solution manual for South-Western Federal Taxation 2024 Essentials of Taxation Individuals and Business Entities, 27th Edition By Annette Nellen

Test Bank for South-Western Federal Taxation 2024 Essentials of Taxation Individuals and Business Entities, 27th Edition By Annette Nellen Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 1 website, in whole or in part. Solution and Answer Guide NELLEN, CUCCIA, PERSELLIN, YOUNG, SWFT ESSENTIALS OF TAXATION: INDIVIDUALS AND BUSINESS ENTITIES 2024, 9780357900796; CHAPTER 1: INTRODUCTION TO TAXATION TABLE OF CONTENTS Problems ..............................................................................................................................1 Bridge Discipline Problems ................................................................................................6 Research Problems.............................................................................................................7 PROBLEMS 1. (LO 1) Various answers are possible, including using the Key Terms at the end of each chapter, referring to the Glossary (Appendix C), looking up the footnote resources to the Internal Revenue Code in Appendix D, using chapter features (e.g., Global Tax Issues, Ethics & Equity, Tax Planning, and Digging Deeper), examining the tax forms used in the chapters, and completing additional end-of-chapter assignments. All of these resources will help students engage more deeply with the materials and help their understanding. 2. (LO 3, 5, 6) Some tax and nontax considerations James should investigate include the following: • State and local income taxes. • State and local sales taxes. • State and local property taxes. • Employee implications of the move (Will James lose current employees? Is the labor market better in the new location? Is cost of living lower or higher in new location?). • Logistics/transportation of products to customers (specifically document lower costs). • State infrastructure (better in new location?). 3. (LO 2) A tax is regressive if it represents a larger percentage of the income of a lowincome taxpayer relative to the income of a high-income taxpayer. Examples of regressive taxes include sales and excise taxes. A tax is progressive if it represents a larger percentage of the income of a high-income taxpayer relative to the income of a low-income taxpayer. The Federal income tax is an example of a progressive tax. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 2 website, in whole or in part. 4. (LO 3) a. The parsonage probably was not listed on the property tax rolls because it was owned by a tax-exempt church. Apparently the taxing authorities are not aware that ownership has changed. b. Ethan should notify the authorities of his purchase. This will force him to pay back taxes but may eliminate future interest and penalties. 5. (LO 1, 2, 6) (See Digging Deeper 1.) As to Adam Smith’s canon on economy, the Federal income tax yields a mixed result. From the standpoint of the IRS, economy exists as collection costs are nominal (when compared with revenue generated). The government’s cost of collecting Federal taxes amounts to less than one-half of 1 percent of the revenue collected. Economy is not present, however, if one looks to the compliance effort and costs expended by taxpayers. According to recent estimates, about 56% of individual taxpayers who file a return pay a preparer, and one-third purchase tax software. 6. (LO 3) Jang probably will be required to pay the Washington use tax if, and when, he applies for Washington license plates. In this case, the use tax probably is the same amount as the Washington sales tax. See the discussion in connection with Example 4 in the textbook. 7. (LO 3) Although the Baker Motors bid is the lowest from a long-term financial standpoint, it is the best. The proposed use of the property by the state and the church probably will make it exempt from the school district’s ad valorem tax. This would hardly be the case with a car dealership. In fact, commercial properties (e.g., car dealerships) often are subject to higher tax rates. 8. (LO 3) A possible explanation is that Sophia made capital improvements (e.g., added a swimming pool) to her residence and her parents became retirees (e.g., reached age 65). 9. (LO 5, 6) SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 December 5, 2023 Cynthia Clay 1206 Seventh Avenue Fort Worth, TX 76101 Dear Cynthia: I am writing this letter to help you decide on what form of entity to choose for your new food delivery business. In our phone conversation, you indicated that you expect to have losses for the first two years in this business and then make substantial profits in subsequent years. You and Marco also indicated that you are concerned about potential personal liability. While I can’t make a conclusive recommendation based on the information you have given me, I can provide you with some general guidelines that should simplify your decision. First, given your concern about personal liability, a partnership does not appear to be a desirable option (you would both be personally liable for any injuries to customers). Similarly, given your expectation of losses in the first two years, it does Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 3 website, in whole or in part. not appear that a C corporation would be a desirable choice, at least initially. This is because any losses in the corporation could only be used to offset future corporate profits—you could not use the losses to immediately offset your personal tax liability. Thus, two choices exist which provide limited liability and deductibility of losses on your personal income tax return. These are the S corporation and the limited liability company. If you choose an S corporation, we would probably convert the entity to a C corporation when the business becomes profitable. At that point, profits would be taxed at the C corporation rate. A second tax would be levied on your personal income tax return for any dividends paid by the corporation once it achieves C status. In contrast, limited liability companies are taxed like partnerships—all income would be taxed on your personal income tax return in profitable years. The relative desirability of each of these two forms depends on a number of factors. One of the most important factors in your situation is the relationship between your personal tax rate and the tax rate of a C corporation. If you are in a high tax bracket and if the income in the business is sufficiently low, you might be best off choosing the S corporation. Alternatively, if you expect the business to generate a sufficiently large profit each year, it might be best to choose the limited liability company. The qualified business income deduction for income from flow-through entities along with the flat tax rate of 21% that applies to corporations also must be taken into consideration. If you would like me to give you a clearer recommendation, we should meet at your earliest convenience. If you have any additional questions, please call me. Best regards, Julian Jackson, CPA 10. (LO 5, 6) a. Year 1 Year 2 Year 3 Corporate Tax Liability Sales revenue $150,000 $320,000 $600,000 Cash expenses (30,000) (58,000) (95,000) Depreciation (25,000) (20,000) (40,000) Taxable income $ 95,000 $242,000 $465,000 Corporate tax liability $ 19,950 $ 50,820 $ 97,650 Cash Available for Dividends Sales revenue $150,000 $320,000 $600,000 Tax-free interest income 5,000 8,000 15,000 Cash expenses (30,000) (58,000) (95,000) Corporate tax liability (19,950) (50,820) (97,650) Cash available for dividends $105,050 $219,180 $422,350 Ashley’s After-Tax Cash Flow Dividend received $105,050 $219,180 $422,350 Tax on dividend at 15% rounded (15,758) (32,877) (63,353) After-tax cash flow $ 89,292 $186,303 $358,997 PV of cash flow* $ 79,729 $148,521 $255,534 Total present value $483,784 *Present value factors (.8929, .7972, .7118) from Appendix E. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 4 website, in whole or in part. b. Year 1 Year 2 Year 3 Individual Tax Liability Sales revenue $150,000 $320,000 $600,000 Cash expenses (30,000) (58,000) (95,000) Depreciation (25,000) (20,000) (40,000) Taxable income $ 95,000 $242,000 $465,000 Individual tax liability** $ 23,750 $ 60,500 $1 1 6,250 **Rate = 25% Ashley’s After-Tax Cash Flow Sales revenue $150,000 $320,000 $600,000 Tax-free interest income 5,000 8,000 15,000 Cash expenses (30,000) (58,000) (95,000) Individual tax liability (23,750) (60,500) (116,250) After-tax cash flow $1 0 1,250 $209,500 $403,750 PV of cash flow* $ 90,406 $167,0 13 $287,389 Total present value $544,808 *Present value factors (.8929, .7972, .7118) from Appendix E. c. If Ashley wants to have access to all available cash from the business, then she will have to pay out dividends annually. As seen in the answers to parts a. and b. above, the present value of future cash flows is substantially greater if she does not incorporate under this assumption. Alternatively, if she does not need to pay out dividends, then she may be better off by incorporating, since only the corporate tax will be incurred, which is less than her individual tax. The value of her stock will increase and she then can sell the stock at a later date at favorable capital gains rates. 11. (LO 1) PowerPoint presentations will vary. In favor of high progressivity: • Ability to pay. • Fairness of result. • Benefits of government skew toward those at upper-income levels. Contrary to high progressivity: • Discouragement of work and innovation. • Unfairness of result. • Civic engagement by those at lower-income levels requires “skin in the game.” 12. (LO 3) a. In terms of taxpayer compliance, an ad valorem tax on personalty is less desirable than one on realty. However, a tax on business personalty, such as inventory, is to be preferred over one on personal use (i.e., nonbusiness) personalty. b. A tax on stock and bonds would be too easily avoided. The taxing authority would have no means of ascertaining ownership of these assets. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 5 website, in whole or in part. c. Poor taxpayer compliance is to be expected for any tax on personal use personalty. However, if boats had to be periodically licensed (e.g., safety inspection), this could provide the taxing authority with a means of discovering unreported boat ownership. 13. (LO 2, 7) a. Economic justification. The tax law addresses the energy crisis—in terms of both reliance on foreign oil and the need to ease the problem of climate change. b. Economic justification. See the comments under part a. above. c. Economic justification. Research and development activities are encouraged by allowing immediate or faster write-off of these expenditures. d. Social justification. The charitable deduction helps fund private organizations and causes that are operated in the interest of the general welfare. This relieves government of the need for considerable public funding. e. Economic justification. Known as the S election, the provision encourages small businesses to operate in the corporate form without suffering all of the tax disadvantages of the regular (C) corporation. 14. (LO 4, 7) a. Social considerations explain the credit. It is socially desirable to encourage parents to provide care for their children while they work. b. These deductions raise the issue of preferential tax treatment for homeowners— taxpayers who rent their personal residences do not receive comparable treatment. Even so, the encouragement of home ownership can be justified on economic and social grounds. c. The joint return procedure came about to equalize the position of married persons living in common law states with those residing in community property jurisdictions. Political and equity considerations caused this result. d. Activities deemed contrary to public policy should not result in tax savings. e. The NOL carryforward provision is an equity consideration designed to mitigate the effect of the annual accounting period concept. f. The installment method of reporting gain is consistent with the wherewithal to pay concept—the seller is taxed when the payments are made by the purchaser. g. The exclusion from Federal income taxation of interest from state and local bonds can be justified largely on political considerations. Political goodwill is generated by allowing state and local jurisdictions to secure financing at a lower cost (i.e., interest rate) due to favorable Federal income tax treatment. h. The treatment of prepaid income is justified under the wherewithal to pay concept. It also eases the task of the IRS as to administration of the tax law. 15. (LO 3) (See Digging Deeper 3.) A value added tax (VAT) taxes the increment in value as goods move through the production and manufacturing stages to the marketplace. Although the tax is paid by the producer, it is reflected in the selling price of the goods. Therefore, a VAT is a tax on consumption. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 6 website, in whole or in part. A national sales tax taxes numerous transactions and is collected on the final sale of goods and services to the consumer. Consequently, it is collected from the consumer and not the producer of the product as does a VAT. In terms of taxpayer compliance, a VAT is preferable to a national sales tax. Without significant collection efforts, a national sales tax could easily be circumvented or avoided in many ways (e.g., resorting to a barter system of doing business). 16. (LO 3) If the tax is imposed on the right to pass property at death, it is classified as an estate tax. If it taxes the right to receive property from a decedent, it is termed an inheritance tax. a. Some states impose both an estate tax and an inheritance tax. Some states (e.g., Florida and Texas) levy neither tax. b. The Federal government imposes an estate tax. 17. (LO 2, 7) Students’ e-mails may vary. Build interaction into the exercise wherever possible, asking the student to send and receive e-mail in a professional and responsible manner. 18. (LO 2, 7) a. $25,020 {[($131,750 − $95,375) × 24%] + $16,290}. b. 10%, 12%, 22%, 24%. c. 24%. d. 19.0% ($25,020  $131,750). e. 17.2% ($25,020  $145,600). 19. (LO 3, 4, 6) If Mike is drafted by a team in one of the listed states, he will escape state income tax on income earned within that state (e.g., training camp, home games). He will not, however, escape the income tax (state and local) imposed by jurisdictions where he plays away games. Called the “jock tax,” it is applied to out-of-state athletes and entertainers. 20. (LO 2, 7) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that they are not paying for the donation. BRIDGE DISCIPLINE PROBLEMS 1. Solutions may vary among students. 2. Solutions may vary among students. 3. Solutions may vary among students. 4. When taxes become “too high,” taxpayers increase the rates of tax cheating, because the payoff from misconduct increases. Property and transaction taxes are difficult to cheat on, as the tax base is easily detectible, while cheating on taxes on income and asset transfers may be more easily accomplished, and enforcement activities by the Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 7 website, in whole or in part. taxing agency become more expensive. High rates of tax cheating can lead to several undesirable consequences. • A “conspicuous consumption” society, wherein taxpayers use their tax underpayments to increase their lifestyles in a public fashion. • A loss of confidence in the self-assessment system, such that certain levels of cheating are assumed to occur, and the number of cheaters increases. • The “missing revenue” keeps the government from delivering the goods and services that the taxes are supposed to pay for. • Political gridlock can occur when it becomes impossible to raise tax rates high enough, or broaden the tax base enough, to offset the cheaters’ “missing revenue.” 5. a. To encourage pension plans is to stimulate saving (economic consideration). Also, it provides security from the private sector for retirement to supplement public programs which tend to provide lesser benefits (social considerations). An opposing consideration is that only higher income individuals are able to fully fund their pension plans and thus gain the greater tax benefit from the favorable rules for retirement savings. b. To make education more widely available is to promote a socially desirable objective. A better educated workforce also serves to improve the country’s economic capabilities. As a result, education tax incentives can be justified on both social and economic grounds. A weakness in the current incentives is that they are only for college education, rather than also in preparation for other careers including health care, personal care, construction, and skilled trades (e.g., mechanics, electricians, and plumbers). c. The encouragement of home ownership can be justified on both social and economic grounds. For example, if a person owns a home and has no mortgage by the time they retire, their monthly living expenses will be lower. An opposing consideration to the tax breaks for home ownership is that the mortgage interest deduction applies to debt up to $750,000, thus providing a greater tax break to higher income individuals who can qualify for this large of a mortgage. Also, renters indirectly pay property taxes through their rent, but receive no tax deduction for that indirect payment. Finally, the home ownership tax breaks today apply once the home is acquired; there are no tax incentives to help an individual buy a home (such as a first-time homeowner tax credit). RESEARCH PROBLEMS These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 8 website, in whole or in part. 1. An example of a sweetened beverage tax proposal is H.R. 2772 (117th Congress), the SWEET Act. Proposals also exist in a number of states and cities. Some cities, including Berkeley, California, Philadelphia, Pennsylvania, and Boulder, Colorado, have already enacted soda taxes. Considerations in analyzing these proposals include issues of regressivity (an equity and fairness issue), complexity of definitions, burden of enforcement, and neutrality in affecting decision making. Cook County, Illinois (Chicago) passed and then repealed a sweetened beverage tax due to a number of these issues. 2. Each of the Big Four firms has information on data analytics and how it can be used for tax purposes: • • • • Students should also find how the IRS and state tax agencies are using big data to improve audit selection and enforcement. For example, see IRS information in the Internal Revenue Manual (IRM) 1.1.18, Research, Applied Analytics and Statistics Division at: • 3. The Safeguards Rule was created as part of the Gramm-Leach-Bliley Act in 1999 (P.L. 106−102). The FTC summarizes this rule as follows: “The Safeguards Rule requires financial institutions under FTC jurisdiction to have measures in place to keep customer information secure. In addition to developing their own safeguards, companies covered by the Rule are responsible for taking steps to ensure that their affiliates and service providers safeguard customer information in their care.” This rule applies to all paid return preparers. • IRS Publication 4557 includes several actions preparers should take to protect client data and meet the Safeguards Rule. In reviewing student answers, confirm that they understand the Safeguards Rule and why a preparer obtaining or renewing a PTIN is asked to confirm that they have a data security plan. The publication lists numerous actions, consider whether the three plan elements the student describes are among the most important. In August 2022, the IRS Security Summit released a document with explanation and templates to help practitioners update or create a security plan. See IR−2022−147 (August 9. 2022) at Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 1: Introduction to Taxation © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 9 website, in whole or in part. 4. Circular 230 § 10.35 on competence states that a practitioner may become competent for an engagement matter in a variety of ways, including by consulting with experts or studying the law. As a result, if someone at the firm gains a better understanding of virtual currency transactions, the record keeping needed to determine the tax consequences of over 2,500 trades and also consider other rules (e.g., the trader versus investor status of the client), they can accept this client. If the firm is not able to become competent, they may not accept this potential new client. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 1 website, in whole or in part. Solution and Answer Guide NELLEN, CUCCIA, PERSELLIN, YOUNG, SWFT ESSENTIALS OF TAXATION: INDIVIDUALS AND BUSINESS ENTITIES 2024, 9780357900796; CHAPTER 2: WORKING WITH THE TAX LAW TABLE OF CONTENTS Problems ..............................................................................................................................1 Bridge Discipline Problems ............................................................................................... 11 Research Problems............................................................................................................12 PROBLEMS 1. (LO 1) See Exhibit 2.4. a. The Tax Court must follow its own cases, the pertinent U.S. Circuit Court of Appeals, and the Supreme Court. b. The Court of Federal Claims must follow its own decisions, the Federal Circuit Court of Appeals, and the Supreme Court. c. The District Court must follow its own decisions, the pertinent U.S. Circuit Court of Appeals, and the Supreme Court. 2. (LO 1, 3) SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 October 19, 2023 Ms. Sonja Bishop Tile, Inc. 100 International Drive Tampa, FL 33620 Dear Ms. Bishop: This letter is in response to your request about information concerning a conflict between a U.S. treaty with Spain and a section of the Internal Revenue Code (IRC). The major reasons for treaties between the United States and certain foreign countries is to eliminate double taxation and to render mutual assistance in tax enforcement. IRC § 7852(d) provides that if a U.S. treaty is in conflict with a provision in the IRC, neither will take general precedence. Rather, the more recent of the two will have precedence. In your case, the treaty with Spain takes precedence over the IRC section. A taxpayer must disclose on the tax return any positions where a treaty overrides a tax law. There is a $1,000 penalty per failure to disclose for individuals and a $10,000 penalty per failure to disclose for corporations. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 2 website, in whole or in part. Should you need more information, feel free to contact me. Sincerely, Jeffrey Hanks, CPA Tax Partner 3. (LO 1) a. Treasury Regulations are issued by the U.S. Treasury Department, while Revenue Rulings are issued by the National Office of the IRS. Both Regulations and Revenue Rulings are designed to provide an interpretation of the tax law. However, Rulings do not have the same legal force and effect as do Regulations. Usually, Rulings deal with more restricted facts. Rulings “are published to provide precedents to be used in the disposition of other cases and may be cited and relied upon for that purpose.” See Rev.Proc. 89–14. b. Revenue Procedures are issued in the same manner as are Revenue Rulings, but Procedures deal with the internal management practices and requirements of the IRS. Familiarity with these Procedures can increase taxpayer compliance and assist the efficient administration of the tax law by the IRS. c. Letter rulings are issued upon a request. They describe how the IRS will treat a proposed transaction. Unlike Revenue Rulings, letter rulings apply only to the taxpayer who applies for and obtains the ruling and generally “may not be used or cited as precedent” [§ 6110(k)(3)]. Letter rulings used to be “private” (i.e., the content of the ruling was made available only to the taxpayer that requested the ruling). However, Federal legislation and the courts have forced the IRS to modify its position on the confidentiality of letter rulings. Such rulings now are published by a number of commercial tax services, but with the taxpayer name and other identifying information removed. d. Like letter rulings, determination letters are issued at the request of taxpayers. They provide guidance concerning the application of the tax law. They differ from letter rulings in that the issuing source is the taxpayer’s own District Director rather than the National Office of the IRS. In addition, determination letters usually involve completed (as opposed to proposed) transactions. Determination letters are not published, but are made known only to the party making the request. 4. (LO 1, 2) The items would probably be ranked as follows (from lowest to highest): (1) Letter ruling (valid only to the taxpayer to whom issued). (2) Proposed Regulation (most courts ignore these). (3) Revenue Ruling. (4) Interpretive Regulation. (5) Legislative Regulation. (6) Internal Revenue Code. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 3 website, in whole or in part. 5. (LO 1) a. This citation refers to a Temporary Regulation; 1 refers to the type of Regulation (i.e., income tax), 956 is the related Code section number, 2 is the Regulation section number, and T refers to temporary. b. Revenue Ruling number 15, appearing on page 975 of the 23rd weekly issue of the Internal Revenue Bulletin for 2012. c. Letter Ruling 51, issued in the 4th week of 2002. 6. (LO 1) The main advantage of the U.S. Court of Federal Claims occurs when a taxpayer’s applicable Circuit Court previously rendered an adverse decision. Such a taxpayer may select the U.S. Court of Federal Claims because any appeal will be to the Federal Circuit. One disadvantage of the U.S. Court of Federal Claims is that the tentative deficiency must be paid before the Court will hear and decide the controversy. The U.S. Court of Federal Claims is a trial court that usually meets in Washington, D.C. It has jurisdiction for any claim against the United States that is based on the Constitution, any Act of Congress, or any Regulation of an executive department. 7. (LO 1, 3) SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 July 6, 2023 Mr. Edmund Falls 200 Mesa Drive Tucson, AZ 85714 Dear Mr. Falls: You have three alternatives should you decide to pursue your $229,030 deficiency in the court system. One alternative is the U.S. Tax Court, the most popular forum. Overall, Tax Court judges have more expertise in tax matters. The main advantage is that the U.S. Tax Court is the only trial court where the tax need not be paid prior to litigating the controversy. However, interest will be due on an unpaid deficiency. The interest rate varies from one quarter to the next as announced by the IRS. One disadvantage of the U.S. Tax Court is the delay that might result before a case is decided. The length of delay depends on the Court calendar, which includes a schedule of locations where cases will be tried. Another disadvantage is being unable to have the case heard before a jury. The major advantage of another alternative, the U.S. District Court, is the availability of a trial by jury. One disadvantage of a U.S. District Court is that the tentative tax deficiency must be paid before the Court will hear and decide the controversy. The Court of Federal Claims, the third alternative, is a trial court that usually meets in Washington, D.C. It has jurisdiction for any claim against the United States that is based on the Constitution, any Act of Congress, or any regulation of an executive department. The main advantage of the U.S. Court of Federal Claims occurs when a Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 4 website, in whole or in part. taxpayer’s applicable Circuit Court previously rendered an adverse decision. Such a taxpayer may select the Court of Federal Claims because any appeal will be to the Federal Circuit instead. One disadvantage of the Court of Federal Claims is that the tentative deficiency must be paid before the Court will hear and decide the controversy. I hope this information is helpful, and, should you need more help, please contact me. Sincerely, Abby Reynolds, CPA Tax Partner 8. (LO 1) See Exhibit 2.4, Exhibit 2.5, and Concept Summary 2.1. a. There is no appeal by either the taxpayer or the IRS from a decision of the Small Cases Division of the U.S. Tax Court. b. The first appeal would be to the Sixth Circuit Court of Appeals. Further appeal would be to the U.S. Supreme Court. c. Same as part b. above. d. The appeal would be to the Federal Circuit Court of Appeals and then to the U.S. Supreme Court. 9. (LO 1) See Concept Summary 2.1. U.S. U.S. U.S. Court Tax District of Federal Court Court Claims a. Number of regular judges 19 Varies; 16 one judge hears a case b. Jury trial No Yes No c. Prepayment of deficiency required No Yes Yes before trial 10. (LO 1) See Exhibit 2.5. a. Tenth. b. Eighth. c. Ninth. d. Fifth. e. Seventh. 11. (LO 1) The term petitioner is a synonym for plaintiff, which refers to the party requesting action in a court. 12. (LO 1, 2) a. If the taxpayer chooses a U.S. District Court as the trial court for litigation, the U.S. District Court of Wyoming will be the forum to hear the case. Unless the prior decision has been reversed on appeal, one would expect the same court to follow its earlier holding. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 5 website, in whole or in part. b. If the taxpayer chooses the U.S. Court of Federal Claims as the trial court for litigation, the decision that was rendered previously by this Court should have a direct bearing on the outcome. If the taxpayer selects a different trial court (i.e., the appropriate U.S. District Court or the U.S. Tax Court), the decision that was rendered by the U.S. Court of Federal Claims will be persuasive but not controlling. It is, of course, assumed that the result that was reached by the U.S. Court of Federal Claims was not reversed on appeal. c. The decision of a U.S. Circuit Court of Appeals will carry more weight than one that was rendered by a trial court. Because the taxpayer lives in California, however, any appeal from a U.S. District Court or the U.S. Tax Court will go to the Ninth Circuit Court of Appeals (see Exhibit 2.4). Although the Ninth Circuit Court of Appeals might be influenced by what the Second Circuit Court of Appeals has decided, it is not compelled to follow such holding. See Exhibit 2.5. d. Because the U.S. Supreme Court is the highest appellate court, one can place complete reliance upon its decisions. Nevertheless, one should investigate any decision to see whether the Code has been modified with respect to the result that was reached. The rare possibility also exists that the Court may have changed its position in a later decision. See Exhibit 2.4. e. When the IRS acquiesces to a decision of the U.S. Tax Court, it agrees with the result that was reached. As long as such acquiescence remains in effect, taxpayers can be assured that this represents the position of the IRS on the issue that was involved. Keep in mind, however, that the IRS can change its mind and can, at any time, withdraw the acquiescence and substitute a nonacquiescence. f. The issuance of a nonacquiescence usually reflects that the IRS does not agree with the result reached by the U.S. Tax Court. Consequently, taxpayers are placed on notice that the IRS will continue to challenge the issue that was involved. 13. (LO 1) The differences between a Regular decision, a Memorandum decision, and a Summary Opinion of the U.S. Tax Court are summarized as follows: • In terms of substance, Memorandum decisions deal with situations that require only the application of previously established principles of law. The dispute between the taxpayer and the IRS is typically over how the law applies to the particular facts. Regular decisions involve novel issues that have not been resolved by the Court. In actual practice, however, this distinction is not always observed. • Memorandum decisions officially were published until 1999 in mimeograph form only, but Regular decisions are published by the U.S. Government in a series that is designated as the Tax Court of the United States Reports. Memorandum decisions are now published on the Tax Court website. Both Regular and Memorandum decisions are published by various commercial tax services (e.g., CCH and Thomson Reuters). • A Summary Opinion is a Small Cases Division case involving amounts of $50,000 or less. They are not precedents for any other court decisions and are not reviewable by any higher court. Proceedings are timelier and less expensive than a Memorandum or Regular decision. Small cases decisions are published as Summary Opinion, found commercially and on the U.S. Tax Court website. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 6 website, in whole or in part. 14. (LO 1) a. CA–2. An abbreviation that designates the U.S. Second Circuit Court of Appeals. b. Fed.Cl. An abbreviation for the Federal Claims Reporter published by West Publishing Company. c. aff’d. An abbreviation for “affirmed,” which indicates that a lower court decision was affirmed (approved of) on appeal. d. rev’d. An abbreviation for “reversed,” which indicates that a lower court decision was reversed (disapproved of) on appeal. e. rem’d. An abbreviation for “remanded,” which indicates that a lower court decision is being sent back by a higher court for further consideration. f. Cert. denied. The Writ of Certiorari has been denied by the U.S. Supreme Court. This Writ means that the Court will not accept an appeal from a lower court and, therefore, will not consider the case further. g. acq. An abbreviation for “acquiescence” (agreement). The IRS follows a policy of either acquiescing or nonacquiescing to certain decisions. h. B.T.A. An abbreviation for the Board of Tax Appeals. From 1924 to 1942, the U.S. Tax Court was designated as the Board of Tax Appeals. i. USTC. U.S. District Court, U.S. Circuit Court of Appeals, U.S. Court of Federal Claims, and U.S. Supreme Court decisions that address Federal tax matters are reported in the Commerce Clearing House U.S. Tax Cases (USTC) and the Thomson Reuters American Federal Tax Reports (AFTR) series. j. AFTR. See the solution to part i. above. k. F.3d. All of the decisions (both tax and nontax) of the U.S. Claims Court (before October 1982) and the U.S. Circuit Court of Appeals are published by West Publishing Company in a reporter that is designated as the Federal Reporter, Second Series (F.2d). Volume 999, published in 1993, is the last volume of the Federal Second Series. It is followed by the Federal Third Series (F.3d). l. F.Supp. Most Federal District Court decisions, dealing with both tax and nontax issues, are published by West Publishing Company in its Federal Supplement Series (F.Supp.). m. USSC. An abbreviation for the U.S. Supreme Court. n. S.Ct. West Publishing Company publishes all of the U.S. Supreme Court decisions in its Supreme Court Reporter (S.Ct.). o. D.Ct. An abbreviation for a U.S. District Court decision. 15. (LO 2) a. Ninth Circuit Court of Appeals. b. U.S. Tax Court. c. U.S. Supreme Court. d. Board of Tax Appeals (old name of U.S. Tax Court). Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 7 website, in whole or in part. e. Tax Court (memorandum decision). f. Court of Claims. g. Not a court decision. h. District Court in New York. i. Not a court decision. 16. (LO 2) a. This citation is to a regular decision of the U.S. Tax Court that was issued in 1950. The decision can be found in Volume 14, page 74, of the Tax Court of the United States Report, published by the U.S. Government Printing Office. b. This citation is for a decision of the U.S. Fifth Circuit Court of Appeals that was rendered in 1979. The decision can be found in Volume 592, page 1251, of the Federal Reporter, Second Series (F.2d), published by West Publishing Company. c. This citation is for a decision of the U.S. Sixth Circuit Court of Appeals that was rendered in 1995. The decision can be found in Volume 1 for 1995, paragraph 50,104 of U.S. Tax Cases, published by Commerce Clearing House. d. This citation is for a decision of the U.S. Sixth Circuit Court of Appeals that was rendered in 1995. The decision can be found in Volume 75, page 110, of the Second Series of American Federal Tax Reports, published by RIA (Thomson Reuters). e. This citation is for a decision of the U.S. District Court of Texas that was rendered in 1963. The decision can be found in Volume 223, page 663, of the Federal Supplement Series, published by West Publishing Company. f. This citation is to a decision of the U.S. First Circuit Court of Appeals that was rendered in 2007. The decision can be found in Volume 491, page 53, of the Federal Reporter, Third Series (F.3d), published by West Publishing Company. g. This citation is to a decision of the U.S. District Court of the Virgin Islands that was rendered in 2011. The decision can be found in Volume 775, page 765, of the Federal Supplement, Second Series (F.Supp.2d), published by West Publishing Company. 17. (LO 2) a. Yes. Exhibit 2.3. b. No. Not published there. c. No. Published by private publishers and the IRS. Exhibit 2.3. d. Yes. Exhibit 2.3. e. Yes. Exhibit 2.3. f. No. g. Yes. Exhibit 2.3. h. No. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 8 website, in whole or in part. 18. (LO 2) a. The U.S. Tax Court. b. Yes, the appellate court affirmed, or agreed with, the trial court. c. United Draperies, Inc., the taxpayer. d. Yes, in effect, by issuing cert. denied to the appellate court decision (refusing to hear the decision). 19. (LO 2, 4) After understanding the relevant facts and the accounting rules related to qualified stock options: • A key word search on an online service is appropriate—Thomson Reuters Checkpoint, CCH IntelliConnect or AnswerConnect, LexisNexis, or Westlaw (or WestlawNext). • Yvonne may browse through IRS publications (available on the IRS website). • Additional information can be found on the internet. Many CPA and law firms post reliable articles on various tax subjects, often with reference and links to primary authority. 20. (LO 1, 2) a. Tom must sue in the U.S. District Court of his locality and not in any other U.S. District Court. b. Tom has four choices of courts with respect to his Federal tax question, and a state court is not one of the choices. He may go to the U.S. Tax Court, Small Cases Division of the U.S. Tax Court, U.S. District Court, or U.S. Court of Federal Claims. c. The B.T.A. decision is an old U.S. Tax Court decision that may have little validity today. Even if the decision still is good law, it probably will have little impact upon a U.S. District Court and certainly no impact upon a state court. d. The U.S. Court of Federal Claims is a trial court that usually meets in Washington, D.C., and Tom cannot appeal from a U.S. District Court to the U.S. Court of Federal Claims. Any appeal from his U.S. District Court would be to the Sixth Circuit Court of Appeals (and not to the Second). e. Few tax decisions reach the U.S. Supreme Court. The U.S. Supreme Court must agree to hear a court case. 21. (LO 1) a. T. b. C (before October 1982) and A. c. D, C, A, and U. d. D, C, A, and U. e. U. f. C and U. g. D. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 9 website, in whole or in part. h. D, T, and C. i. A and U. j. C. k. T. l. T. 22. (LO 1, 2) a. N, a cite for an IRS Revenue Ruling. b. T, U.S. Tax Court. c. A, U.S. Circuit Court of Appeals. d. U, U.S. Supreme Court. e. T, U.S. Tax Court (previous name of the Tax Court). f. D, U.S. District Court. g. T, U.S. Tax Court. h. N, a cite for a Letter Ruling. i. T, U.S. Tax Court’s Small Cases Division decision. 23. (LO 1, 2) a. P. b. P. c. P. d. S. e. P. f. S. g. P. Valid for three years. h. P. i. N. j. P. k. P. 24. (LO 1) b. Subchapter C; see discussion on p. 2-5. 25. (LO 1, 2) b. Internal Revenue Bulletin; see Exhibit 2.3. 26. (LO 1, 2) The number 66 is the volume number for the U.S. Tax Court, 39 refers to the page number of the 562nd volume of the Federal Second Series, and nonacq. means that the IRS disagreed with the decision. The Tax Court (T.C.) cite is to the trial court. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 10 website, in whole or in part. 27. (LO 1) There is no automatic right of appeal to the U.S. Supreme Court. Appeal is by Writ of Certiorari. If the Court agrees to hear the dispute, it will grant the Writ (Cert. granted). Most often, the highest court will deny jurisdiction (Cert. denied). 28. (LO 2) Tax research serves two major functions: (a) alerting the tax advisor to planning opportunities and documentation requirements that can reduce a taxpayer’s liability through alternative means of structuring a transaction and (b) determining the correct treatment of completed transactions to ensure accurate compliance with U.S. tax laws. A professional approach to client service, therefore, demands thorough tax research as part of the job. Attention to the requirements of our country’s tax laws is also mandated by the canons of professional ethics and the regulations applicable to professional tax preparers. Although some clients might prefer a head-in-the-sand approach to tax compliance, the range of potential penalties and interest charges make knowledge of the likely tax treatment of a particular transaction imperative. The low IRS audit rate, moreover, does not justify playing the “audit lottery.” Besides, this low rate masks much higher audit rates for certain categories of taxpayers and certain types of income—including returns prepared by persons known by the IRS to be negligent or unduly aggressive. 29. (LO 1) a. Regular, memorandum, and summary opinions. b. A ruling where the amount owed is under $50,000 and no appeal is allowed. c. A ruling dealing primarily with determining the relevant facts, rather than an interpretation of the law. d. Answers will vary among students. e. Answers will vary among students. 30. (LO 1, 2) Build interaction into the exercise wherever possible, asking the student to send and receive e-mail in a professional and responsible manner. a. Section 61(a)(12): Gross income of a taxpayer includes the distributive share of partnership gross income. b. Section 643(a)(2): Distributable net income of a trust or estate is computed without allowing a deduction for a personal exemption. c. Section 2503(g)(2)(A): The term “qualified work of art” means any archaeological, historic, or creative tangible personal property. 31. (LO 1) a. In 2023, the Chair is Jason Smith. He represents the 8th District from the state of Missouri. b. In 2023, there are 43 members (25 Republican; 18 Democratic). c. The Committee on Ways and Means is the oldest committee of the United States Congress, and is the chief tax-writing committee in the House of Representatives. The Committee derives a large share of its jurisdiction from Article I, Section VII of the U.S. Constitution which declares, “All Bills for raising Revenue shall originate in the House of Representatives.” First established as a select committee on July 24, Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 11 website, in whole or in part. 1789, it was discharged less than two months later. The committee was reappointed from the first session of the Fourth Congress in 1795 and was formally listed as a standing committee in the House Rules on January 7, 1802. Until 1865, the jurisdiction of the committee (referred to as the Committee of Ways and Means before 1880) included the critically important areas of revenue, appropriations, and banking. Since 1865, the committee has continued to exercise jurisdiction over revenue and related issues such as tariffs, reciprocal trade agreements, and the bonded debt of the United States. Revenue-related aspects of the Social Security system, Medicare, and social services programs also come within the scope of the Committee on Ways and Means. d. In 2023, there are six subcommittees: Health, Oversight, Social Security, Select Revenue Measures, Trade, and Worker and Family Support. BRIDGE DISCIPLINE PROBLEMS 1. a. There is a correspondence between the sources of the Federal tax law and the three branches of the law as described in the U.S. Constitution. Congress is the legislative branch, Treasury and the IRS are the executive branch, and the courts are the judicial branch. But the IRS likely is more aggressive than most other federal agencies, despite its “customer service” orientation. And there are few federal courts in which the taxpayer’s chances of prevailing are so low as they are in tax litigation. And one seldom sees elsewhere the power of the congressional committees assigned to shepherd tax proposals to a vote. b. Any litigation can be expensive due to the need to prepare numerous documents for a trial. However, the fact that a taxpayer is not required to pay the tax liability before bringing an action in the U.S. Tax Court reduces litigation costs at the start of this process. There are opportunities for the taxpayer to reach an agreeable settlement with the government without the need for litigation. For issues that arise in an IRS examination, the taxpayer has several options, including meeting with the examiner’s supervisor and taking the issue to the Independent Office of Appeals. 2. Solutions may vary among students. 3. Solutions may vary among students. 4. There is nothing illegal or immoral about minimizing one’s tax liability. A citizen has every legal right to arrange his or her affairs so as to keep the attendant taxes as low as possible. One is required to pay no more taxes than the law demands. There is no ethical difference between a tax advisor’s reduction of a tax expense and a cost accountant’s reduction of a cost of operating a business. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 12 website, in whole or in part. RESEARCH PROBLEMS 1. a. In this Tax Court Memorandum decision, the court upheld the taxpayer’s claim for the American Opportunity tax credit finding that the Form 1098-T she received was incorrect. b. In this letter ruling, a proposed merger between members of an affiliated group qualified for tax-free reorganization treatment under § 355. c. The IRS issued an acquiescence in result only to Jacobs v. Commissioner, 148 T.C. No. 24 (2017), involving the owners of the Boston Bruins. 2. a. Code § 708(a) is located in Subchapter K, Part I. It provides that an existing partnership shall be considered as continuing if it is not terminated. b. Code § 1371(a) is located in Subchapter S, Part III. It provides that, with exceptions, Subchapter C shall apply to S corporations and its shareholders. c. Code § 2503(a) is located in Subchapter A (no part). It provides that the term “taxable gifts” means the total amount of gifts made during the calendar year, less the deductions provided in Subchapter C. 3. a. Regulation § 1.170A–4(A)(b)(2)(ii)(C) provides that the care of the ill means alleviation or cure of an existing illness and includes care of the physical, mental, or emotional needs of the ill. b. Regulation § 1.672(b)–1 defines a nonadverse party as any person who is not an adverse party. c. Regulation § 1.1031(a)–3(a) defines real property under § 1031. 4. a. Higgens v. Comm., 312 U.S. 212 (1941). b. Talen v. U.S., 355 F.Supp.2d 22 (D.Ct. D.C., D.D.C., 2004). c. Rev.Rul. 2008–18, 2008–13 I.R.B. 674. d. Pahl v. Comm., 150 F.3d 1124 (CA–9, 1998). e. Veterinary Surgical Consultants PC, 117 T.C. 141 (2001). f. Yeagle Drywall Co., T.C. Memo. 2001–284. 5. Using the citation, find the case in Thomson Reuters Checkpoint or find the case on the U.S. Tax Court website (), under “Opinions Search” tab. The issue in Green concerns the deductibility of commuting expenses. The taxpayer, Thomas Green, was a television executive whose office, his primary place of work, was in Manhattan. However, Mr. Green claimed that the den in his Long Island home was also a place of business because he worked there in the evenings. As a result, Mr. Green deducted the commuting costs he incurred driving between his home and his clients’ offices, on the way to his Manhattan office. The Tax Court concluded that these costs were nondeductible commuting expenses. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 2: Working with the Tax Law © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 13 website, in whole or in part. Mr. Green used an IRS publication (Publication 17, Your Federal Income Tax) to support the conclusion that his expenses were deductible commuting expenses. However, IRS publications are not primary sources of tax law on which research conclusions should be based. This was confirmed by the Tax Court. In the opinion, the judge said that even if the sentence taken out of context from the publication could support Mr. Green’s conclusion, “…the sources of authoritative law in the tax field are the statute and regulations, and not informal publications such as Your Federal Income Tax.” 6. IRC § 7463(b) states that a decision entered into by any small case decision “shall not be reviewed in any other court and shall not be treated as precedent for any other case.” In the reviewed opinion Larry Mitchell 131 T.C. 215 (2008), the court held that an exspouse’s share of military retirement payments is subject to tax. This same issue had been litigated previously by the taxpayer in Mitchell, T.C. Summ. 2004–160. In the past, the Tax Court has used collateral estoppel in small tax case decisions to stop (estop) a party from litigating the same issue in a regular Tax Court case. As a result, this reviewed decision seems to contradict their stance. Judge Holmes stated that this Tax Court decision means “that they are without effect on future litigation at all.” 7. In the Tax Court case Kathryn Bernal: a. Docket number 930-02. b. Filed on February 20, 2003. c. Respondent is David Jojola for the IRS. d. Kathryn Bernal, the taxpayer, acted as her own attorney (e.g., pro se). e. This case was assigned to and written by the Chief Trial Judge Peter J. Panuthos. f. The court granted respondent’s (IRS) motion to dismiss for lack of jurisdiction. Taxpayer mailed her petition beyond the 3-year available time period. RESEARCH PROBLEMS 8 AND 9 These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 8. Solutions may vary among students. 9. Solutions may vary among students. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 3: Taxes in the Financial Statements © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 1 website, in whole or in part. Solution and Answer Guide NELLEN, CUCCIA, PERSELLIN, YOUNG, SWFT ESSENTIALS OF TAXATION: INDIVIDUALS AND BUSINESS ENTITIES 2024, 9780357900796; CHAPTER 3: TAXES IN THE FINANCIAL STATEMENTS TABLE OF CONTENTS Problems ..............................................................................................................................1 Bridge Discipline Problems .............................................................................................. 19 Research Problems...........................................................................................................20 Solutions To Becker CPA Review Questions...................................................................20 PROBLEMS (LO 1) This statement is a fair assessment of the underlying meaning of book-tax differences. There are many legitimate reasons that book and tax income can differ in the same year unrelated to any potential tax evasion. Financial statements are designed for different purposes and for different audiences, relative to Federal income tax returns. (LO 1) Temporary differences are caused by income and expenses appearing in both the financial statements and tax return but in different periods (i.e., a timing difference). Permanent differences are caused by items appearing in the financial statements or the tax return but not both. Both types of differences result in a gap between book and taxable income. Temporary differences reverse over time, but permanent differences do not. (LO 1) Examples of temporary differences include the following: • Cost recovery deductions for tax that differ in timing and amount from book depreciation. • GAAP requires use of the allowance method to recognize bad debt expense, estimating the future collectibilty of receivables related to prior sales. For tax purposes, a deduction for a bad debt is not allowed until an account is identified as uncollectible. • Warranty expenses accrued for book purposes but not deductible for tax purposes until the services are provided. Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 3: Taxes in the Financial Statements © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 2 website, in whole or in part. • Goodwill is not expensed for book purposes unless and until impaired; § 197 permits the amortization of goodwill over 15 years. Examples of permanent differences include the following: • Municipal bond interest (i.e., nontaxable income). • The disallowed portion of business meals expense (i.e., nondeductible expenses). • Certain penalties. • Federal income taxes. • Tax credits. (LO 1, 2) SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 November 17, 2023 Marcellus Jackson Mac, Inc. 482 Linden Road Paris, KY 40362 Dear Mr. Jackson: A significant difference may exist between a corporation’s U.S. Federal income tax liability as reported on its Form 1120 (tax) and the corporation’s income tax expense as reported on its financial statements (book) prepared using generally accepted accounting principles (GAAP). This difference is caused primarily by the following: • Different definition of taxes included in the income tax expense amount. • Different accounting methods. • Intra-period allocation. • Different criteria for recognizing the benefits of uncertain tax positions. Different Taxes. The income tax expense reported on a corporation’s financial statements is the combination of Federal, state, local, and foreign income taxes. The income tax expense reported on the Form 1120 is the current-year Federal income tax expense only. Different Methods. Due to the different purposes served by GAAP and taxable income, the period in which revenues and expenses are recognized often differs across the two measures. As a result, many items of revenue and expense, though recognized for both book and taxable income, impact a company’s taxable income (and tax liability) in a different year than when they are reported in its book income. However, GAAP requires that all of the tax related to the net income reported in the currentyear financial statements be recognized in those financial statements (regardless of when the income is recognized for tax purposes and the related tax is due). So the tax expense reported in the financial statements includes not only what is reflected on the current-year tax returns (current tax expense) but also the tax consequences Solution and Answer Guide: Nellen, Cuccia, Persellin, Young, SWFT Essentials of Taxation: Individuals and Business Entities 2024, 9780357900796; Chapter 3: Taxes in the Financial Statements © 2024 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible 3 website, in whole or in part. of those items that are included in current-year book income but not in current-year taxable income (deferred tax expense). Intra-period Allocation. Any tax expense or benefit attributable to items included in comprehensive income but not in income from operations must be netted with those items when reported on the income statement. Therefore, tax expense may omit the tax consequences of items included in taxable income. Unrecognized Tax Benefits. A corporation may be unable to recognize in its financial statements tax saving legally taken on its tax return that nonetheless fail to meet the criteria to be recognized for financial accounting purposes (i.e., unrecognized tax benefits due to uncertain tax position). I hope this answers your question regarding the difference in taxes shown on the financial statements and the income tax return for Mac, Inc. Please let me know if I can provide you with any additional information. Very truly yours, Latoya Collins Tax Consultant (LO 5) Most likely the sales forecast constituted positive evidence as to the realizability of YoungCo’s deferred tax assets. Because the release of an allowance increases a company's deferred tax assets and decreases its deferred tax expense with no corresponding impact on its current tax expense, it is considered a permanent book-tax difference and reduces the taxpayer’s current-year book effective tax rate. (LO 5) a. Positive. b. Negative. c. Positive. d. Negative. e. Positive. Taxable income will increase, so it is more likely that the deferred tax asset will be realized. (LO 6, 7) Current tax expense may differ from the