gifts made during a taxpayer’s lifetime may affect the amount of estate tax paid by the taxpayer’s estate.
TRUE
Gift and estate taxes are applied to cumulative transfers under the uniform tax system.
While federal and state income taxes, as well as the federal gift and estate taxes, are generally progressive in nature,
property taxes are proportional.
True or False
TRUE
Property taxes are assessed on the value of the property.
The unified transfer tax system
A) imposes a single tax upon transfers of property during an individual’s lifetime only.
B) imposes a single tax upon transfers of property during an individual’s life and at death.
C) imposes a single tax upon transfers of property only at an individual’s death.
D) none of above.
Imposes a single tax upon transfers of property during an individual’s life and at death.
When property is transferred, the gift tax is based on
A) replacement cost of the transferred property.
B) fair market value on the date of transfer.
C) the transferor’s original cost of the transferred property.
D) the transferor’s depreciated cost of the transferred property.
Fair market value on the date of transfer.
The gift tax is based on the property’s fair market value on the date of transfer.
Paul makes the following property transfers in the current year:
- $22,000 cash to his wife
- $34,000 cash to a qualified charity
- $220,000 house to his son
- $3,000 computer to an unrelated friend
The total of Paul’s taxable gifts, assuming he does not elect gift splitting with his spouse, subject to the unified transfer tax is
A) $205,000.
B) $212,000.
C) $245,000.
D) $279,000.
$205,000.
$220,000 - $15,000 = $205,000.
The gift to the unrelated friend is below the $15,000 annual gift tax exclusion. The gifts to his wife and to the charity are not subject to gift tax.
Charlie makes the following gifts in the current year: $40,000 to his spouse, $30,000 to his church, $18,000 to his nephew, and $25,000 to a friend. Assuming Charlie does not elect gift splitting with his wife, his taxable gifts in the current year will be
A) $28,000.
B) $13,000.
C) $25,000.
D) $43,000.
$13,000
($18,000 - $15,000) + (25,000 - $15,000) = $13,000.
The gift to his spouse and the charitable gift are
not subject to gift taxes.
Shaquille buys new cars for five of his friends. Each car cost $70,000. What is the amount of Shaquille’s taxable gifts?
A) $0
B) $275,000
C) $335,000
D) $350,000
$275,000
5 × ($70,000 - $15,000) = $275,000
In 2019, an estate is not taxable unless the sum of the taxable estate and taxable gifts made after 1976 exceeds
A) $4,505,800.
B) $10,000,000.
C) $5,000,000.
D) $11,400,000.
$11,400,000
The unified credit equivalent for estate and gift taxes is
$11,400,000 for 2019.
Eric dies in the current year and has a gross estate valued at $16,500,000. The estate incurs funeral and administrative expenses of $100,000 and also pays off Eric’s debts which amount to $250,000. Eric bequeaths $600,000 to his wife. Eric made no taxable transfers during his life. Eric’s taxable estate will be
A) $4,250,000.
B) $15,550,000.
C) $4,150,000.
D) $16,500,000.
$15,550,000.
($16,500,000 - $100,000 - $250,000 - $600,000) = $15,550,000
Jose dies in the current year and has a gross estate valued at $13,000,000 in 2019. Over the past ten years, Jose had made taxable gifts of $400,000. The estate incurs funeral and administrative expenses of $100,000 and also pays off Jose’s debts which amount to $300,000. Jose bequeaths $500,000 to his wife. What is the amount of Jose’s tax base, the amount on which the estate tax is computed?
A) $12,100,000
B) $12,500,000
C) $700,000
D) $1,100,000
$12,500,000
$13,000,000 - $100,000 funeral/administrative expense - $300,000 liabilities - $500,000 marital transfers = $12,100,000 taxable estate + $400,000 gifts = $12,500,000 tax base
Which of the following statements is incorrect?
A) Property taxes are levied on real estate.
B) Excise taxes are assessed on items such as gasoline and telephone use.
C) Gift taxes are imposed on the recipient of a gift.
D) The estate tax is based on the fair market value of property at death or the alternate valuation date.
Gift taxes are imposed on the recipient of a gift.
Gift taxes are imposed on the donor of a gift, not the recipient.
Kole earns $140,000 in 2019 in his job as a sales manager. What is his FICA tax?
A) $10,270
B) $8,240
C) $10,710
D) $10,167
$10,270
(132,900 × .062) + (140,000 × .0145) = $10,270
Jillian, a single individual, earns $230,000 in 2019 through her job as an accounting manager. What is her FICA tax?
A) $11,845
B) $11,575
C) $17,595
D) $10,167
$11,845
(132,900 × .062) + (230,000 × .0145) +
((230,000 - 200,000)
× .009) = $11,845
Martha is self-employed in 2019. Her self employment income is $140,000. What is her self-employment tax?
A) $20,334
B) $20,540
C) $21,420
D) None of the above
$20,540
(132,900 × .124) + (140,000 × .029) = $20,540
Vincent makes the following gifts during 2019:
$15,000 cash gift to wife
Gift of automobile valued at $35,000 to his adult son
Gift of golf clubs valued at $5,000 to a friend
$10,000 contribution to church
Although he is married, none of the gifts are considered joint gifts with his wife. What are the total taxable gifts subject to the unified transfer tax?
Gift Value
Adjustment
Taxable Gift
Cash to wife
$15,000
spousal gifts excluded
$ 0
Auto to son
35,000
less $15,000 exclusion
20,000
Clubs to friend
5,000
less $15,000 exclusion
0
Church donation
10,000
charity gifts excluded
0
Taxable gifts
$20,000
Jeffery died in 2019 leaving a $16,000,000 gross estate. Six months after his death, the gross assets are valued at $16,100,000. In years prior to 2019 (but after 1976), Jeffery had made taxable gifts of $300,000. Of the $16,000,000 gross estate, estate assets valued at $3 million were transferred to his wife and $100,000 was used to pay administrative and funeral expenses. Jeffery had debts of $200,000 which were paid by the estate, and the remainder of the estate was transferred to his children.
a. What is the amount of Jeffery’s taxable estate?
b. What is the tax base for computing Jeffery’s estate?
c. What is the amount of estate tax owed if the unified credit is $4,505,800?
d. Alternatively, if six months after his death, the gross assets in Jeffery’s estate declined in value to $15,000,000, can the administrator of Jeffery’s estate elect the alternate valuation date?
Gross Estate
$16,000,000
Minus: Funeral and administrative expenses
( 100,000)
Minus: Debts
( 200,000)
Minus: Marital deduction
(3,000,000)
Taxable estate (a)
$12,700,000
Plus: Taxable gifts made after 1976
300,000
Tax base (b)
$13,000,000
Tentative tax on estate tax base $345,800 + [.4 × (13,000,000 - $1,000,000)]
$ 5,145,800
Minus: Tax credits (unified tax credit)
4,505,800
Unified transfer tax due (c)
$ 640,000
The alternate valuation date (six months after the date of death) may be elected only if the aggregate value of the gross estate decreases during the six-month period following the date of death and the election results in a lower estate tax liability. In this case, the alternate valuation date can be elected.
Mia is self-employed as a consultant. During 2019, Mia earned $180,000 in self-employment income.
What is Mia’s self-employment tax?
- 124 × $132,900 = $16,480
- 029 × $180,000 = 5,220
___________________________________
Self-employment tax $21,700
Adam Smith’s canons of taxation are equity, certainty, convenience, and economy.
True or False
TRUE
Adam Smith’s canons of taxation include equity, certainty, convenience and economy.
The primary objective of the federal income tax law is to achieve various economic and social policy objectives.
True or False
FALSE
The primary objective of the federal income tax law is to
raise revenues for government operations.
Which of the following is not one of Adam Smith’s canons of taxation?
A) equity
B) convenience
C) certainty
D) economic stimulation
Economic stimulation
Smith’s canons of taxation are equity, certainty, convenience and economy (in terms of administration of the tax system).
Horizontal equity means that
A) taxpayers with the same amount of income should pay the same amount of tax.
B) taxpayers with larger amounts of income should pay more tax than taxpayers with lower amounts of income.
C) all taxpayers should pay the same tax.
D) None of the above.
Taxpayers with the same amount of income should pay the same amount of tax.
Horizontal equity means that taxpayers with the same amount of income
should pay the same amount of tax.
Vertical equity means that
A) taxpayers with the same amount of income should pay the same amount of tax.
B) taxpayers with larger amounts of income should pay more tax than taxpayers with lower amounts of income.
C) all taxpayers should pay the same tax.
D) None of the above.
taxpayers with larger amounts of income should pay more tax than
taxpayers with lower amounts of income.
Which of the following is not an objective of the federal income tax law?
A) Stimulate private investment.
B) Redistribution of wealth.
C) Encourage research and development activities.
D) Prevent taxpayers from paying a higher percentage of their income in personal income taxes due to inflation.
Redistribution of wealth.
Redistribution of wealth is not an objective of the federal income tax law.
Which of the following is not a social objective of the tax law?
A) prohibition of a deduction for illegal bribes, fines and penalties
B) a deduction for charitable contributions
C) an exclusion for interest earned by large businesses
D) creation of tax-favored pension plans
an exclusion for interest earned by large businesses
There is no exclusion for interest income earned by large businesses.
Individuals are the principal taxpaying entities in the federal income tax system.
True or False
TRUE
Revenues from income taxation of individuals far exceed those of other taxpayers.
Dividends paid from most U.S. corporations are taxed at the same rate as the recipients’ salaries and wages.
True or False
FALSE
Qualifying dividends are taxed at a preferential rate.
Flow-through entities do not have to file tax returns since they are not taxable entities.
True or False
FALSE
S Corporations, partnerships and limited liability companies have to
file an informational tax return each year.
Organizing a corporation as an S Corporation results in a single level of taxation.
True or False
TRUE
S Corporations do not pay tax. Owners of the corporation pay tax on their share of the corporation’s taxable income, but do not pay tax on the distributions received.
In a limited liability partnership (LLP), a partner is not liable for his
partner’s acts of negligence or misconduct.
True or False
TRUE
A partner in an LLP is liable for his own acts of negligence or misconduct,
but not those of his partners.
Limited liability companies (LLC) may elect to be taxed as corporations.
True or False
TRUE
An LLC can affirmatively elect to be taxed as a corporation.
Limited liability company (LLC) members (owners) are responsible for the liabilities of their limited liability company.
True or False
FALSE
Limited liability company members have protection from entity-level liability in a manner similar to that of shareholders of corporations.
Which of the following is not a taxpaying entity?
A) C corporation
B) partnership
C) individual
D) All of the above are taxpayers.
Partnership
A partnership is a flow-through entity.
All of the following are classified as flow-through entities for tax purposes
except
A) partnerships.
B) C corporations.
C) S corporations.
D) limited liability companies.
C corporations
C corporation is a taxpaying entity.
Firefly Corporation is a C corporation. Freya owns all of the stock. During the current year, Firefly earned a taxable income of $500,000 and paid a $300,000 dividend to Freya. Which of the following statements is correct?
A) Firefly will pay corporate income tax on its earnings, and Freya will pay individual income tax on the dividends.
B) Only Firefly will pay taxes. Freya will not pay any taxes due to her holdings in Firefly.
C) Firefly’s income will flow through to Freya’s tax return, and she will pay the taxes on the $500,000 of corporate income.
D) Firefly will not pay any taxes, but Freya will pay taxes on the dividend received.
Firefly will pay corporate income tax on its earnings, and Freya will pay individual income tax on the dividends.
The C corporation pays tax on its own taxable income, and then a second layer of tax is paid by the shareholders when dividends are paid to them.
Rocky and Charlie form RC Partnership as equal partners. Rocky contributes $100,000 into RC while Charlie contributes real estate with a cost and fair market value of $100,000. During the current year, RC earned net income of $600,000. The partnership distributes $200,000 to each partner. The amount that Rocky should report on his individual tax return is
A) $0.
B) $100,000.
C) $200,000.
D) $300,000.
$300,000.
Rocky must report 50% × $600,000 or $300,000, his share of partnership net income. The distribution of $200,000 is not taxable but rather a nontaxable return of capital reducing Rocky’s basis ($100,000 original investment + $300,000 share of income) by $200,000 to $200,000.
AB Partnership earns $500,000 in the current year. Partners A and B are equal partners who do not receive any distributions during the year. How much income does partner A report from the partnership?
A) $0
B) $250,000
C) $500,000
D) None of the above
$250,000
Partners are taxed on their share of partnership income, regardless of whether they receive a distribution. $500,000 × .5 = $250,000
In an S corporation, shareholders
A) are taxed on their proportionate share of earnings.
B) are taxed only on dividends.
C) may allocate income among themselves in order to consider special contributions.
D) are only taxed on salaries.
are taxed on their proportionate share of earnings.
Similar to partners in a partnership, S corporation shareholders are taxed on their proportionate share of the income earned by the corporation, regardless of distribution payments
Fireball Corporation is an S corporation. Leyla owns all of the stock. During the current year, Fireball earned taxable income of $500,000 and paid a $300,000 distribution to Leyla. Which of the following statements is correct?
A) Fireball will pay corporate income tax on its earnings, and Leyla will pay individual income tax on the distribution.
B) Only Fireball will pay taxes. Leyla will not pay any taxes due to her holdings in Fireball.
C) Fireball’s income will flow through to Leyla’s tax return, and she will pay the taxes on the $500,000 of corporate income.
D) Fireball will not pay any taxes, but Leyla will pay taxes on the distribution received.
Fireball’s income will flow through to Leyla’s tax return, and she will pay the taxes on the $500,000 of corporate income.
Similar to partners in a partnership, S corporation shareholders are taxed on their proportionate share of the income earned by the corporation, regardless of distribution payments.
All of the following statements are true except
A) the net income earned by a sole proprietorship is reported on the owner’s individual income tax return.
B) the net income of an S corporation is subject to double taxation because it is taxed at the entity level and dividends paid from the S corporation to individual shareholders are also taxed.
C) the net income of C corporation is subject to double taxation because it is taxed at the entity level and dividends paid from the C corporation to individual shareholders is also taxed.
D) LLCs are generally taxed as partnerships.
the net income of an S corporation is subject to double taxation because it is taxed at the entity level and dividends paid from the S corporation to individual shareholders are also taxed.
An S corporation is a flow-through entity, not a taxable entity. The items of income/loss are allocated to each shareholder who pays tax on the items on his or her individual income tax return.
Brad and Angie had the following income and deductions during 2020:
Salaries $110,000
Interest income 10,000
Itemized deductions 26,000
Taxes withheld during year 12,000
Calculate Brad and Angie’s tax liability due or refund. They file a joint tax return.
Tax = $9,086 + .22(94,000 - 78,950) = $12,397
$12,397 - 12,000 taxes withheld = $397 taxes due
Chris, a single taxpayer, had the following income and deductions during 2019:
Salary $65,000
Interest on bank account 300
Tax-exempt interest 200
Deduction for AGI 3,500
Itemized deductions 13,000
Taxes withheld 7,500
Calculate Chris’s tax liability due or refund.
Tax $4,543 + .22(48,800 - 39,475) = $6,594.50
$7,500 taxes withheld -$6,594.50 = $905.50 tax refund
During the current tax year, Frank Corporation generated gross income of $1,900,000 and had ordinary and necessary deductions of $1,400,000. What is the amount of Frank Corporation’s corporate income tax for the year?
Taxable income is $1,900,000 - $1,400,000 = $500,000.
($500,000 × 0.21) = $105,000 tax
Corporate Tax Rate in the United States is 21%
During the current tax year, Charlie Corporation generated gross income of $1,800,000 and had ordinary and necessary deductions of $1,300,000, resulting in taxable income of $500,000. If Charlie Corporation paid qualifying dividends of $200,000 to shareholders, all of whom are in the 24% marginal tax bracket, what is the total tax paid on both corporate income and the corporate dividends?
Corporate taxable income is $1,800,000 - $1,300,000 = $500,000. Dividends are not tax-deductible.
Corporate tax: ($500,000 × .21) = $105,000
Shareholder tax on qualifying dividends: ($200,000 × 0.15 maximum rate on qualifying dividends for taxpayers in 24% marginal tax bracket) = $30,000
Total Tax: $105,000 + $30,000 = $135,000
Doug and Frank form a partnership, D and F Advertising, each contributing $50,000 to start the business. During the first year of operations, D and F earns $80,000, which is allocated $40,000 each to Doug and Frank. At the beginning of the second year, Doug sells his interest to Marcus for $90,000. What is the amount of Doug’s taxable gain on the sale?
There is no gain on the sale.
Amount realized $90,000
Adjusted basis * -90,000
Gain or loss on sale. 0
*Adjusted basis as of date of sale is the $50,000 contributed basis plus the $40,000 income allocated to basis.
