SOLUTIONS MANUAL
PEARSON'S FEDERAL TAXATION 2025 INDIVIDUALS
38TH EDITION
CHAPTER I:1: AN INTRODUCTION TO TAXATION
DISCUSSION QUESTIONS
I:1-1 The Supreme Court held the income tax to be unconstitutional in 1895 because the
income tax was considered to be a direct tax. At that time, the U.S. Constitution required that an
income tax be apportioned among the states in proportion to their populations. This type of tax
system would be extremely difficult to administer because different rates of tax would apply to
individual taxpayers depending on their states of residence. p. I:1-2.
I:1-2 The pay-as-you-go withholding was needed in 1943 to avoid significant tax collection
problems as the tax base broadened from 6% of the population in 1939 to 74% in 1945.
Pay-as-you-go permitted the federal government to deduct taxes directly out of an employee's
wages. p. I:1-3.
I:1-3 Under a progressive tax rate structure, the tax rate increases as the taxpayer's income
increases. Currently, for 2024, tax rates of 10%, 12%, 22%, 24%, 32%, 35% or 37% apply
depending upon the taxpayer's filing status and taxable income levels. Under a proportional tax rate
or "flat tax" structure, the same tax rate applies to all taxpayers regardless of their income levels.
Under a regressive tax rate structure, the tax rate decreases with an increase in income level. The
concept of vertical equity holds that taxpayers with higher income levels should pay a higher
proportion of tax and that the tax should be borne by those who have the "ability to pay." Thus,
Congressman Patrick's opposition to the flat tax is philosophically correct; under a flat tax system,
all taxpayers pay taxes at the same rate, regardless of the ability to pay. pp. I:1-4 and I:1-5.
I:1-4 It is possible for the government to raise taxes without raising tax rates. Because there are
two components in computing a taxpayer's tax, the tax base and the tax rate, taxes can be raised
by increasing either the rate or the base. Thus, even though the Governor proclaimed that tax
,rates have remained at the same level, adjustments to the tax base, such as the elimination of
deductions, result in tax increases which can be as much, or more, as increases in tax rates. p.
I:1-4.
I:1-5 The marginal tax rate is of greater significance in measuring the tax effect for Carmen's
decision. The marginal tax rate is the percentage that is applied to an incremental amount of
taxable income that is added to or subtracted from the tax base. Through the marginal tax rate,
the taxpayer may measure the tax effect of the charitable contribution to her church. If her
marginal tax rate is 24%, she will save 24¢ for each $1 contributed to her church. The average
tax rate is simply the total tax liability divided by taxable income. pp. I:1-5 and I:1-6.
I:1-6 Gift and estate taxes are levied when a transfer of wealth (property) takes place and are
both part of the unified transfer tax system. The tax base for computing the gift tax is the fair
market value of all gifts made in the current year minus an annual donee exclusion of $18,000
(2024) per donee, minus a marital deduction for gifts to spouse and a charitable contributions
deduction if applicable, plus the value of all taxable gifts in prior years. The tax base for the
estate tax is the decedent's gross estate, minus deductions for expenses, and a marital or
charitable deduction if applicable, plus taxable gifts made after 1976. pp. I:1-7 through I:1-10.
I:1-7 a. Cathy, the donor, is primarily liable for the gift tax on the two gifts. The children
are contingently liable for payment of the gift tax in the event the donor fails to pay.
b. Before considering the unified tax credit equivalent of $13.61 million for 2024, a
gift tax results on the two gifts for the current year 2024 computed as follows:
Total gifts $100,000
Minus: Annual gift tax exclusion ($18,000 x 2 donees) ( 36,000)
Gift tax base $ 64,000
Since Cathy has never made gifts in prior years, no gift tax will be due because of the substantial
unified tax credit that is available. pp. I:1-8 and I:1-9.
,I:1-8 Carlos would report a taxable gain of $2,000 ($27,000 - $25,000). His tax basis in the
stock that he inherited is the fair market value on the date of his father’s death. pp. I:1-9 and I:1-10.
I:1-9 a. Most estates are not subject to the federal estate tax because of generous credit and
deduction provisions, such as the unified tax credit and the unlimited marital deduction. The
unified tax credit equivalent for 2024 is $13.61 million. This means that, at a minimum, for
decedents dying in 2024, no estate of $13.61 million or less will be subject to the federal estate tax.
b. This is a controversial question that has proponents on both sides of the issue.
Those that believe the estate tax should be reduced or eliminated basically argue that the estate
tax is a double tax, that is, the property of the decedent has already been subject to income
taxation during his or her lifetime and should not be subjected to further taxation at death. On the
other hand, proponents of retaining or increasing the estate tax believe in the ability to pay
principle. p. I:1-10.
I:1-10 a. Progressive.
b. Progressive.
c. Proportional.
d. Proportional.
e. Proportional. (However, state and local sales taxes are considered regressive when
measured against income).
pp. I:1-4 and I:1-5 and I:1-12.
I:1-11 Decrease. When Carolyn operates her business as a sole proprietor, she is considered to
be self-employed. A self-employment tax is imposed at the rate of 15.3% for 2024 (12.4%
OASDI + 2.9% Medicare) on all of her business income with a ceiling on the non-hospital
insurance (OASDI) portion of the tax base of $168,600 in 2024. Carolyn is also entitled to an
income tax deduction equal to 50% of the self-employment tax payments if she is self-employed.
If she works as an employee, however, the OASDI and Medicare taxes are imposed at the
employee level at a rate of 7.65% for 2024. The OASDI is imposed on earned income up to a
maximum of $168,600 in 2024 while Medicare taxes have no ceiling. Her employer would have
to match Carolyn’s OASDI and Medicare taxes. Thus, Social Security taxes are levied at the
, same rate of 15.3% (7.65% on the employee and 7.65% on the employer). If the corporation does
not pay Carolyn a salary equal to its earnings, the Social Security taxes will be slightly less than
under the sole proprietorship. The hospital insurance portion of the FICA premium continues to
apply with no ceiling amount for employees, employers, and self-employed individuals. The rate
is 2.9% for self-employed individuals and 1.45% each for employees and employers. p. I:1-11.
I:1-12 a. Property taxes are primarily used by local governments and include both real
property taxes (real estate) and personal property taxes (tangible and intangible property).
b. Excise taxes are primarily used by the federal government and are imposed on
items such as alcohol, tobacco, telephone usage, and many other goods. While not as extensive
as the federal government, many state and local governments impose similar types of taxes.
c. Sales taxes are primarily used by state governments and constitute a major
revenue source for many states. Local governments are increasingly using sales taxes as well as
states. The local governments frequently tack-on 1¢ or 2¢ to the existing state sales tax rather
than imposing a separate sales tax.
d. Income taxes are the primary domain of the federal government and constitutes its
major source of revenue. However, many state and local governments now use the income tax in
their revenue structures.
e. Employment taxes are primarily used by the federal government. Social security
(FICA) taxes are a major source of federal revenue. Unemployment taxes are used by states as a
compliment to the federal unemployment compensation tax. pp. I:1-10 and I:1-11.
I:1-13 a. The five characteristics of a “good” tax are equity, certainty, convenience,
economy, and simplicity. Equity refers to the fairness of the tax to the taxpayers. A certain tax is
one that ensures a stable source of government revenue and provides taxpayers with some degree
of certainty concerning the amount of their annual tax liability. Convenience refers to the case of
assessment, collectability, and administration for the government and reasonable compliance
requirements for taxpayers. An economical tax requires minimal compliance costs for taxpayers
and minimal administration costs for the government. Simplicity means the tax system is simple
to understand and to comply.
PEARSON'S FEDERAL TAXATION 2025 INDIVIDUALS
38TH EDITION
CHAPTER I:1: AN INTRODUCTION TO TAXATION
DISCUSSION QUESTIONS
I:1-1 The Supreme Court held the income tax to be unconstitutional in 1895 because the
income tax was considered to be a direct tax. At that time, the U.S. Constitution required that an
income tax be apportioned among the states in proportion to their populations. This type of tax
system would be extremely difficult to administer because different rates of tax would apply to
individual taxpayers depending on their states of residence. p. I:1-2.
I:1-2 The pay-as-you-go withholding was needed in 1943 to avoid significant tax collection
problems as the tax base broadened from 6% of the population in 1939 to 74% in 1945.
Pay-as-you-go permitted the federal government to deduct taxes directly out of an employee's
wages. p. I:1-3.
I:1-3 Under a progressive tax rate structure, the tax rate increases as the taxpayer's income
increases. Currently, for 2024, tax rates of 10%, 12%, 22%, 24%, 32%, 35% or 37% apply
depending upon the taxpayer's filing status and taxable income levels. Under a proportional tax rate
or "flat tax" structure, the same tax rate applies to all taxpayers regardless of their income levels.
Under a regressive tax rate structure, the tax rate decreases with an increase in income level. The
concept of vertical equity holds that taxpayers with higher income levels should pay a higher
proportion of tax and that the tax should be borne by those who have the "ability to pay." Thus,
Congressman Patrick's opposition to the flat tax is philosophically correct; under a flat tax system,
all taxpayers pay taxes at the same rate, regardless of the ability to pay. pp. I:1-4 and I:1-5.
I:1-4 It is possible for the government to raise taxes without raising tax rates. Because there are
two components in computing a taxpayer's tax, the tax base and the tax rate, taxes can be raised
by increasing either the rate or the base. Thus, even though the Governor proclaimed that tax
,rates have remained at the same level, adjustments to the tax base, such as the elimination of
deductions, result in tax increases which can be as much, or more, as increases in tax rates. p.
I:1-4.
I:1-5 The marginal tax rate is of greater significance in measuring the tax effect for Carmen's
decision. The marginal tax rate is the percentage that is applied to an incremental amount of
taxable income that is added to or subtracted from the tax base. Through the marginal tax rate,
the taxpayer may measure the tax effect of the charitable contribution to her church. If her
marginal tax rate is 24%, she will save 24¢ for each $1 contributed to her church. The average
tax rate is simply the total tax liability divided by taxable income. pp. I:1-5 and I:1-6.
I:1-6 Gift and estate taxes are levied when a transfer of wealth (property) takes place and are
both part of the unified transfer tax system. The tax base for computing the gift tax is the fair
market value of all gifts made in the current year minus an annual donee exclusion of $18,000
(2024) per donee, minus a marital deduction for gifts to spouse and a charitable contributions
deduction if applicable, plus the value of all taxable gifts in prior years. The tax base for the
estate tax is the decedent's gross estate, minus deductions for expenses, and a marital or
charitable deduction if applicable, plus taxable gifts made after 1976. pp. I:1-7 through I:1-10.
I:1-7 a. Cathy, the donor, is primarily liable for the gift tax on the two gifts. The children
are contingently liable for payment of the gift tax in the event the donor fails to pay.
b. Before considering the unified tax credit equivalent of $13.61 million for 2024, a
gift tax results on the two gifts for the current year 2024 computed as follows:
Total gifts $100,000
Minus: Annual gift tax exclusion ($18,000 x 2 donees) ( 36,000)
Gift tax base $ 64,000
Since Cathy has never made gifts in prior years, no gift tax will be due because of the substantial
unified tax credit that is available. pp. I:1-8 and I:1-9.
,I:1-8 Carlos would report a taxable gain of $2,000 ($27,000 - $25,000). His tax basis in the
stock that he inherited is the fair market value on the date of his father’s death. pp. I:1-9 and I:1-10.
I:1-9 a. Most estates are not subject to the federal estate tax because of generous credit and
deduction provisions, such as the unified tax credit and the unlimited marital deduction. The
unified tax credit equivalent for 2024 is $13.61 million. This means that, at a minimum, for
decedents dying in 2024, no estate of $13.61 million or less will be subject to the federal estate tax.
b. This is a controversial question that has proponents on both sides of the issue.
Those that believe the estate tax should be reduced or eliminated basically argue that the estate
tax is a double tax, that is, the property of the decedent has already been subject to income
taxation during his or her lifetime and should not be subjected to further taxation at death. On the
other hand, proponents of retaining or increasing the estate tax believe in the ability to pay
principle. p. I:1-10.
I:1-10 a. Progressive.
b. Progressive.
c. Proportional.
d. Proportional.
e. Proportional. (However, state and local sales taxes are considered regressive when
measured against income).
pp. I:1-4 and I:1-5 and I:1-12.
I:1-11 Decrease. When Carolyn operates her business as a sole proprietor, she is considered to
be self-employed. A self-employment tax is imposed at the rate of 15.3% for 2024 (12.4%
OASDI + 2.9% Medicare) on all of her business income with a ceiling on the non-hospital
insurance (OASDI) portion of the tax base of $168,600 in 2024. Carolyn is also entitled to an
income tax deduction equal to 50% of the self-employment tax payments if she is self-employed.
If she works as an employee, however, the OASDI and Medicare taxes are imposed at the
employee level at a rate of 7.65% for 2024. The OASDI is imposed on earned income up to a
maximum of $168,600 in 2024 while Medicare taxes have no ceiling. Her employer would have
to match Carolyn’s OASDI and Medicare taxes. Thus, Social Security taxes are levied at the
, same rate of 15.3% (7.65% on the employee and 7.65% on the employer). If the corporation does
not pay Carolyn a salary equal to its earnings, the Social Security taxes will be slightly less than
under the sole proprietorship. The hospital insurance portion of the FICA premium continues to
apply with no ceiling amount for employees, employers, and self-employed individuals. The rate
is 2.9% for self-employed individuals and 1.45% each for employees and employers. p. I:1-11.
I:1-12 a. Property taxes are primarily used by local governments and include both real
property taxes (real estate) and personal property taxes (tangible and intangible property).
b. Excise taxes are primarily used by the federal government and are imposed on
items such as alcohol, tobacco, telephone usage, and many other goods. While not as extensive
as the federal government, many state and local governments impose similar types of taxes.
c. Sales taxes are primarily used by state governments and constitute a major
revenue source for many states. Local governments are increasingly using sales taxes as well as
states. The local governments frequently tack-on 1¢ or 2¢ to the existing state sales tax rather
than imposing a separate sales tax.
d. Income taxes are the primary domain of the federal government and constitutes its
major source of revenue. However, many state and local governments now use the income tax in
their revenue structures.
e. Employment taxes are primarily used by the federal government. Social security
(FICA) taxes are a major source of federal revenue. Unemployment taxes are used by states as a
compliment to the federal unemployment compensation tax. pp. I:1-10 and I:1-11.
I:1-13 a. The five characteristics of a “good” tax are equity, certainty, convenience,
economy, and simplicity. Equity refers to the fairness of the tax to the taxpayers. A certain tax is
one that ensures a stable source of government revenue and provides taxpayers with some degree
of certainty concerning the amount of their annual tax liability. Convenience refers to the case of
assessment, collectability, and administration for the government and reasonable compliance
requirements for taxpayers. An economical tax requires minimal compliance costs for taxpayers
and minimal administration costs for the government. Simplicity means the tax system is simple
to understand and to comply.
