INCOME TAX FUNDAMENTALS - Test Bank, Manual...

SOLUTIONS MANUAL/TEST BANK

2009 EDITION

INCOME TAXFUNDAMENTALS

Gerald E. WhittenburgSan Diego State University

Martha Altus-BullerSan Diego, California

© 2009 South-Western, Cengage Learning

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CONTENTS

PREFACE ..................................................................................................................................................................... iv

CHAPTER OUTLINES AND SUGGESTED MINIMUM ASSIGNMENTS............................................................. 1

SOLUTIONS FOR QUESTIONS AND PROBLEMS................................................................................................... 25

Chapter 1 The Individual Income Tax Return ........................................................................................................... 27Chapter 2 Gross Income and Exclusions.................................................................................................................... 37Chapter 3 Business Expenses and Retirement Plans ................................................................................................. 51Chapter 4 Self-Employed and Employee Expenses................................................................................................... 75Chapter 5 Itemized Deductions and Other Incentives ............................................................................................... 105Chapter 6 Credits and Special Taxes.......................................................................................................................... 135Chapter 7 Accounting Periods and Methods and Depreciation................................................................................. 159Chapter 8 Capital Gains and Losses ........................................................................................................................... 177Chapter 9 Withholding, Estimated Payments, and Payroll Taxes............................................................................. 203Chapter 10 Partnership Taxation .................................................................................................................................. 231Chapter 11 The Corporate Income Tax ........................................................................................................................ 243Chapter 12 Tax Administration and Tax Planning ...................................................................................................... 257

SOLUTIONS FOR ADDITIONAL COMPREHENSIVE TAX RETURN PROBLEMS......................................... 259

TEST BANK

Chapter 1 The Individual Income Tax Return ........................................................................................................... 291Chapter 2 Gross Income and Exclusions.................................................................................................................... 305Chapter 3 Business Expenses and Retirement Plans ................................................................................................. 317Chapter 4 Self-Employed and Employee Expenses................................................................................................... 331Chapter 5 Itemized Deductions and Other Incentives ............................................................................................... 343Chapter 6 Credits and Special Taxes.......................................................................................................................... 359Chapter 7 Accounting Periods and Methods and Depreciation................................................................................. 371Chapter 8 Capital Gains and Losses ........................................................................................................................... 385Chapter 9 Withholding, Estimated Payments, and Payroll Taxes............................................................................. 399Chapter 10 Partnership Taxation .................................................................................................................................. 409Chapter 11 The Corporate Income Tax ........................................................................................................................ 419Chapter 12 Tax Administration and Tax Planning ...................................................................................................... 429

TEST BANK SOLUTIONS ............................................................................................................................................... 435

PREFACE

This manual contains the solutions to the multiple choice questions, problems, and comprehensive problems in thetext and also provides a source of exam questions for your class. Some of the test bank questions require additional tablesor schedules. The tax calculations and phase-outs have become so complex that professors may prefer open book tests insome circumstances. If you wish to make the manual available for student review, the pages in the manual are perforated sothat test materials may be removed from the manual to retain their integrity.

The test bank is also available for use on personal computers through ExamView®. If you would like a copy ofthis computerized test generator, please contact your Cengage Learning representative.

The manual also contains a brief topical outline for each chapter designed to assist you in presenting the coursematerial. Suggested minimum case and problem assignments, selected to provide a representative sample of the text’sproblem material, follow each chapter outline.

Gerald E. WhittenburgMartha Altus-Buller

Chapter Outlines 1

CHAPTER OUTLINES

AND

SUGGESTED MINIMUM ASSIGNMENTS

2 Chapter Outlines

Chapter Outlines 3

CHAPTER 1

THE INDIVIDUAL INCOME TAX RETURN

BRIEF TOPICAL OUTLINE

A. Learning ObjectivesB. History and Objectives of the Tax System

1. Social objectives2. Economic objectives

C. Reporting and Taxable Entities1. The individual2. The corporation3. The partnership

D. The Tax Formula for Individuals1. Gross income2. Deductions for adjusted gross income3. Adjusted gross income4. Standard deduction or itemized deductions5. Exemptions6. Taxable income7. Gross tax liability

E. Who Must File1. Who must file (see Figures 1, 2 and 3)

F. Filing Status and Tax Computation1. Filing Status

- Single taxpayers- Married filing jointly- Married filing separately- Head of household- Surviving spouse/Qualifying widow(er)

2. Tax Computation3. Qualifying dividends

G. Personal and Dependency Exemptions1. Personal exemptions2. Dependency exemptions

- Relationship test for qualifying children- Domicile test- Age test- Joint return test- Citizenship test- Self-support test

3. Dependency exemptions for qualifying relatives- Relationship or member of household test- Gross income test- Support test- Joint return test- Citizenship test

4 Chapter Outlines

H. The Standard Deduction1. Amounts2. Additional amounts for old age and blindness3. Individuals not eligible for the standard deduction4. Special limitations for dependents

I. A Brief Overview of Capital Gains and Losses1. Adjusted basis2. Amount realized3. Ordinary versus capital gains and losses

J. Tax and the Internet1. IRS Site

- Forms & Pubs2. Other useful tax information sites

K. Electronic Filing (e-Filing)1. Individual tax preparation software2. Tax professionals

SUGGESTED MINIMUM ASSIGNMENT:

Problems 2, 4, 7, 9, 10, 12, 13, 15, and 16Comprehensive problems 1 and 2A or 2BOptional: Cumulative Software Problem

Chapter Outlines 5

CHAPTER 2

GROSS INCOME AND EXCLUSIONS


A. Learning ObjectivesB. The Nature of Gross Income

1. Internal Revenue Code definition2. Inclusions (see Table 1)3. Exclusions (see Table 2)

C. Interest and Dividend Income1. Schedule B not always required2. U.S. Savings Bonds3. Qualifying dividends (special zero or 15% tax rate)

D. Alimony1. Definition of alimony2. Divorces before 19853. Divorces after 19844. Alimony recapture

5. Property transfers6. Child support

E. Prizes and Awards1. General rule2. Exception for certain employee awards

F. Annuities1. The General Rule2. The Simplified Method3. Employee annuities

G. Life Insurance1. General rule2. Policies transferred for valuable consideration

H. Gifts and Inheritances1. Property received2. Subsequent income from property

I. Scholarships1. Amounts received for tuition, books and course-required supplies2. Amounts received for room and board

J. Accident and Health InsuranceK. Meals and Lodging

1. Test for exclusion of meals- Convenience of the employer- On the business premises

2. Test for exclusion of lodging- On the business premises- Condition of employment

6 Chapter Outlines

L. Municipal Bond Interest1. Exclusion of interest2. After-tax return

M. Social Security Benefits1. Partial inclusion in income2. Consequences of receiving tax-exempt interest income

N. Unemployment CompensationO. Employee Fringe Benefits

1. Employer-provided spending accounts- Dependent care accounts- Medical flexible spending accounts- Public transportation and parking at work

2. Group term life insurance3. No-additional-cost services4. Qualified employee discounts5. Working condition fringe benefits6. De minimis fringe benefits7. Tuition reduction8. Athletic facilities9. Retirement planning fringe benefit


Problems 1, 2, 3, 6, 8, 9, 10, 14, 15, and 18Comprehensive problems 1 and 2A or 2BOptional: Cumulative Software Problem

Chapter Outlines 7

CHAPTER 3

BUSINESS EXPENSES AND RETIREMENT PLANS


A. Learning ObjectivesB. Rental Income and Expenses

1. Schedule E2. Vacation homes

- Primarily personal use- Primarily rental use- Rental/Personal use

C. Passive Loss Limitations1. Classification of income and losses2. Real estate rental activities

- Special rule for “actively managed” rental activities3. Real estate rental as a trade or business

D. Bad Debts1. Definition2. Business and nonbusiness bad debts

E. Inventories1. Calculation of cost of goods sold2. Valuation of inventory: FIFO and LIFO3. LIFO election restrictions

F. Net Operating Losses1. Trade or business losses2. Carrybacks and carryovers

G. Individual Retirement Accounts1. Definition2. Maximum annual contribution

- Under 50- 50 and over

3. Qualification for deduction of contributions- Phase outs- Nondeductible contributions

4. Distributions5. Time for making contributions6. Roth IRAs

- Nondeductible contribution- Tax free earnings- Qualified distribution

H. Keogh (H.R. 10) Plans1. Qualification2. Contribution limits3. Distributions

8 Chapter Outlines

I. Qualified Retirement Plans Including Section 401(k) Plans1. Tax treatment of contributions2. Qualified plan requirements3. Types of qualified plans4. Contribution and benefit limitations5. Section 401(k) plans

J. Rollovers1. Direct transfers2. Distribution rollovers

K. SIMPLE Plans1. IRAs and 401(k) plans2. Matching contribution formula3. Alternative contribution formula4. Early withdrawals5. Elective deferrals


Problems 1, 3, 4, 5, 6, 7, 10, 11, and 14Comprehensive problems 1 and 2A or 2BOptional: Cumulative Software Problem

Chapter Outlines 9

CHAPTER 4

SELF-EMPLOYED AND EMPLOYEE EXPENSES


A. Learning ObjectivesB. Classification of Deductions

1. Self-employed taxpayer’s business expenses2. Business expenses incurred by an employee

C. Travel Expenses1. Ordinary and necessary test2. Overnight test3. Fifty-percent deduction for meals4. Combined business and pleasure trip

- Within the United States- Outside the United States

5. Substantiation- Actual expenses- Per diem methods

D. Transportation1. Automobile Expenses

- Standard mileage method- Actual cost

2. Commuting costs3. Other transportation expenses

E. Office In The Home1. Qualification for deduction of expenses2. Gross income limitation3. Home office allocation

F. Entertainment1. “Directly related to” taxpayer’s trade or business test2. “Associated with” the active conduct of the business test3. Entertainment facilities4. Fifty-percent deduction

G. Educational Expenses1. Education required by employer or law2. Maintaining or improving existing skills3. Expenses of travel for educational purposes

H. Dues, Subscriptions, and PublicationsI. Special Clothing and Uniforms

1. Required as a condition of employment2. Not suitable for everyday use3. Costs related to special clothing and uniforms4. Protective clothing and equipment

J. Business Gifts1. Dollar limits2. Substantiation requirement

10 Chapter Outlines

K. Schedule C1. Net profit or loss from sole proprietorship2. Schedule C and Schedule C-EZ3. Self-Employment Tax


Problems 1, 3, 5, 6, 7, 8, 9 and 12Comprehensive problems 1 and 2A or 2BOptional: Cumulative Software Problem

Chapter Outlines 11

CHAPTER 5

ITEMIZED DEDUCTIONS AND OTHER INCENTIVES


A. Learning ObjectivesB. Medical Expenses

1. Formula for calculating the medical expense deduction2. What qualifies as a medical expense?3. Medical insurance4. Medicines and drugs5. Capital expenditures6. Transportation7. Lodging for medical care8. Health Savings Accounts (HSAs)

C. Taxes1. Deductible and nondeductible taxes2. State income tax versus sales tax election3. Real property taxes

- For general public welfare- Special assessments

4. Personal property taxesD. Interest

1. What qualifies as interest?2. Taxpayer’s obligation3. Prepaid interest4. Qualified residence and consumer interest

- Acquisition debt- Home equity debt- Consumer debt

5. Education loan interest6. Investment interest

E. Contributions1. What qualifies as a charitable contribution?

- Qualified recipients2. Donation of property

- Ordinary income property- Long-term capital gain property

3. Adjusted gross income limitations4. Substantiation rules

F. Casualty and Theft Losses1. What is a casualty or theft?2. When deductible?3. Measuring the loss4. Deduction limitations

12 Chapter Outlines

G. Miscellaneous Deductions1. Miscellaneous deductions not subject to the two percent of adjusted gross income limitation2. Miscellaneous deductions subject to the two percent of adjusted gross income limitation3. Investment expenses4. Tax return preparation fees5. Job hunting expenses

H. Phase-out of Itemized Deductions and Exemptions for High Income Taxpayers1. Limitation on total itemized deductions2. Personal and dependency exemptions

I. Moving Expenses1. Change of job sites and minimum distance tests2. Length of employment test3. Qualifying expenses4. Nonqualifying expenses

J. Hobby Losses1. Operational rules2. Loss limitations

K. Educational Incentives1. Qualified Tuition Programs (QTP)2. Educational Savings Accounts3. Higher Education Expenses Deduction


Problems 2, 3, 5, 8, 9, 11, 14, 16, 17, and 21Comprehensive problems 1 and 2A or 2BOptional: Cumulative Software Problem

Chapter Outlines 13

CHAPTER 6

CREDITS AND SPECIAL TAXES


A. Learning ObjectivesB. Child Tax Credit

1. Maximum credit2. Phase-outs

C. Earned Income Credit1. Who is eligible?2. Phase out based on AGI3. Qualifying children4. EIC Tables

D. Child and Dependent Care Credit1. Eligibility for the credit2. Qualified expenses3. Allowable credit4. Special rules for determination of the credit

E. Education Tax Credits1. HOPE credit2. Timing of expenses3. Lifetime Learning credit4. Credit phase-out5. Limitations6. Using both credits

F. Foreign Tax Credit1. Overall limitation2. Carrybacks and carryovers

G. Adoption Expenses1. Adoption credit2. Domestic multi-year adoption3. Foreign multi-year adoption4. Employer-provided adoption assistance5. Coordination of adoption credit and assistance6. Qualified adoption expenses

H. Temporary Energy Credits1. Hybrid vehicles2. Energy saving improvements (extended to 2009 but not 2008)3. Photovoltaic, solar hot water, fuel cell, and wind energy

I. The Individual Alternative Minimum Tax1. Purpose of the alternative minimum tax2. Calculation of the alternative minimum tax3. Alternative minimum tax adjustments and preferences

J. Unearned Income of Minor Children1. Children to whom the parental tax rate applies2. Calculation of net unearned income3. Computation of parental tax4. Allocation of parental tax5. Election to include a child’s unearned income on parent’s return

14 Chapter Outlines

K. Community Property1. Income from community property2. Income from separate property3. Special rules for spouses living apart


Problems 1, 4, 5, 7, 8, 10, 11 and 12Comprehensive problems 1 and 2A or 2BOptional: Cumulative Software Problem

Chapter Outlines 15

CHAPTER 7

ACCOUNTING PERIODS AND METHODS AND DEPRECIATION


A. Learning ObjectivesB. Accounting Periods

1. Restrictions on tax years- Annual required tax payment- Limitation on deduction of salary expense

2. Short period taxable incomeC. Accounting Methods

1. Cash method2. Accrual method3. Hybrid method4. Election of method of accounting5. Restrictions on the use of the cash method

D. Depreciation1. Definition2. Concept of depreciation3. Assets acquired before 1981

E. Modified Accelerated Cost Recovery System (MACRS)1. Classification (recovery period) of assets acquired after 19862. Personal property cost recovery

- Half-year convention- Straight-line election

3. Bonus depreciation for certain properties4. Mid-quarter convention5. Real estate cost recovery6. Mid-month convention7. Reporting depreciation expense

F. Election to expense1. Qualified property2. Maximum deduction allowable under the election to expense

- Additional limitations3. Calculation of depreciation once the expense election has been made

G. Listed Property1. Definition of listed property2. Qualified business use3. Restriction on use of accelerated depreciation method

H. Limitation on Depreciation of Luxury Automobiles1. Annual dollar limitations2. Reduction in annual limitation where business use is less than 100 percent.

I. Intangibles1. Section 197 intangibles2. Exclusions

16 Chapter Outlines

J. Related Parties (Section 267)1. Losses2. Unpaid expenses and interest3. Relationships


Problems 3, 4, 5, 6, 7, 8, 9 and 13Comprehensive problems 1 or 2Optional: Cumulative Software Problem

Chapter Outlines 17

CHAPTER 8

CAPITAL GAINS AND LOSSES


A. Learning ObjectivesB. What is a Capital Asset?C. Holding period

- Short-term- Long-term

D. Calculation of Gain or Loss1. Sale or exchange2. Amount realized3. Adjusted basis

- Original basis- Capital improvements- Accumulated depreciation

E. Net Capital Gains1. Calculation of Net Capital Position2. Capital gains tax calculation

- Capital gains tax rates- Capital gains ordering

F. Net Capital Losses1. Calculation of net capital losses2. Treatment of net capital losses3. Carryovers4. Ordering rules for capital losses

G. Section 1231 Gains and Losses1. Definition of Section 1231 assets2. Calculation of net Section 1231 gain or loss

H. Depreciation Recapture1. Section 1245 recapture2. Section 1250 recapture3. Unrecaptured depreciation on real estate

I. Capital Gains and Casualty Gains and Losses1. Personal property casualty gains and losses2. Casualty gains and losses from business or investment property

J. Installment Sales1. Taxable gain2. Election to report all gain in the year of sale3. Contract price

K. Like-Kind Exchanges1. Property qualifying for like-kind exchange2. Amount of gain deferred3. Basis of like-kind property received4. Holding period of like-kind property received5. Definition of like-kind property

18 Chapter Outlines

L. Involuntary Conversions1. Recognition of gain2. Time limit for replacement of involuntarily converted property3. Basis of replacement property

M. Sale of a Personal Residence after May 6, 19971. General exclusion2. Married taxpayers


Problems 2, 4, 6, 7, 9, 10, 11, 12, 13, 15 and 17Comprehensive problems 1 or 2Optional: Cumulative Software Problem

Chapter Outlines 19

CHAPTER 9

WITHHOLDING, ESTIMATED PAYMENTS, AND PAYROLL TAXES


A. Learning ObjectivesB. Withholding Methods

1. Withholding allowances and Form W-42. Computing withholding

- Percentage method- Wage bracket method

3. Pension and deferred income4. Tip reporting5. Backup withholding

C. Estimated Payments1. Requirements for filing2. Underpayment of estimated tax3. Avoiding the underpayment penalty

D. The FICA Tax1. Two parts, the Social Security tax and the Medicare tax

2. Paid by employee and employer3. Applicable rates

- Social Security rate- Medicare rate

4. Maximum base amounts- Social Security tax maximum base amount- No Medicare tax maximum base amount

5. Overpayment of FICA taxesE. Federal Tax Deposit System

1. Frequency of deposits2. Where deposits are made3. Filing Form 941

F. Employer Reporting Requirements1. Form W-2

- Wages and tips reported on Form W-2- Other compensation, including reimbursements

2. Other Form W-2s3. Information returns—Form 1099s

G. Self-Employment Tax1. Comprised of two parts, the Social Security tax and the Medicare tax2. Applicable rates

- Social Security rate- Medicare rate

3. Maximum base amounts- Social security tax maximum base amount- No Medicare tax maximum base amount

4. Net earnings from self-employment5. Calculation of self-employment tax

20 Chapter Outlines

H. The FUTA Tax1. Rates

- Federal- State

2. Maximum base amount3. Filing Form 940

I. The Nanny Tax1. Threshold for reporting2. Employee-employer relationship3. Schedule H


Problems 1, 3, 4, 5, 6, 7, 9, 13 and 16Comprehensive problem 1

Chapter Outlines 21

CHAPTER 10

PARTNERSHIP TAXATION


A. Learning ObjectivesB. Nature of Partnership Taxation

1. Information return only2. What is a partnership?

C. Partnership Formation1. Gain or loss recognized2. Basis of partnership interest

- Original basis of partner’s partnership interest- Increases and decreases in basis of partner’s partnership interest

3. Partnership’s basis in property contributedD. Partnership Income Reporting

1. Form 10652. Partnership ordinary income or loss3. Items reported separately4. Limit on losses passed through from the partnership

E. Current Distributions and Guaranteed Payments1. Partnership recognition of gain or loss on a current distribution2. Recognition of gain or loss by a partner on a current distribution3. Basis of property received by the partner in a current distribution4. Guaranteed payments

F. Tax Years1. Permitted tax years2. Partnership termination

G. Partner/Partnership Transactions1. Disallowance of certain losses2. Ordinary income treatment of capital gains

H. The At-Risk Rule1. Limit on loss deductions2. Amounts-at-risk

I. Limited Liability Companies (LLC’s)1. Treated as partnership for tax purposes2. No general partner required3. New legal form yet to be fully defined and understood


Problems 1, 4, 5, 6, 7, 9, 10, 11 and 12Comprehensive problem 1

22 Chapter Outlines

CHAPTER 11

THE CORPORATE INCOME TAX


A. Learning ObjectivesB. Corporate Tax Rates

1. Regular tax rates2. “Bubbles”3. Personal service corporations

C. Corporate Capital Gains and Losses1. Alternative tax treatments2. Limitation on capital losses

D. Special Deductions and Limitations1. Dividends received deduction

- General rule- Taxable income limitation

2. Organizational expenditures3. Charitable contributions

E. Schedule M-11. Purpose2. Adjustments to book income

F. Filing requirements and estimated tax1. Form 11202. Form 1120S3. Estimated tax payments

G. S Corporations1. Qualified small business corporations2. Making the election3. Losing or revoking the election4. Reporting income5. S Corporation losses6. Pass-through items7. Special taxes

H. Corporate Formation1. Requirements for nonrecognition of gains or losses at formation2. Liabilities transferred3. Shareholder’s stock basis4. Corporation’s basis in property contributed

I. Corporate Accumulations1. Accumulated earnings tax2. Personal holding company tax

J. Corporate Alternative Minimum Tax1. Tax rate2. Exemption amount3. Tax preferences and adjustments


Problems 2, 3, 4, 5, 6, 8, 11 and 12Comprehensive problem 1

Chapter Outlines 23

CHAPTER 12

TAX ADMINISTRATION AND TAX PLANNING


A. Learning ObjectivesB. The Internal Revenue Service (in Transition)

1. National Office2. Regional offices3. District offices4. Service centers5. The 1998 IRS Restructuring Act6. Examination of records

C. The Audit Process1. Office audits2. Field audits3. Correspondence audits4. Selection of returns for audit

- The Discriminant Function (DIF) System- Other methods of selection

5. The appeals process- Figures 2 and 3

D. Interest and Penalties1. Interest charges and payments2. Interest rates applicable to underpayments and overpayments3. The failure to file and failure to pay penalties4. The accuracy-related penalty

- Negligence or disregard of rules or regulations- Substantial understatement of tax- Substantial valuation overstatement

5. The fraud penalty6. Miscellaneous penalties

E. Statute of Limitations1. General rule2. Exceptions

- Fraudulent tax returns- Omission of significant amount of gross income- Bad debts and worthless securities- Mutual consent

F. Preparers, Proof, and Privilege1. Types of practitioners

- Commercial preparers- Enrolled agents- Attorneys- Certified Public Accountants (CPAs)

2. No minimum requirements to prepare returns or give tax advice3. Representing clients in proceedings before the IRS4. Tax practitioner penalties5. Burden of proof6. Tax confidentiality privilege

24 Chapter Outlines

G. The Taxpayer Bill of RightsH. Tax Planning

1. Definition of tax planning2. Tax rate terminology3 Examples of tax planning4. Avoiding tax traps


Problems 1, 3, 4, 5, 6 and 11

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