Wassim Zhani Federal Taxation Chapter 3 Taxable Entities; Tax Formula, Introduction to Property Transactions.pdf

Taxable Entities;
Tax Formula; Introduction to
Property Transactions
Solutions to Tax Research Problems
3-56 The purpose for this problem is to allow one to gain an appreciation for the organization of the Internal
Revenue Code and the differing authorities for taxing income, deductiong items, and classifying them. The
specific questions are answered as follows:
a. Congress defined the word “income” in § 61(a) by using the word “income.” The section states that
“income” includes income from all sources. This definition is enhanced by listing numerous examples,
such as salaries and wages, commissions, interest, dividends, and alimony.
b. Under § 63, the deductions allowed by 151-152 are properly deducted from A.G.I. in arriving at
taxable income. The only other deductions from A.G.I. are the larger of the itemized deductions or the
appropriate standard deduction.
c. Ordinary and necessary expenses incurred in the operation of a trade or business are deductible under
the authority of § 162. Section 62 defines A.G.I. by specifying which deductions are allowable in
calculating A.G.I. It specifies that the trade or business expenses of a self-employed person shall be
allowed as deductions for adjusted gross income. Only reimbursed expenses of an employee are
deductible for A.G.I. Other employee business expenses are miscellaneous itemized deductions.
d. Alimony is deductible within limits, as will be demonstrated in Chapter 7. The deductible amount is
allowable for A.G.I. under § 62, as explained for trade or business expenses above. It is important to
realize that the authority for the deduction and the authority for the classification thereof are separate.
Note: The sections that classify income and deduction items, §§ 61-68, are the basis for the “tax
formula” developed in this chapter.
3
3-1

Taxable Entities;
Test Bank
True or False
1. A single taxpayer will pay the same amount of tax (or less) as a head of household when their taxable
incomes are equal.
2. The income of a child under age 19 is taxed to the parent.
3. Citizens and residents of the United States generally are taxed on income earned in a foreign country.
4. The sole proprietorship business of an individual taxpayer is treated as a separate entity for tax
purposes.
5. F operates his computer repair business as a sole proprietorship. His sole proprietorship’s taxable
income is subject to tax using the corporate tax rates since it is a business.
6. B and D are beneficiaries of a trust that distributed $6,000 out of its taxable earnings to each of them
in 20X0. The trust had $11,000 of taxable net income in 20X0. The trust is not required to pay income
tax for 20X0.
7. The partnership entity does not pay a Federal income tax on its taxable income.
8. A partnership is taxed at the same rates as estates and trusts for Federal income tax purposes.
9. An S corporation generally pays no tax on the taxable income it generates.
10. A corporation does not distinguish between deductions for adjusted gross income and itemized
deductions.
11. A corporation is generally entitled to an income tax deduction for cash dividends paid to shareholders
because the shareholders are required to include the dividend in gross income.
12. For 2012, the highest income tax rate for corporations with the highest incomes is the same as the
highest marginal individual income tax rate.
3
3-3

13. Gross income is total income before subtracting exclusions.
14. Deductions for adjusted gross income (A.G.I.) can only be deducted if they exceed the standard
deduction.
15. An increase in adjusted gross income can cause a decrease in certain otherwise allowable itemized
deductions.
16. All employee business deductions of an individual are deductions for adjusted gross income.
17. The standard deduction is an amount that one deducts in addition to one’s itemized deductions.
18. V is single for tax purposes, has itemized deductions totaling $5,600, and is entitled to one $3,800
exemption deduction for 2012. V should itemize her deductions in 2012.
19. John, a widower of four years who is supporting his two young (under age 19) daughters, will have a
larger standard deduction in 2012 than will Kate, who is single and sharing an apartment with two friends.
20. A taxpayer who itemizes receives no special tax break for being 65 years of age or older.
21. The exemption amount is the same for both personal and dependency exemptions.
22. Brent, a 19-year-old student at Private University, is financially supported by his parents and does not
have a regular job. Brent most likely cannot claim any personal exemption on his return for the
current year.
23. W, a U.S. citizen, earned $6,000 from foreign sources on which she paid tax of $1,200 to the foreign
government. W’s U.S. tax was $4,000, $1,500 of which was on the foreign income. W must pay
$2,800, after the foreign tax credit, to the United States.
24. H and W are married with twins, eight years of age. H and W can elect to claim either exemption
deductions for each of their dependents or a child tax credit for each child but not both exemptions
and credits.
25. Assuming the selling price remains constant, the gain realized on the sale of a property decreases if the
adjusted basis of the property sold increases.
26. The amount realized on the sale of property is reduced by any related selling costs.
27. T sold the family car at a $400 loss. T can claim the $400 loss as an itemized deduction.
28. A taxpayer’s motor home, which is used for personal enjoyment, is a capital asset.
29. Capital losses of individuals in excess of the $3,000 annual limit may be carried forward indefinitely to
future tax years, but may not be carried back to prior years.
30. Short-term capital gains in excess of capital losses are treated just like other income.
31. Long-term capital gains may be taxed at 15 percent for a taxpayer whose gains would otherwise be
taxed at 31 percent.
3-4 Chapter 3 Taxable Entities; Tax Formula; Introduction to Property Transactions

Multiple Choice
32. Which of the following is not a tax-paying entity under the Federal income tax?
a. The regular corporation
b. The estate of a deceased individual
c. The partnership entity
d. A trust for the benefit of a minor child
33. Foreign income earned by U.S. citizens is
a. Nontaxable
b. Taxable, but the U.S. tax may be reduced by taking a credit for foreign taxes paid
c. Is not affected by any applicable treaty
d. Both b. and c.
34. Which one of the following is not true of the tax treatment of fiduciaries?
a. Income is taxed to the beneficiary of the trust or estate to the extent of current distributions of
income.
b. The trust or estate is entitled to a deduction for current distributions of income.
c. Distributions to beneficiaries are treated like corporate dividends.
d. Distributions from corpus generally are not taxable to beneficiaries.
35. A trust established for the benefit of A, age 23, and B, age 13, generated $8,000 of dividend income.
The trustee distributed $2,000 to A and $1,500 to B. The taxable income of the trust (before the
exemption deduction) is
a. $8,000
b. $6,000
c. $4,500
d. $0
36. Sandy and Dave formed a law partnership, agreeing to split the income 50:50. The partnership had net
income of $100,000. Dave withdrew $55,000 throughout the year, and Sandy withdrew $50,000. Dave
and Sandy had no other income. Because of the partnership activities, Dave’s A.G.I. increased by
a. $100,000
b. $55,000
c. $50,000
d. $35,000
37. Sandy and Dave formed a law partnership, agreeing to split the income 50:50. The partnership had net
income of $100,000. Dave withdrew $35,000 throughout the year, and Sandy withdrew $30,000. Dave
and Sandy had no other income. Because of the partnership activities, Sandy’s A.G.I. increased by
a. $100,000
b. $80,000
c. $50,000
d. $30,000
38. Sandy and Dave formed a law partnership, agreeing to split the income 50:50. The partnership had
net income of $100,000. Dave withdrew $35,000 throughout the year, and Sandy withdrew $30,000.
Dave and Sandy had no other income. The partnership must pay taxes on income of
a. $0
b. $35,000
c. $65,000
d. $100,000
Test Bank 3-5

39. An S corporation’s tax treatment is most similar to the
a. Sole proprietorship
b. Partnership
c. Individual
d. Corporation
40. F’s share of income from various sources is as follows for the current year:
Source
F’s Share
of Entity’s
Net Income
F’s Share of
Distributions
ABC Partnership after deducting partner’s salary $ 6,000 $ 9,000
F’s salary from ABC Partnership n/a 30,000
XYZ Corporation, a C corporation 80,000 10,000
Interest from bank savings account 40,000 n/a
F’s A.G.I. (ignoring the deduction for one-half of any self-employment tax) is how much?
a. $89,000
b. $156,000
c. $86,000
d. $56,000
41. G is an 11-year-old heiress whose share of income from various sources is as follows for the current
year:
Source
G’s Share
of Entity’s
Net Income
G’s Share of
Distributions
LM Trust $ 45,000 $30,000
ABC Partnership 80,000 22,000
XYZ Corporation, a C corporation 480,000 76,000
Interest from bank savings account 50,000
G’s A.G.I. (ignoring the deduction for one-half of any self-employment tax, if any) is how much?
a. $178,000
b. $605,000
c. $251,000
d. $236,000
42. G had income and expenses as follows for the current taxable year:
Total income $32,400
Exclusions (municipal bond
interest) 2,000
Deductions for A.G.I. 1,200
Total itemized deductions 9,920
Standard deduction 5,150
Exemption deductions 6,600
What are G’s adjusted gross income and her taxable income, respectively? Assume all amounts are
correct.
a. $29,200; $12,680
b. $31,200; $14,680
c. $29,200; $17,050
d. $28,000; $12,680

43. The following represent elements of the tax formula for individual taxpayers:
A. Income from any source
B. Personal and dependency exemptions
C. Itemized deductions
D. Deductions for A.G.I.
E. Exclusions from gross income
F. Standard deduction amount
Which of the items listed are considered in arriving at A.G.I.?
a. A., D. and E.
b. A., D., E. and F.
c. A., B. and D.
d. A., E. and F.
Which of the above are subtracted from A.G.I. in the computation of taxable income?
a. B., D. and F.
b. B., C. and F.
c. B. and C. or B. and F.
d. C. and F. or B. and C.
Which of the above are not included in the formula for corporate taxpayers?
a. B., D. and E.
b. B., C. and F.
c. B., C. and E.
d. B., D. and F.
46. Which of the following income is generally excluded from gross income?
a. Alimony
b. Unemployment compensation
c. Hobby income
d. Social Security benefits
e. All of the above
Test Bank 3-7

47. Why are deductions of individual taxpayers broken down into these two groups: (1) deductions for A.
G.I. and (2) deductions from A.G.I.?
a. To separate business and nonbusiness deductions
b. To distinguish self-employment expenses from employee expenses
c. To provide for simplification and reduce the number of taxpayers who itemize their deductions
d. To distinguish corporate taxpayers from non-corporate taxpayers
48. M, age 65 and single, has no dependents and an A.G.I. of $50,000 and these expenses: medical
expenses of $2,200, personal casualty losses of $5,000, real estate taxes of $2,000, and residence
mortgage interest of $1,000. In 2012 the taxpayer should deduct which of the following total amounts
from A.G.I.?
a. $10,200
b. $14,000
c. $11,200
d. Some other amount
49. Which of the following is not true of the standard deduction?
a. It is the amount that itemized deductions must exceed before a taxpayer itemizes.
b. It is increased for elderly taxpayers.
c. The amount varies depending on the taxpayer's filing status.
d. It is a deduction that is allowed for the taxpayer and any qualifying dependents.
50. Which one of the following is not true of itemized deductions of an individual taxpayer?
a. Any deductions other than personal and dependency exemptions and those for adjusted gross
income are itemized deductions.
b. Itemized deductions are deductible only if they exceed a taxpayer’s standard deduction.
c. Residential interest is a common example of an itemized deduction.
d. All employee trade or business expenses are itemized deductions.
51. Which of the following is not true of A.G.I.?
a. A.G.I. is not computed for corporations.
b. The deduction for personal and dependency exemptions affects the taxpayer's A.G.I.
c. A.G.I. is sometimes referred to as ``the line.''
d. The amount of certain deductions varies with A.G.I.
52. Which of the following is true of the standard deduction amounts?
a. The amount is standard for all individual tax returns; that is, the amount deducted on all
individual tax returns is the same.
b. The standard deduction does not affect adjusted gross income.
c. The standard deduction for all taxpayers who file a joint return provides the same tax benefit.
d. All of the above are true.

53. Each of the following individual taxpayers is planning on making a deductible $500 payment (e.g., a fully
deductible charitable contribution) either in December 20X1 or in January 20X2. Assume the standard
deduction for both years for joint filers is $10,000 and for single filers is $4,000. Ignore the time value of
money.
Abe Ben Cathy Diane Earl
Type of return Joint Joint Joint Single Single
Marginal tax rate 30% 20% 20% 20% 20%
Other itemized deductions for 20X1 $11,000 $9,000 $8,000 $4,000 $6,000
Expected other itemized deductions for 20X2 $11,500 $11,000 $8,500 $4,500 $7,500
Assuming that between years there are no changes in tax rates and other items (e.g., standard
deduction, personal exemption, etc.) and ignoring the time value of money, who would gain the
greatest tax savings by making the payment in 20X2 instead of 20X1?
a. Abe
b. Ben
c. Cathy
d. Diane
c. Earl
54. After his great performance for the U.S. soccer team in the World Cup, Alex, a U.S. citizen, signed a
contract to play with the Italian team, Parma, earning over $500,000 per year. While there, he met the
great English star, David. Which of the following statements is correct?
a. Assuming that Alex lives in Italy during all of the next year, his Italian income (salary and
interest from his Italian bank account) would probably be subject to Italian taxes but he would
not be required to report any of his Italian income for U.S. income tax purposes since he lived in
Italy.
b. Assuming that Alex lives in Italy only for a few months during all of next year, his income earned
in Italy would effectively be taxed twice, i.e., he would pay taxes to the Italian government and
taxes to the U.S. government, unless a treaty provided otherwise.
c. Assume David, the English star, comes to the U.S. in the next to play in the U.S. professional
soccer league. David would not be required to file a regular income tax return on income earned
in the U.S. if he is considered a resident alien.
d. None of the above is correct.
55. J and Z, husband and wife, created a trust for J’s aging mother, Betty. This year the trust received
dividend income of $15,000 and distributed $10,000 to Betty. The taxable income of the trust and
Betty is?
a. Trust $15,000, Betty $10,000
b. Trust $0, Betty $15,000
c. Trust $5,000, Betty $10,000
d. Trust $15,000, Betty $0
e. None of the above
56. Barnum and Bailey incorporated their circus this year and elected to be treated as an S corporation.
Barnum owns 60% of the corporation’s stock while Bailey owns the remaining 40%. This year, the
corporation had net income of $300,000 before the owners took any money out of the business (e.g.,
before salaries, dividend distributions, etc.). Assuming the corporation paid Barnum a deductible
salary of $100,000 for managing the business and made dividend distributions of $12,000 to Barnum
and $8,000 to Bailey, what is the amount of taxable income to be reported by Barnum?
a. $220,000
b. $192,000
c. $180,000
d. $108,000
e. None of the above
Test Bank 3-9

57. Ralph and Lauren incorporated their bagel business this year. For tax purposes, the corporation
operates as a regular C corporation. For the year, the corporation was profitable, making $300,000
before the owners took any money out of the business. Assuming the corporation paid Ralph a salary
of $40,000 and Lauren a salary of $60,000 and also paid each a dividend of $20,000 to each ($40,000
in total), what is the corporation’s taxable income?
(Ignore payroll taxes)
a. $200,000
b. $300,000
c. $160,000
d. $340,000
e. Some other amount
58. Last year, Ben and Jeri (unrelated) formed a partnership to operate a restaurant. Ben contributed all
of the money, $2,000,000, to the venture for a 50% interest while Jeri agreed to work for the
partnership for five years without pay for her 50% interest. According to the agreement, Jeri would
receive 50% of the profits (or losses) of the business. During the year, Jeri worked tirelessly, often
80 hours per week. On the other hand, Ben did little, sitting back and watching the fruits of Jeri’s
efforts. For the year, the partnership reported a $900,000 loss (revenues $600,000, deductible expenses
$1,500,000). Ben and Jeri are both married and their spouses have salaries from their jobs. Neither
Ben nor Jeri have any other investments. Which of the following statements is true?
a. None of the loss can be used by either Ben or Jeri; rather the loss is carried forward to offset
future profits of the partnership.
b. Both Ben and Jeri can use their share of the loss as a deduction to offset their other income they
might have on their own individual tax return (Form 1040) such as the salary income of their spouses.
c. Ben can use his share of the loss as a deduction to offset his other income he might have on his
individual tax return (Form 1040) such as the salary income of his spouse because he took the risk
of investing in the venture while Jeri did not take a similar risk.
d. Jeri can use her share of the loss as a deduction to offset her other income she might have on her
individual tax return (Form 1040) such as the salary income of her spouse because she was
regularly and continuously involved on a substantial basis.
e. None of the above is correct.
59. Jim Smith and Bob Jones recently decided to start their own car wash business. Jim’s spouse and
Bob’s spouse both work for the same law firm each receives a salary exceeding $200,000 annually. Jim
and Bob anticipate that the business will not be profitable for a few years but rather operate at a loss.
Both Jim and Bob will both be working in the business. Based on these facts, the best form of business
organization for the car wash would be:
a. A limited liability company
b. A C corporation
c. A partnership
d. A sole proprietorship
60. Which of the following is not a correct observation related to the comparison between a deduction and
a credit?
a. A deduction of $100 is less valuable than a credit of $100.
b. A deduction of $100 is more valuable to a 40 percent bracket taxpayer than is a $30 credit.
c. A deduction of $100 is more valuable to a 40 percent bracket taxpayer than it is to a 30 percent
bracket taxpayer.
d. A credit of $100 is more valuable to a 40 percent bracket taxpayer than it is to a 30 percent
bracket taxpayer.
61. Which one of the following taxes does not have to be reported and paid with the Federal income tax?
a. Alternative minimum tax
b. Federal excise tax
c. Self-employment tax
d. More than one of the above

62. Which one of the following individuals likely would not have to make quarterly estimated payments?
a. A child with $10,000 trust income
b. An individual whose only income is salaries and wages
c. A self-employed individual with net income of $15,000
d. An individual with a large stock and bond portfolio
63. W sold a parcel of land that he had owned for three years for $4,000 cash, and the buyer assumed a
note secured by the property in the amount of $6,000. W originally paid $7,500 for the land. What is
his gain (or loss) realized on the sale?
a. $10,000
b. $6,000
c. $2,500
d. $(3,500)
64. Susan sold her car at a $5,000 loss and her stereo for a $500 loss. Susan is a factory worker. Susan will
be able to deduct how much?
a. $5,500 loss
b. $5,000 loss
c. $3,000 loss
d. $0
65. A sold 100 shares of F corporation stock for $32,500. A had to pay a sales commission of $940. F had
originally paid $14,750 for the shares and a purchase commission of $420. How much are A’s amount
realized and gain realized, respectively?
a. $32,500; $16,390
b. $31,140; $16,390
c. $31,560; $16,390
d. $31,140; $17,750
66. Which of the following is a capital asset?
a. A camera used in a trade or business
b. A computer held for sale to customers
c. A taxpayer’s principal residence
d. An account receivable from a client of an attorney
67. Which one of the following losses is not at least partially deductible?
a. Earthquake damage to a vacation home
b. Loss on sale of 100 shares of A Corporation stock held for investment
c. Theft of silver coin collection
d. Loss on sale of personal residence
68. J sold the following capital assets during the current year:
100 shares of X Corp. held 14 months $(500) loss
50 shares of T Corp. held four months (240) loss
City lot held seven years for speculation 900 gain
How much is J’s overall net capital gain, if any?
a. $740
b. $660
c. $400
d. $160
Test Bank 3-11

69. Which of the following is not true of capital gains and losses?
a. Capital gains and losses are always netted before the treatment of the excess is determined.
b. Net short-term capital gains in excess of net long-term capital losses are subject to tax at ordinary
rates.
c. Net capital losses in excess of net capital gains are fully deductible within an annual limitation.
d. A capital gain deduction is allowed for a portion of net long-term capital gains in excess of net
short-term capital losses.
70. In 20X2, T, an individual taxpayer, had a net short-term capital loss of $3,000 and a net long-term
capital loss of $3,000. The capital loss carryover is
a. $3,000 net short-term capital loss
b. $3,000 net long-term capital loss
c. $1,500 net short-term and $1,500 net long-term capital loss
d. $0; losses cannot be carried over
71. In 20X3, B sold 200 shares of K Inc., which she had owned for three years, for $1,230 (net of $75
commission). B’s basis in the shares, which were held for investment, was $7,300. How much of the
loss may B deduct against her other 20X3 income if she had no other sales or exchanges?
a. $6,070
b. $1,000
c. $3,000
d. $3,035

Taxable Entities;
Solutions to Test Bank
True or False
1. False. The tax for heads of households at higher income levels is lower than that for single taxpayers (i.e.,
the tax brackets are larger so a head of household pays 15% on more income). (See § 1 and inside front
cover of book.)
2. False. A child’s income is taxed to the child and not to the parent. A child may be taxed at her or his
parent’s rate for a portion of her or his unearned income. (See p. 3-4.)
3. True. Nonresident aliens are taxed only on their U.S. source income, but citizens and resident aliens are
taxed on their worldwide income. (See p. 3-4.)
4. False. The business earnings are reported on the individual’s tax return along with any other income and
deductions. The sole proprietorship is treated as a separate entity for accounting purposes, though, and
must keep separate records. (See pp. 3-8 through 3-9.)
5. False. The sole proprietorship’s net income is, along with all other income of the individual owner, subject
to tax at individual tax rates. (See pp. 3-8 and 3-9.)
6. True. When a trust distributes its income to the beneficiaries (2 × $6,000 = $12,000), the distributed
income is generally taxed to the beneficiary to the extent of the taxable income received by the trust rather
than the trust. (See p. 3-7.)
7. True. The partnership itself is not a taxpaying entity under the Federal income tax system. All of the
gains, losses, income, and expenses pass through to the individual partners and are taxable to them. (See
p. 3-10 and § 701.)
8. False. The partnership is a conduit for Federal income tax purposes. This means that it pays no tax and
any gains, losses, income, or expenses pass through and are taxed to its partners. A trust or estate pays tax
on its undistributed income. (See p. 3-9 and § 701.)
9. True. The income of an S corporation passes through to its shareholders much like the income of a
partnership passes through to the individual partners. (See p. 3-11 and §§ 1363 and 1366.)
10. True. All deductions are treated the same and a corporation is not required to calculate adjusted gross
income. (See Exhibit 3-2 and p. 3-5.)
3
3-13

11. False. No such deduction is allowed. Since the dividend is taxed to the shareholder and no deduction is
allowed to the corporation, some argue that there is a double tax on the corporate earnings. (See p. 3-6.)
12. True. The highest individual rate is 35 percent. The highest corporate rate is 35 percent, but there is also a
3 percent surtax on corporate incomes over certain ranges to eliminate the benefits of the lower brackets.
Thus, the marginal rate is actually 38 percent over those ranges and 39 percent over other ranges. (See
p. 3-6.)
13. False. Gross income is total income less any applicable exclusions from gross income. (See Exhibits 3-2
and 3-3 and p. 3-16.)
14. False. Deductions from A.G.I. or itemized deductions may be deducted only if they exceed the taxpayer’s
standard deduction. Deductions for A.G.I. are allowable regardless of whether the taxpayer itemizes
deductions or uses the standard deduction. (See p. 3-19.)
15. True. Several itemized deductions (i.e., medical expenses and casualty losses) are deductible only if they
exceed a certain percentage of A.G.I., so an increase in A.G.I. results in a decrease in the allowable
deduction (See Exhibit 3-7, Example 11 and p. 3-18.)
16. False. All business deductions of a self-employed individual are deductions for A.G.I. However, for
employees, only reimbursed business expenses are deductions for A.G.I. Unreimbursed business expenses
of an employee are classified as miscellaneous itemized deductions (e.g., dues to professional
organizations). (See Exhibit 3-6, pp. 3-19 and 3-22, and § 62.)
17. False. The standard deduction is allowed in lieu of itemizing deductions. The purpose of the standard
deduction is to reduce the number of taxpayers who must itemize their deductions. (See pp. 3-18 through
3-19 and § 63.)
18. False. V’s standard deduction for 2012 is $5,900. She will itemize only if her itemized deductions exceed
$5,900. (See p. 3-21.)
19. True. John would be considered an unmarried head of household with a standard deduction in 2012 of
$8,700. Kate is an unmarried taxpayer and her standard deduction would be $5,950. (See p. 3-20.)
20. True. The tax break for a person age 65 or over is an increased standard deduction. Therefore, a person
who chooses to itemize does not benefit from the increased standard deduction. (See p. 3-20.)
21. True. For 2012, an individual taxpayer is entitled to a deduction of $3,800 for each personal and
dependency exemption. (See p. 3-22.)
22. True. Taxpayers who can be claimed as a dependent on another taxpayer’s return are given an exception
equal to zero. Most likely, Brent’s parents could claim him as a dependent. (See p. 3-23.)
23. True. The foreign tax credit directly reduces the U.S. federal income tax. The amount is generally the
amount paid to the foreign government; however, it is limited to the U.S. tax on the foreign source
income. (See Example 2 and p. 3-4.)
24. False. Taxpayers with children generally are entitled to a dependent exemption for each child as well as a
child tax credit for each child less than 17 years of age. (See p. 3-27, Review Question 3.)
25. True. The realized gain decreases as the adjusted basis is increased because the gain realized equals the
entire amount that is realized less the adjusted basis. (See Exhibit 3-12 and p. 3-29.)
26. True. The amount realized is reduced by any selling costs. Essentially, the amount realized is the net
proceeds from the sale. (See Exhibit 3-10, pp. 3-28 through 3-29, and § 1001.)
27. False. Losses from dispositions of personal use assets are not deductible. (See p. 3-33.)
28. True. A capital asset is any asset except those specifically enumerated in § 1221. Generally, assets that are
capital assets are either personal use assets or assets held for passive investment. (See p. 3-35 and § 1221.)

29. True. Excess capital losses of individuals may not be carried back, but are carried forward indefinitely.
[See p. 3-34 and § 1212(b)(1).]
30. True. Only long-term capital gains qualify for preferable rates. (See p. 3-32.)
31. True. The net gains can be taxed at a rate as low as 15 percent or lower in 2012 for the 10 and 15 percent
bracket taxpayers. [See p. 3-32.]
Multiple Choice
32. c. The entities taxed by the Federal government are the individual, the corporation, and the estate or
trust. (See p. 2.)
33. b. U.S. citizens are subject to Federal income tax on their annual income regardless of where it is earned
(i.e., their worldwide income). Any foreign tax paid on the taxpayer’s income may be used to offset
the U.S. income tax either in the form of a credit for foreign tax paid, or a deduction to reduce the
amount of income subject to U.S. tax. (See Example 2 and p. 3-4.)
34. c. Dividends, although taxable income to the recipients, are not deductible by the corporation. Thus,
they differ fundamentally from a fiduciary’s distribution of income since any amount taxable to the
beneficiary is not taxable to the fiduciary. All of the other statements are true. (See Examples 4 and 5
and pp. 3-7 and 3-8.)
35. c. A trust is only taxed on the income not distributed to the beneficiaries. ($8,000 $3,500 = $4,500.)
(See Example 5 and p. 3-8.)
36. c. A partner pays taxes on his or her share (50%) of the partnership income ($100,000). Therefore,
Sandy and Dave each have gross income of $50,000. (See Example 7 and p. 3-10.)
37. c. A partner pays taxes on his or her share (50%) of the partnership income ($100,000). Therefore,
Sandy and Dave each have gross income of $50,000. (See Example 7 and p. 3-10.)
38. a. The partnership is a conduit for Federal income tax purposes, and not subject to tax itself. (See p. 3-9.)
39. b. If a corporation elects S corporation status, it is taxed in virtually the same fashion as a partnership.
(See p. 3-11.)
40. c. F’s income includes his salary and his interest income, plus his share of the partnership’s income, plus
the dividends received from the corporation ($30,000 þ $40,000 þ $6,000 þ $10,000). (See pp. 3-3
through 3-11.)
41. d. G’s income includes her interest income, plus the distributions from the trust (not exceeding the
trust’s income), plus her share of the partnership’s income, plus the dividends received from the
corporation ($50,000 þ $30,000 þ $76,000 þ $80,000). (See pp. 3-3 through 3-11.)
42. a. Adjusted gross income is gross income ($32,400 $2,000 = $30,400) less any deductions for adjusted
gross income ($1,200), or $29,200. Taxable income is the adjusted gross income minus the larger of the
standard deduction ($5,150) or the itemized deductions ($9,920) and minus the personal and dependency
exemptions: $29,200 $9,920 $6,600 = $12,680. (See Exhibit 3-3 and pp. 3-17 through 3-22.)
43. a. See the tax formula for individuals. [Exhibit 3-3, p. 3-6, and §§ 62 and 63(b).]
44. c. See the tax formula for individuals. If the standard deduction is chosen, the taxpayer may not itemize.
[See Exhibit 3-3, p. 3-6, and § 63(b).]
45. b. Compare the tax formula for individuals with the one for corporations. Because corporations are not
individuals, they are not eligible for personal exemptions. Corporations do not need the standard
deduction because they take all allowable deductions. [See Exhibits 3-2 and 3-3, p. 3-6, and §§ 62 and
63(a) and (b).]
Solutions to Test Bank 3-15

46. d. Social Security benefits are generally excluded. All of the others are included. (See Exhibits 3-4
and 3-5 on pp. 3-15 and 3-16.)
47. c. The fact that taxpayers itemize only if their deductions exceed the standard deduction
amount reduces the number of itemizers and simplifies the returns of those who do not itemize. (See
pp. 3-18 through 3-20.)
48. d. The amount M can deduct is $11,200, the sum of the personal exemption in 2012 ($3,800), the basic
standard deduction in 2012 ($5,950 and the additional standard deduction for being aged 65 ($1,450
in 2012). M’s medical and casualty loss expenses are not deductible because they did not exceed the
deduction floors. The real estate tax and the mortgage interest are not large enough for M to itemize.
(See Example 11 and pp. 3-18 through 3-22.)
49. d. Choice d. refers to the personal and dependency exemption, not the standard deduction. All other
statements are true of the standard deduction amount. [See pp. 3-19 through 3-22 and §§ 63(b), (c),
(d), and (f).]
50. d. Reimbursed employee expenses are deductions for A.G.I. Unreimbursed employee expenses are
miscellaneous itemized deductions. (See Exhibit 3-6, pp. 3-18 through 3-22, and § 62.)
51. b. (See p. 3-18.)
52. b. The standard deduction is not a deduction for adjusted gross income but rather a deduction from
adjusted gross income. Item c is false since the amount of the tax benefit depends on the taxpayer’s
marginal tax rate. (See p. 3-19.)
53. b. Assuming no change in the standard deduction or tax rates, the benefit of the deduction for Abe and
Earl would remain the same because they both would deduct the expense since their deduction exceed
their standard deductions. For Cathy and Diane, there would be no benefit in either year because
neither itemizes deductions. If B made the contribution in 20X1, he would receive no benefit because
he does not itemize. On the other hand if he postponed the contribution to the following year, he
would could deduct it because his itemized deductions exceed his standard deduction. He would
receive a benefit of $100 (20% $500). (See pp. 3-18 and 3-19.)
54. d. None of the statements are correct. Statement (a) is false since U.S. citizens are taxed on their
worldwide income regardless of where they live or how long they live there. A foreign earned income
exclusion exists but it insufficient to exclude all of the taxpayer’s income. Statement (b) is false
because the taxpayer is entitled to some relief from the foreign tax credit or the deduction for foreign
income taxes. Statement (c) is incorrect because if the a foreign citizen is considered a resident alien
he must pay U.S. taxes. (See pp. 3-3 and 3-4.)
55. c. A trust is treated as a separate taxable entity. It is taxed on the taxable income it received but is entitled
to a deduction to the extent it distributes it. The trust received $15,000 of taxable dividend income and
distributed $10,000 so the trust reports $5,000 ($15,000 $10,000) of taxable income while Betty
reports $10,000 taxable income. Note that all of the taxable income is taxed. (See Example 5 and
p. 3-8.)
56. a. The corporation has taxable income of $200,000 ($300,000 salaries of $100,000). Note the dividend
distributions do not reduce taxable income. Thus Barnum has taxable income of $220,000 consisting
of salary of $100,000 and his share of the S corporation’s income of $120,000 (60% $200,000 =
$120,000). (See p. 3-11.)
57. a. The corporation has taxable income of $200,000 ($300,000 before payments to owners - $60,000
salary to Lauren - $40,000 salary to Ralph). The dividend payments are not deductible. (See Example
3 and pp. 3-5 through 3-7.)
58. d. The loss would be a passive loss to Ben since he does not materially participate in the venture and
therefore he could not deduct his share of the loss unless he had other passive income. In contrast,
Jeri materially participates in the activity so her loss is not passive and she could use her share to
offset other income. (See p. 3-17 and Chapter 12.)

59. a. In selecting the form in which it conducts its operations, a business that expects losses will typically opt
for a flow-through entity. The owners would want any losses to flow through so it could be used to
offset their other income. The passive loss rules would not limit use of the loss since both owners
materially participate in the activity. The loss would not flow through if a C corporation is used.
Among the choices given, the best would be to use a limited liability company since it would be treated
as a partnership, the losses would flow through to be used by the owners and the owners would have
limited liability that is unavailable with a partnership. (See p. 3-36.)
60. d. All other statements are true. A credit of $100 is of equal value to any taxpayer who can benefit from
it. (See p. 3-23.)
61. b. The Federal excise tax is not paid with the Federal income tax. (See Exhibit 3-9 on p. 3-25.)
62. b. Generally, an individual needs to make quarterly estimated tax payments if he or she anticipates
income not subject to withholding of taxes. Only in b is the income subject to withholding of taxes.
(See p. 3-24.)
63. c. The amount realized in this transaction is the amount of cash received ($4,000) plus the liabilities
discharged ($6,000). Since the basis in the property disposed of was $7,500, the gain realized is $2,500
($10,000 $7,500). (See Exhibits 3-10 and 3-11 and 3-12; pp. 3-28 through 3-29; and § 1001.)
64. d. Other than casualty and theft losses, losses from dispositions of personal use assets are not deductible.
(See pp. 3-30 through 3-31.)
65. c. The amount realized is $31,560 ($32,500 $940) and the gain realized is $16,390 ($31,560
$15,170). (See Exhibits 3-10 and 3-12, pp. 3-28 through 3-29, and §§ 1001 and 1011.)
66. c. Personal use assets are capital assets. Answer a is a § 1231 business asset. Answer b is inventory.
Accounts receivable are not capital assets. (See pp. 3-31 and 3-34 and § 1221.)
67. d. All of the losses are deductible except for the loss on the sale of the residence. Losses related to
personal use properties are deductible only to the extent that they result from casualty or theft, and
then only to the extent that they exceed certain limits. [See p. 3-31 and § 165(c).]
68. d. The net long-term capital gain is the excess of any long-term capital gain ($900 $500 = $400) over
any short-term capital loss ($240), or $160. [See Exhibit 3-12, pp. 3-32 through 3-33 and § 1222(3).]
69. d. The capital gain deduction of 60 percent was repealed for years after 1986. Currently, net short-term
capital losses must be used before net long-term capital losses. (See pp. 3-34 through 3-37 and
§ 1201.)
70. b. When an individual has both a net short-term and net long-term capital loss, the net short-
term capital loss must be used first toward the $3,000 capital loss deduction limit. (See p. 3-36)
71. c. There is a net capital loss of $6,070, but the overall deduction for an individual for any year cannot
exceed $3,000. The deductible capital loss is a deduction for A.G.I. B may carry forward the unused
loss of $3,070. (See Example 21 and p. 3-34 and §§ 1201 through 1212.)
Solutions to Test Bank 3-17

Taxable Entities;
Comprehensive Problems
1. Walter is single and has the following items of income and expense for the calendar year 2012:
Salaries and wages $39,660
Federal income tax withheld $4,220
FICA withheld 2,978
Dividend and interest income 1,590
Itemized deductions:
Qualified residence interest 1,460
Cash charitable contributions ,850
Tax preparation fee ,140
Personal exemptions ,001
Dependency exemptions ,000
11-
Calculate Walter’s adjusted gross income and taxable income. Present your answers in good form.
2. Mr. and Mrs. Gregg have the following items of income and expense for their calendar year 2012:
Salaries and wages (Mr. G) $ 35,980
Federal income tax withheld $ 3,720
FICA withheld 2,702
Income from sole proprietorship (Mrs. G)
Gross income $ 56,700
Cash operating expenses (includes deduction
for 1/2 of self-employment tax)
$24,500
Tax depreciation expense 7,950 (32,450)
Net income $ 24,250
3
Dividend and interest income $ 2,340
Alimony paid by Mrs. G to ex-husband 2,400
Deductible residence interest 10,700
State income taxes paid (exceeds state sales taxes) 3,150
Cash charitable contributions 1,650
Tax preparation fee ,240
Tuition to private elementary schools 3,600
Personal exemptions ,002
Dependency exemptions for minor children ,002
Estimated tax payments 1,200
11-
Calculate the Greggs’ adjusted gross income and taxable income. Present your answers in good form.
3-19

Solutions to Comprehensive Problems
1. Walter is entitled to a standard deduction of $5,800 and a personal exemption of $3,700 for 2012.
Accordingly, he will not itemize and his taxable income is determined as follows:
Salaries and wages $39,660
Adjusted gross income $41,250
Standard deduction (5,950)
Personal exemption (3,800)
Taxable income $31,500
2. The Greggs’ are entitled to a $11,900 (2012) standard deduction and four $3,800 (2012) exemptions. They
calculate their taxable income for 2012 as follows:
Salaries and wages $ 35,980
Income from sole proprietorship: 24,250
Alimony paid by Mrs. G to ex-husband (2,400)
Adjusted gross income $ 60,170
Itemized deductions:
Deductible residence interest $10,700
State income taxes paid 3,150
Cash charitable contributions 1,650
Tax preparation fee (1) ,000
Tuition to private school (2) ,000 (15,500)
Personal exemptions ($3,800 in 2012 × 2) (7,600)
Dependency exemptions for minor children ($3,800 in 2012 × 2) (7,600)
Taxable income $ 29,470
(1) Miscellaneous itemized deduction. Total must 2% of A.G.I.
5- (2) Nondeductible item. Note, however, that such costs may qualify for the child care credit if for
kindergarten or below.

Wassim Zhani Federal Taxation Chapter 3 Taxable Entities; Tax Formula, Introduction to Property Transactions.pdf

Empfohlen

Empfohlen

Weitere ähnliche Inhalte

Ähnlich wie Wassim Zhani Federal Taxation Chapter 3 Taxable Entities; Tax Formula, Introduction to Property Transactions.pdf

Ähnlich wie Wassim Zhani Federal Taxation Chapter 3 Taxable Entities; Tax Formula, Introduction to Property Transactions.pdf (19)

Mehr von Wassim Zhani

Mehr von Wassim Zhani (20)

Kürzlich hochgeladen

Kürzlich hochgeladen (20)

Wassim Zhani Federal Taxation Chapter 3 Taxable Entities; Tax Formula, Introduction to Property Transactions.pdf