TEST BANK For South-Western Federal Taxation 2025 Essentials of Taxation Individuals and Business En

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Chapter 01: Introduction to Taxation True / False 1. The Medicare component of the FICA tax (1.45% on wages) is progressive as the tax due increases as wages increase. a. True b. False 2. The Federal estate and gift taxes are examples of progressive rate taxes. a. True b. False 3. The Federal excise tax on gasoline has a proportional effect on all taxpayers (that is, neither progressive or regressive). a. True b. False 4. Currently, the Federal corporate income tax is less progressive than the individual income tax. a. True b. False 5. Mona inherits her mother’s personal residence, which she converts to a furnished rental house. These changes should affect the amount of ad valorem property taxes levied on the properties. a. True b. False 6. A fixture will be subject to the ad valorem tax on personalty rather than the ad valorem tax on realty. a. True b. False 7. Even if property tax rates are not changed, the amount of ad valorem taxes imposed on realty may not remain the same. a. True b. False 8. The ad valorem tax on personal use personalty is more often avoided by taxpayers than the ad valorem tax on business use personalty. a. True b. False 9. An excise tax is often used to try to influence behavior. a. True b. False 10. There is a Federal excise tax on hotel occupancy. a. True b. False 11. The Federal gas-guzzler tax applies only to automobiles manufactured overseas and imported into the United States. a. True Powered by Cognero

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Chapter 01: Introduction to Taxation b. False 12. The amount of the state excise taxes on gasoline varies from state to state. a. True b. False 13. Not all of the states that impose a general sales tax also have a use tax. a. True b. False 14. Sales made over the internet are not exempt from the application of a general sales (or use) tax. a. True b. False 15. Two persons who live in the same state but in different counties may not be subject to the same general sales tax rate. a. True b. False 16. States impose either a state income tax or a general sales tax, but not both types of taxes. a. True b. False 17. A safe and easy way for a taxpayer to avoid local and state sales taxes is to make the purchase in a state that levies no such taxes. a. True b. False 18. On transfers by death, the Federal government relies on an estate tax, while states may impose an estate tax, an inheritance tax, both taxes, or neither tax. a. True b. False 19. An inheritance tax is a tax on a decedent’s right to pass property at death. a. True b. False 20. One of the major reasons for the enactment of the Federal estate tax was to prevent large amounts of wealth from being accumulated within a family unit. a. True b. False 21. Under Clint’s will, all of his property passes to either the Lutheran Church or to his spouse. No Federal estate tax will be due on Clint’s death. a. True b. False Powered by Cognero

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Chapter 01: Introduction to Taxation 22. Under the usual state inheritance tax, two heirs, a cousin and a son of the deceased, would not be taxed at the same rate. a. True b. False 23. The annual exclusion, currently $18,000, is available for gift and estate tax purposes. a. True b. False 24. In 2024, José, a widower, sells land (fair market value of $100,000) to his daughter, Linda, for $50,000. José has not made a taxable gift. a. True b. False 25. Julius, a married taxpayer, makes gifts to each of his six children. A maximum of twelve annual exclusions could be allowed as to these gifts. a. True b. False 26. One of the motivations for making a gift is to save on income taxes. a. True b. False 27. The formula for the Federal income tax on corporations is the same as that applicable to individuals. a. True b. False 28. A state income tax can be imposed on nonresident taxpayers who earn income within the state on an itinerant basis. a. True b. False 29. For state income tax purposes, some states allow a credit for dependents rather than a deduction. a. True b. False 30. Some states use their state income tax return as a means of collecting unpaid use tax. a. True b. False 31. No state may offer an income tax amnesty program more than once. a. True b. False 32. For Federal income tax purposes, there never has been a general amnesty period. a. True b. False Powered by Cognero

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Chapter 01: Introduction to Taxation 33. Under state amnesty programs, all delinquent and unpaid income taxes are forgiven. a. True b. False 34. When a state decouples from a Federal tax provision, it means that this provision will not apply for state income tax purposes. a. True b. False 35. The principal objective of the FUTA tax is to provide some measure of retirement security. a. True b. False 36. Currently, the tax base for the Social Security component of the FICA is not limited to a dollar amount. a. True b. False 37. A parent employs her twin daughters, age 17, in her sole proprietorship. The daughters are not subject to FICA coverage. a. True b. False 38. Unlike FICA, FUTA requires that employers comply with state as well as Federal rules. a. True b. False 39. A major advantage of a flat tax type of income tax is its simplicity. a. True b. False 40. The objective of pay-as-you-go (paygo) is to improve administrative feasibility. a. True b. False 41. When Congress enacts a tax cut that is phased in over a period of years, revenue neutrality is achieved. a. True b. False 42. A tax cut enacted by Congress that contains a sunset provision will make the tax cut temporary. a. True b. False 43. The tax law provides various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. These provisions can be justified on both economic and equity grounds. a. True Powered by Cognero

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Chapter 01: Introduction to Taxation b. False 44. Various tax provisions encourage the creation of certain types of retirement plans. Such provisions can be justified on both economic and social grounds. a. True b. False 45. To lessen or eliminate the effect of multiple taxation, a taxpayer who is subject to both foreign and U.S. income taxes on the same income is allowed either a deduction or a credit for the foreign tax paid. a. True b. False 46. To mitigate the effect of the annual accounting period concept, the tax law permits the carryforward of excess charitable contributions of a particular year to other years. a. True b. False 47. Jason’s business warehouse is destroyed by fire. Because the insurance proceeds exceed the basis of the property, a gain results. If Jason shortly reinvests the proceeds in a new warehouse, no gain is recognized due to the application of the wherewithal to pay concept. a. True b. False 48. Because it is consistent with the wherewithal to pay concept, the tax law requires a seller to recognize a gain in the year the installment sale occurs. a. True b. False 49. Stealth taxes have the effect of generating additional taxes from all taxpayers. a. True b. False 50. A provision in the law that compels accrual basis taxpayers to pay a tax on prepaid income in the year received and not when earned is consistent with generally accepted accounting principles. a. True b. False 51. As a matter of administrative convenience, the IRS would prefer to have Congress decrease (rather than increase) the amount of the standard deduction allowed to individual taxpayers. a. True b. False 52. In cases of doubt, courts have held that tax relief provisions should be broadly construed in favor of taxpayers. a. True b. False 53. On occasion, Congress has to enact legislation that clarifies the tax law in order to change a result reached by the U.S. Powered by Cognero

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Chapter 01: Introduction to Taxation Supreme Court. a. True b. False 54. Ultimately, most taxes are paid by individuals. a. True b. False 55. Tomas owns a sole proprietorship, and Lucy is the sole shareholder of a C corporation. In the current year, both businesses make a net profit of $60,000. Neither business distributes any funds to the owners in the year. For the current year, Tomas must report $60,000 of income on his individual tax return, but Lucy is not required to report any income from the corporation on her individual tax return. a. True b. False 56. Carol and Candace are equal partners in Peach Partnership. In the current year, Peach had a net profit of $75,000 ($250,000 gross income – $175,000 operating expenses) and distributed $25,000 to each partner. Peach must pay tax on $75,000 of income. a. True b. False 57. Rajib is the sole shareholder of Cardinal Corporation, a calendar year S corporation. In the current year, Cardinal generated a net profit of $350,000 ($520,000 gross income – $170,000 operating expenses) and distributed $80,000 to Rajib. Rajib must report the Cardinal Corporation profit of $350,000 on his Federal income tax return. a. True b. False 58. Donald owns a 45% interest in a partnership that earned $130,000 in the current year. He also owns 45% of the stock in a C corporation that earned $130,000 during the year. Donald received $20,000 in distributions from each of the two entities during the year. With respect to this information, Donald must report $78,500 of income on his individual income tax return for the year. a. True b. False 59. Quail Corporation is a C corporation that generates net income of $125,000 during the current year. If Quail paid dividends of $25,000 to its shareholders, the corporation must pay tax on $100,000 of net income. Shareholders must report the $25,000 of dividends as income. a. True b. False 60. Eagle Company, a partnership, had a short-term capital loss of $10,000 during the current year. Aaron, who owns 25% of Eagle, will report $2,500 of Eagle’s short-term capital loss on his individual tax return. a. True b. False 61. Matt, the sole shareholder of Pastel Corporation (a C corporation), has the corporation pay him a salary of $600,000 in the current year. The Tax Court has held that $200,000 represents unreasonable compensation. Matt must report a salary Powered by Cognero

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Chapter 01: Introduction to Taxation of $400,000 and a dividend of $200,000 on his individual tax return. a. True b. False Multiple Choice 62. Which, if any, is not one of Adam Smith’s canons (principles) of taxation? a. Economy in collection b. Certainty c. Convenience of payment d. Simplicity 63. Which, if any, of the following taxes are regressive (rather than progressive)? a. State general sales tax b. Federal individual income tax c. Federal estate tax d. Federal gift tax 64. Which, if any, of the following transactions will increase a taxing jurisdiction’s revenue from the ad valorem tax imposed on real estate? a. A resident dies and leaves his farm to his church. b. A large property owner issues a conservation easement as to some of her land. c. A tax holiday issued 10 years ago has expired. d. A bankrupt motel is acquired by the Red Cross and is to be used to provide housing for homeless persons. e. None of these choices are correct. 65. Which, if any, of the following transactions will decrease a taxing jurisdiction’s ad valorem tax revenue imposed on real estate? a. A tax holiday is granted to an out-of-state business that is searching for a new factory site. b. An abandoned church is converted to a restaurant. c. A public school is razed and turned into a city park. d. A local university sells a dormitory that will be converted for use as an apartment building. 66. Which, if any, of the following is a typical characteristic of an ad valorem tax on personalty? a. Taxpayer compliance is greater for personal use property than for business use property. b. The tax on automobiles sometimes considers the age of the vehicle. c. Most states impose a tax on intangibles. d. The tax on intangibles generates considerable revenue as it is difficult for taxpayers to avoid. 67. Federal excise taxes that are no longer imposed include: a. Tax on air travel. b. Tax on wagering. c. Tax on alcohol. d. None of these choices are correct. Powered by Cognero

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Chapter 01: Introduction to Taxation 68. Taxes not imposed by the Federal government include: a. Tobacco excise tax. b. Customs duties (tariffs on imports). c. Tax on rental cars. d. Gas guzzler tax. 69. Taxes levied by all states include: a. Tobacco excise tax. b. Individual income tax. c. Inheritance tax. d. General sales tax. 70. A use tax is imposed by: a. The Federal government and all states. b. The Federal government and a majority of the states. c. All states but not the Federal government. d. Most of the states but not the Federal government. 71. Gabriele and Lisa are married and live in a common law state. They want to make gifts to their four children in 2024. What is the maximum amount of the annual exclusion they will be allowed for these gifts? a. $18,000. b. $36,000. c. $72,000. d. $144,000. 72. Property can be transferred within the family group by gift or at death. One motivation for preferring the gift approach is: a. To take advantage of the higher unified transfer tax credit available under the gift tax. b. To avoid a future decline in value of the property transferred. c. To take advantage of the per donee annual exclusion. d. To shift income to higher bracket donees. 73. Indicate which, if any, statement is incorrect. State income taxes: a. Can piggyback to the Federal version. b. Cannot apply to visiting nonresidents. c. Can decouple from the Federal version. d. Can provide occasional amnesty programs. 74. State income taxes generally can be characterized by: a. The same date for filing as the Federal income tax. b. No provision for withholding procedures. c. Allowance of a deduction for Federal income taxes paid. d. Applying only to individuals but not to corporations. 75. A characteristic of FICA tax is that: Powered by Cognero

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Chapter 01: Introduction to Taxation a. It does not apply when one spouse works for the other spouse. b. It is imposed only on the employer. c. It provides a modest source of income in the event of loss of employment. d. None of these choices are correct. 76. A characteristic of FUTA is that: a. It is imposed on both employer and employee. b. It is imposed solely on the employee. c. Compliance requires following guidelines issued by both state and Federal regulatory authorities. d. It is applicable to spouses of employees but not to any children under age 18. 77. The United States (either Federal, state, or local) does not impose: a. Franchise taxes. b. Severance taxes. c. Custom duties. d. Export duties. 78. Both economic and social considerations can be used to justify: a. Favorable tax treatment for accident and health plans provided for employees and financed by employers. b. Disallowance of any deduction for expenditures deemed to be contrary to public policy (e.g., fines, penalties, illegal kickbacks, bribes to government officials). c. Various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. d. Allowance of a deduction for state and local income taxes paid. 79. Social considerations can be used to justify: a. Allowance of a credit for child care expenses. b. Allowing excess capital losses to be carried over to other years. c. Allowing accelerated amortization for the cost of installing pollution control facilities. d. Allowing a Federal income tax deduction for state and local sales taxes. 80. Allowing a tax credit for certain solar energy property can be justified: a. As helping small businesses. b. As promoting administrative feasibility. c. As promoting a government policy to use alternative energy sources. d. Based on the wherewithal to pay concept. 81. Provisions in the tax law that promote energy conservation and more use of alternative (nonfossil) fuels can be justified by: a. Political considerations. b. Economic and social considerations. c. Promoting administrative feasibility. d. Encouragement of small business. 82. Which, if any, of the following provisions cannot be justified as mitigating the effect of the annual accounting period Powered by Cognero

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Chapter 01: Introduction to Taxation concept? a. Nonrecognition of gain allowed for involuntary conversions. b. Net operating loss carryover provisions. c. Use of the installment method to recognize gain. d. Carryover of excess capital losses. 83. Which, if any, of the following provisions of the tax law cannot be justified as promoting administrative feasibility (simplifying the task of the IRS)? a. Penalties are imposed for failure to file a return or pay a tax on time. b. Annual adjustments for indexation increases the amount of the standard deduction allowed. c. Personal casualty losses in Federally declared disaster areas must exceed 10% of AGI to be deductible. d. A deduction is allowed for charitable contributions. 84. A landlord leases property upon which the tenant makes improvements. The improvements are significant and are not made in lieu of rent. At the end of the lease, the value of the improvements are not income to the landlord. This rule is an example of: a. A clear reflection of income result. b. The tax benefit rule. c. The arm’s length concept. d. The wherewithal to pay concept. 85. Before proposing that the state’s sales tax be expanded to include food, a legislator should ask whether: a. The state tax agency will allow this expansion. b. A majority of his constituents agree. c. Grocery stores will be able to collect the tax. d. The state’s constitution allows for this tax. 86. Two years ago, State Y enacted a new income tax credit for college prep materials. The credit is available to individuals and is equal to 40% of the cost of the items. The credit may not exceed $50 in any year. State Y's director of finance has discovered this year that the amount of credit claimed is far higher than expected. Which principle of good tax policy might not have been considered in designing this tax that caused the original cost estimate to be too low? a. Equity. b. Simplicity. c. Economy in collection. d. Minimum tax gap. 87. A rationale for the installment sale method tax rule is: a. Ability to pay. b. Equity and fairness. c. Simplicity. d. Revenue neutrality. 88. Luis is the sole shareholder of a regular C corporation, and Eduardo owns a proprietorship. In the current year, both businesses make a profit of $80,000, and each owner withdraws $50,000 from his business. With respect to this information, which of the following statements is incorrect? Powered by Cognero

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Chapter 01: Introduction to Taxation a. Eduardo must report $80,000 of income on his return. b. Luis must report $80,000 of income on his return. c. Eduardo’s proprietorship is not required to pay its own income tax, separate from Eduardo, on it's $80,000 of income. d. Luis’s corporation must pay income tax on $80,000. Matching Using the following choices, show the justification for each provision of the tax law listed. a. Economic considerations b. Social considerations c. Equity considerations d. Both a. and b. 89. A tax credit for amounts spent to furnish care for children while the parent is at work. 90. Additional depreciation deduction allowed for the year the asset is acquired. 91. Tax brackets are increased for inflation. 92. A small business corporation can elect to avoid the corporate income tax. 93. A deduction for contributions by an employee to certain retirement plans. 94. A deduction for qualified tuition paid to obtain higher education. 95. A deduction for certain expenses (interest and taxes) incident to home ownership. 96. A Federal deduction for state and local income taxes paid. 97. A deduction for interest on student loans. 98. A bribe to the local sheriff, although business related, is not deductible. 99. Contributions to charitable organizations are deductible. 100. A Federal deduction for state and local sales taxes paid. 101. Tax credits available for the purchase of a vehicle that uses alternative (nonfossil) fuels. 102. Tax credits for home improvements that conserve energy. 103. More rapid expensing for tax purposes of the costs of installing pollution control devices. Subjective Short Answer 104. Taylor, a widow, makes cash gifts to her five married children (including their spouses) and to her seven grandchildren. What is the maximum amount Taylor can give for calendar year 2024 without using her unified transfer tax credit? Powered by Cognero

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Chapter 01: Introduction to Taxation 105. Paige is the sole shareholder of Citron Corporation. During the year, she leases a building to Citron for a monthly rental of $80,000. If the fair rental value of the building is $60,000, what are the income tax consequences to the parties involved? 106. In 1993, Martina leased real estate to Drab Corporation for 20 years. Drab Corporation made significant capital improvements to the property. In 2012, Drab decided not to renew the lease and vacated the property. At that time, the value of the improvements was $800,000. Martina sells the real estate in 2024 for $1,200,000 of which $900,000 is attributable to the improvements. When is Martina taxed on the improvements made by Drab Corporation? 107. In 1992, Martina leased real estate to Drab Corporation for 20 years. Drab Corporation made significant capital improvements to the property. In 2011, Drab decided not to renew the lease and vacated the property. At that time, the value of the improvements was $800,000. Martina sells the real estate in 2023 for $1,200,000 of which $900,000 is attributable to the improvements. When is Martina taxed on the improvements made by Drab Corporation? Essay 108. Due to population change, Goose Creek School District has decided to close one of its high schools. Since it has no further need of the property, the school is listed for sale. The two bids it receives are as follows: United Methodist Church $1,700,000 Planet Motors 1,600,000 The United Methodist Church would use the property to establish a sectarian middle school. Planet, a well-known car dealership, would revamp the property and operate it as a branch location. If you were a member of the School District board, what factors would you consider in evaluating the two bids? 109. Morgan inherits her father’s personal residence including all of the furnishings. She plans to add a swimming pool and sauna to the property and rent it as a furnished house. What are some of the ad valorem property tax issues Morgan can anticipate? 110. In 2022, Deborah became 65 years old. In 2023 she added a swimming pool and in 2024 she converted the residence to rental property and moved into an assisted living facility. Since 2021, Deborah’s ad valorem property taxes have decreased once and increased twice. Explain. 111. A lack of compliance in the payment of use taxes can be resolved by several means. In this regard, comment on the following: a. b.

Registration of automobiles. Reporting of Internet purchases on state income tax returns.

112. What are the pros and cons of the following state and local tax provisions? a. b. c.

An ad valorem property tax holiday made available to a manufacturing plant that is relocating. Hotel occupancy tax and a rental car surcharge. A back-to-school sales tax holiday.

113. What is a severance tax? How productive can it be in terms of generating revenue? 114. What is the difference between an inheritance tax and an estate tax? Who imposes these taxes? Powered by Cognero

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Chapter 01: Introduction to Taxation 115. Antonio dies with an estate worth $20 million. Under his will, $10 million passes to his spouse and $10 million goes to his church. What is Antonio’s Federal estate tax result? 116. What might cause an individual to owe income taxes in more than one state? 117. Virtually all state income tax returns contain checkoff boxes for donations to various causes. On what grounds has this procedure been criticized? 118. State and local governments are sometimes forced to find ways to generate additional revenue. Comment on the pros and cons of the following procedures: a. b. c.

Decouple what would be part of the piggyback format of the state income tax. Tax amnesty provisions. Internet shaming.

119. Briana lives in one state and works in the adjoining state. Both states tax the income she earns from her job. Does Briana have any relief from this apparent double taxation of the same income? 120. In terms of revenue neutrality, comment on a tax cut enacted by Congress that: a. b.

Contains revenue offsets. Includes a sunset provision.

121. The tax law contains various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. On what grounds can these provisions be justified? 122. The tax law contains various provisions that encourage home ownership. a. b.

On what basis can this objective be justified? Are there any negative considerations? Explain.

123. The tax law allows an income tax deduction (or a credit) for foreign income taxes. Explain why. 124. The tax law allows, under certain conditions, deferral of gain recognition for involuntary conversions. a. b.

What is the justification for this relief measure? What happens if the proceeds are not entirely reinvested?

125. How do the net operating loss provisions in the tax law mitigate the effect of the annual accounting concept? 126. In connection with facilitating the function of the IRS in the administration of the tax laws, comment on the utility of the following: a. b. c.

An increase in the amount of the standard deduction. Dollar and percentage limitations on the deduction of personal casualty losses in Federally declared disaster areas. Availability of interest and penalties for taxpayer noncompliance.

127. Ultimately, most taxes are paid by individuals. Explain what this means in terms of income and payroll taxes paid by a corporation. Powered by Cognero

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Chapter 01: Introduction to Taxation 128. Compare the basic tax and nontax factors of doing business as a partnership, an S corporation, and a C

corporation. Circle the correct answers. Tax Questions

Column A Partnership

Column B S Corporation

Who pays tax on the entity’s income?

Partners Partnership

Shareholders S corporation

Column C C Corporation Shareholders C Corporation

Are operating losses passed through to owners?

Yes No

Yes No

Yes No

Yes No

Yes No

Yes No

Are distributions of profits taxable to owners?

Yes No

Yes No

Yes No

Nontax Factors

Partnership

S Corporation

C Corporation

Is the liability of owners limited?

Yes No

Yes No

Yes No

Is there free transferability of ownership interests?

Yes No

Yes No

Yes No

Are capital gains (losses) reported on owners’ tax returns as such?

129. Sofía is the sole shareholder of Thrush Corporation, a C corporation. In the current year, Thrush earned $350,000 and distributed $75,000 to Sofía. Kirk is the sole shareholder of Swallow Corporation, an S corporation. In the current year, Swallow earned $350,000 and distributed $75,000 to Kirk. Contrast the tax treatment of Thrush Corporation and Sofía with the tax treatment of Swallow Corporation and Kirk.

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Chapter 01: Introduction to Taxation Answer Key 1. False 2. True 3. False 4. True 5. True 6. False 7. True 8. True 9. True 10. False 11. False 12. True 13. False 14. True 15. True 16. False 17. False 18. True 19. False 20. True 21. True 22. True 23. False 24. False 25. True Powered by Cognero

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Chapter 01: Introduction to Taxation 26. True 27. False 28. True 29. True 30. True 31. False 32. True 33. False 34. True 35. False 36. False 37. True 38. True 39. True 40. True 41. False 42. True 43. False 44. True 45. True 46. True 47. True 48. False 49. False 50. False Powered by Cognero

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Chapter 01: Introduction to Taxation 51. False 52. False 53. True 54. True 55. True 56. False 57. True 58. True 59. False 60. True 61. True 62. d 63. a 64. c 65. a 66. b 67. d 68. c 69. a 70. d 71. d 72. c 73. b 74. a 75. d 76. c Powered by Cognero

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Chapter 01: Introduction to Taxation 77. d 78. c 79. a 80. c 81. b 82. a 83. d 84. d 85. d 86. d 87. a 88. b 89. b 90. a 91. c 92. a 93. d 94. d 95. d 96. c 97. d 98. b 99. b 100. c 101. a Powered by Cognero

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Chapter 01: Introduction to Taxation 102. a 103. a 104. $306,000 [$18,000 (annual exclusion) × 17 donees]. 105. The rent charged by Paige is not “arms length”; as such, Citron Corporation’s rent deduction is $60,000 (not $80,000). The $20,000 difference is a nondeductible dividend distribution. For Paige, the change merely requires reclassification. Instead of $80,000 of rent income, she has $60,000 of rent income and $20,000 of dividend income. 106. Martina is not subject to taxation on the improvements until she disposes of the property (i.e., 2024). After a controversial Supreme Court decision years ago, Congress clarified the tax law to make it more consistent with the wherewithal to pay concept. 107. Martina is not subject to taxation on the improvements until she disposes of the property (i.e., 2023). After a controversial Supreme Court decision years ago, Congress clarified the tax law to make it more consistent with the wherewithal to pay concept. 108. Although the bid from the United Methodist Church is higher, several other factors need to be considered. Does, for example, Goose Creek School District exempt property owned by churches from its ad valorem taxes? If so, losing this property from the tax base could prove very costly over the long run. Also, it is probable that income-producing property (such as a car dealership) would be taxed at a higher rate than that owned by a nonprofit organization (a school operated by a church). This assumes, of course, that the school would be taxed at all. The auto dealership also would generate sales tax. 109. The real estate taxes probably will increase for several reasons. The capital improvements and the conversion from residential to rental will trigger the increase. Furthermore, the furnishings may generate an ad valorem tax on personalty. (Depending on applicable law, furniture might not be subject to tax unless used for business purposes—such as in this case.) 110. The decrease probably came in 2022 when Deborah reached age 65. The increases probably occurred in 2023 when she added the pool and in 2024 when the residence was converted to rental property with the property reassessed due to the change in use and/or removal of the homestead exemption. 111. a. As reflected in Example 5, re-registration of a car purchased out of state is the occasion for the owner’s home state to collect the use tax. b. Completing the state income tax return reminds (or forces) the taxpayer to pay use tax on out of state purchases.

112. a.

b.

Such a holiday is designed to attract new industry to the area. This will bring more jobs and growth in consumption. On the other hand, if the tax holiday is too generous, this places a strain on available public revenue. The result could be that schools and capital maintenance (roads, public services) will suffer. The hotel occupancy tax and car rental surcharges are popular because they mainly impact visitors. Also, they can generate considerable revenue to finance major capital improvements. If these taxes become excessive, however, they could discourage major events (such as conventions).

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Chapter 01: Introduction to Taxation c.

Such holidays are popular with both merchants and consumers and serve the social need of defraying some of the costs of sending children to school. Once established, however, they are difficult to get rid of. Thus, they become an annual drain on sales tax revenue. In addition, since they are available to buyers at all income levels, they provide tax savings to taxpayers who do not need them and who might obtain greater tax breaks than others, as they have more funds to spend on the tax free items.

113. A severance tax is one imposed when natural resources (e.g., oil, gas, iron ore, coal) are extracted. It is based on the notion that the state has an interest in such resources. For some states, the revenue from severance taxes can be significant. Alaska, for example, relies heavily on its severance taxes and has been able to avoid both a state income tax and a general sales tax. 114. An inheritance tax is a tax on the right to receive property from a decedent. An estate tax is imposed on the right to pass property at death. The Federal government imposes estate taxes and states impose inheritance taxes. Some states impose both, whereas others impose neither. 115. None. After a marital deduction of $10 million and a charitable deduction of $10 million, Antonio’s taxable estate is $0. 116. Working in more than one state or owning income-generating property in more than one state can cause this. 117. In many cases, the procedure is overused (i.e., a multiplicity of boxes). This overuse adds complexity to the return. Also, in most cases, the donation is being drawn from any income tax refund that might be due. Thus, taxpayers may not fully appreciate that they are paying for such checkoffs. 118. a. The decoupling process is easily accomplished regarding new Federal tax changes that have never taken effect at the state level. Taxpayers are not apt to miss what they never have enjoyed. b. Tax amnesty provisions generate considerable revenue. It also unmasks many taxpayers who have not previously paid taxes. Now that the taxing jurisdiction is aware of their existence, they will tend to pay taxes in the future. c. By use of a public internet site, the taxing authority posts the names of those taxpayers that are delinquent as to various taxes (e.g., sales, income). This public humiliation (or threat of) very often results in compliance.

119. Most states allow their residents some form of tax credit for the income taxes paid to other states. In Briana’s case, the credit would be allowed by the state where she lives for the taxes paid to the state where she works. 120. a. Ideally, to achieve revenue neutrality, all tax cuts should be accompanied by revenue offsets. b.

A sunset provision does not account for the immediate revenue losses generated by a tax cut. It merely provides that such losses will not continue beyond a specified date when the tax cut

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Chapter 01: Introduction to Taxation expires and the former tax law is reinstated.

121. Social and economic considerations are the justification. As to the latter, a better educated workforce carries a positive economic impact. 122. a. Home ownership can be justified on economic and social grounds. b. Granting tax advantages to persons who are purchasing their homes places the taxpayers who rent at a disadvantage. The result is inequality in treatment. 123. The deduction (or a credit) for foreign income taxes can be justified on the grounds that it mitigates the double tax imposed on the same income. 124. a. By recognizing that the taxpayer’s relative economic situation has not changed and that they lack the wherewithal to pay a tax, any recognition of realized gain is deferred. b. If the proceeds from an involuntary conversion are not fully reinvested in property that is similar or related in service or use, recognized gain results. Such recognized gain cannot exceed realized gain and will be limited to the amount of the proceeds not reinvested. Recognition is based on the notion that the taxpayer now has the wherewithal to pay the tax that results. 125. Without the allowance of a loss carryforward, the losses would disappear. As shown by Example 27, this result places a business with profit and loss fluctuations on a more level playing field with one that maintains a stable income pattern. 126. a. An increase in the amount of the standard deduction reduces the number of taxpayers who choose to itemize their personal deductions. This, in turn, reduces the deductions the IRS has to check. b. Limitations placed on casualty and theft losses curtail the number of taxpayers who can claim the deduction. c. The imposition of extra penalties, in addition to the tax owed, definitely deters taxpayer noncompliance. 127. A corporation pays many types of taxes, but like any other expenditure, some of these taxes are ultimately paid by an individual. Income taxes are included in the price the corporation charges for goods and services. Or all or part might result in reduced earnings affecting investors or through reduced wages affecting employees. The payroll taxes paid by the corporate employer are likely borne by workers in the form of lower wages. That is, if the employer did not have to pay the taxes, it could pay higher wages to employees. These taxes might also be borne by customers and investors. 128. The correct answers are shaded. Tax Questions

Column A Partnership

Column B S Corporation

Column C C Corporation

Who pays tax on the entity’s income?

Partners Partnership

Shareholders S corporation

Shareholders C Corporation

Are operating losses passed through to owners?

Yes No

Yes No

Yes No

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Chapter 01: Introduction to Taxation Are capital gains (losses) reported on owners’ tax returns as such?

Yes No

Yes No

Yes No

Are distributions of profits taxable to owners?

Yes No

Yes No

Yes No

Nontax Factors

Partnership

S Corporation

C Corporation

Is the liability of owners limited?

Yes No

Yes No

Yes No

Is there free transferability of ownership interests?

Yes No

Yes No

Yes No

129. A C corporation is a separate taxable entity; thus, Thrush Corporation is taxed on the $350,000 of earnings. Income of a C corporation has no effect on the shareholders until such time a dividend is paid. When dividends are paid, shareholders must report dividend income on their tax returns. Thus, Sofía is taxed on $75,000 of dividends, and the 0%/15%/20% preferential tax rate applies with respect to the dividends. Generally, an S corporation is not subject to an entity-level Federal income tax. Instead, the corporation’s income, gains, deductions, and losses are passed through to and reported by the shareholders on their tax returns. Thus, Swallow reports the $350,000 of earnings on its tax return (Form 1120S) but pays no income tax. Kirk is taxed on the $350,000 of earnings from Swallow on his individual income tax return (Form 1040). Distributions from S corporations are not taxable to the shareholder (to the extent of stock basis). Thus, Kirk is not taxed on the $75,000 distribution from Swallow.

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Chapter 02: Working with the Tax Law True / False 1. Rules of tax law do not include Revenue Rulings and Revenue Procedures. a. True b. False 2. A tax professional need not worry about the relative weight of authority within the various tax law sources. a. True b. False 3. In recent years, Congress has been relatively successful in simplifying the Internal Revenue Code. a. True b. False 4. A taxpayer should always minimize their tax liability. a. True b. False 5. The first codification of the tax law occurred in 1954. a. True b. False 6. This Internal Revenue Code section citation is correct: § 212(1). a. True b. False 7. Subchapter D refers to the “Corporate Distributions and Adjustments” section of the Internal Revenue Code. a. True b. False 8. In general, Regulations are issued immediately after a statute is enacted. a. True b. False 9. Temporary Regulations are only published in the Internal Revenue Bulletin. a. True b. False 10. Revenue Rulings issued by the National Office of the IRS carry the same legal force and effect as Regulations. a. True b. False 11. A Revenue Ruling is an administrative source of Federal tax law. a. True b. False Powered by Cognero

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Chapter 02: Working with the Tax Law 12. The following citation could be a correct citation: Rev. Rul. 2021-42, 2021-64 I.R.B. 982. a. True b. False 13. Revenue Procedures deal with the internal management practices and procedures of the IRS. a. True b. False 14. Post-1984 letter rulings may be substantial authority for purposes of the accuracy-related penalty in § 6662. a. True b. False 15. A letter ruling applies only to the taxpayer who asks for and obtains a letter ruling. a. True b. False 16. The IRS is not required to make a letter ruling public. a. True b. False 17. Determination letters usually involve completed transactions. a. True b. False 18. Technical Advice Memoranda deal with completed transactions. a. True b. False 19. Technical Advice Memoranda may not be cited as precedents by taxpayers. a. True b. False 20. A taxpayer must pay any tax deficiency assessed by the IRS and sue for a refund to bring suit in the U.S. Court of Federal Claims. Only in the Tax Court can jurisdiction be obtained without first paying the assessed tax deficiency. a. True b. False 21. In a U.S. District Court, a jury can decide both questions of fact and questions of law. a. True b. False 22. Three judges will normally hear each U.S. Tax Court case. a. True b. False 23. A taxpayer can obtain a jury trial in the U.S. Tax Court. Powered by Cognero

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Chapter 02: Working with the Tax Law a. True b. False 24. A taxpayer must pay any tax deficiency assessed by the IRS and sue for a refund to bring suit in the U.S. District Court. a. True b. False 25. Arizona is in the jurisdiction of the Eighth Circuit Court of Appeals. a. True b. False 26. Texas is in the jurisdiction of the Second Circuit Court of Appeals. a. True b. False 27. The Golsen rule has been overturned by the U.S. Supreme Court. a. True b. False 28. The granting of a Writ of Certiorari indicates that at least four members of the Supreme Court believe that an issue is of sufficient importance to be heard by the full court. a. True b. False 29. The petitioner refers to the party against whom a suit is brought. a. True b. False 30. The term petitioner is a synonym for defendant. a. True b. False 31. The U.S. Tax Court meets most often in Washington, D.C. a. True b. False 32. There are 11 geographic U.S. Circuit Court of Appeals. a. True b. False 33. The following citation is correct: Larry G. Mitchell, 131 T.C. 215 (2008). a. True b. False 34. The IRS issues an acquiescence or nonacquiescence only for regular Tax Court decisions. Powered by Cognero

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Chapter 02: Working with the Tax Law a. True b. False 35. There is a direct conflict between an Internal Revenue Code section adopted in 2017 and a treaty with France (signed in 2016). The Internal Revenue Code section controls. a. True b. False 36. The Small Cases Division of the U.S. Tax Court will hear only those cases involving amounts of $100,000 or less. a. True b. False 37. A U.S. District Court is considered the lowest trial court. a. True b. False 38. The research process should always begin with a tax service. a. True b. False 39. Electronic (online) databases are most frequently searched by the keyword approach. a. True b. False 40. A treasure trove is taxable when sold or exchanged. a. True b. False 41. A Bluebook is substantial authority for purposes of the accuracy related penalty. a. True b. False 42. The primary purpose of effective tax planning is to reduce or defer the tax in the current tax year. a. True b. False 43. Deferring income to a subsequent year is considered to be tax avoidance. a. True b. False 44. Tax planning usually involves a completed transaction. a. True b. False 45. On the redesigned 2024 CPA exam, Business Law is allocated 15%–25% of the REG section. a. True Powered by Cognero

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Chapter 02: Working with the Tax Law b. False 46. Tax changes passed as part of the Inflation Reduction Act of 2022 became part of the Internal Revenue Code of 1986. a. True b. False 47. Revenue tax measures typically originate in the Senate Finance Committee of the U.S. Congress. a. True b. False 48. Currently, the Internal Revenue Code of 1986 does not contain §§ 308, 309, and 310. This absence means these sections were repealed by Congress. a. True b. False 49. Before a tax bill can become a law, it must be approved (signed) by the President of the United States. a. True b. False 50. Normally, when the Senate version of a tax bill differs from that passed by the House, a Joint Conference Committee drafts a compromise tax bill. a. True b. False 51. Subchapter C refers to the subchapter in the Internal Revenue Code that deals with partnerships and partners. a. True b. False 52. Revenue Rulings issued by the National Office of the IRS carry the same legal force and effect as Regulations. a. True b. False 53. Revenue Rulings are first published in the Internal Revenue Bulletin. a. True b. False 54. A Temporary Regulation under § 303 of the Code would be cited as follows: Temp. Reg. § 303. a. True b. False Multiple Choice 55. The Internal Revenue Code was first codified in what year? a. 1913 b. 1923 c. 1939 Powered by Cognero

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Chapter 02: Working with the Tax Law d. 1954 56. Tax bills are handled by which committee in the U.S. House of Representatives? a. Taxation Committee b. Ways and Means Committee c. Finance Committee d. Budget Committee 57. Federal tax legislation generally originates in which of the following? a. Internal Revenue Service b. Senate Finance Committee c. House Ways and Means Committee d. Senate Floor 58. Subtitle A of the Internal Revenue Code covers which of the following taxes? a. Income taxes b. Estate and gift taxes c. Excise taxes d. Employment taxes 59. In § 212(1), the number (1) stands for the: a. Section number. b. Subsection number. c. Paragraph designation. d. Subparagraph designation. 60. Which of these is not a correct citation to the Internal Revenue Code? a. Section 211 b. Section 1222(1) c. Section 2(a)(1)(A) d. All of these choices are correct cites. 61. Which of the following is not an administrative source of tax law? a. Chief Counsel Advice (CCA) b. Notice c. Code § 199A d. General Counsel Memorandum 62. Which of the following sources has the highest tax authority? a. Revenue Ruling b. Revenue Procedure c. Regulations d. Internal Revenue Code section Powered by Cognero

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Chapter 02: Working with the Tax Law 63. Which of the following types of Regulations has the highest tax validity? a. Temporary b. Legislative c. Interpretive d. Proposed 64. Which statement is not true with respect to a Regulation that interprets the tax law? a. Issued by the U.S. Congress. b. Issued by the U.S. Treasury Department. c. Designed to provide an interpretation of the tax law. d. Carries more legal force than a Revenue Ruling. 65. In addressing the importance of a Regulation, an IRS agent must: a. Give equal weight to the Internal Revenue Code and the Regulations. b. Give more weight to the Internal Revenue Code rather than to a Regulation. c. Give more weight to the Regulation rather than to the Internal Revenue Code. d. Give less weight to the Internal Revenue Code rather than to a Regulation. 66. Which item may not be cited as a precedent? a. Regulations b. Temporary Regulations c. Technical Advice Memoranda d. U.S. District Court decision 67. What statement is not true with respect to Temporary Regulations? a. May not be cited as precedent. b. Issued with Proposed Regulations. c. Automatically expire within three years after the date of issuance. d. Found in the Federal Register. 68. What administrative release deals with a proposed transaction rather than a completed transaction? a. Letter Ruling b. Technical Advice Memorandum c. Determination Letter d. Field Service Advice 69. Which of the following indicates that a decision has precedential value for future cases? a. Stare decisis b. Golsen doctrine c. En banc d. Reenactment doctrine 70. A taxpayer who loses in a U.S. District Court may appeal to the: a. U.S. Supreme Court. Powered by Cognero

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Chapter 02: Working with the Tax Law b. U.S. Tax Court. c. U.S. Court of Federal Claims. d. Appropriate U.S. Circuit Court of Appeals. 71. A taxpayer who decides not to pay a tax deficiency, must litigate in which court? a. Appropriate U.S. Circuit Court of Appeals b. U.S. District Court c. U.S. Tax Court d. U.S. Court of Federal Claims 72. A jury trial is available in the following trial court: a. U.S. Tax Court. b. U.S. Court of Federal Claims. c. U.S. District Court. d. U.S. Circuit Court of Appeals. 73. A taxpayer may not appeal a case from which court? a. U.S. District Court. b. U.S. Circuit Court of Appeals. c. U.S. Court of Federal Claims. d. Small Case Division of the U.S. Tax Court. 74. The IRS will not acquiesce to the following tax decisions: a. U.S. District Court. b. U.S. Tax Court. c. U.S. Court of Federal Claims. d. Small Case Division of the U.S. Tax Court. 75. Which publisher offers the Standard Federal Tax Reporter? a. Thomson Reuters Checkpoint (Research Institute of America) b. Wolters Kluwer (Commerce Clearing House) c. Bloomberg BNA d. LexisNexis 76. Which is presently not a commercial tax service? a. CCH Intelliconnect b. Federal Taxes c. Thomson Reuters Checkpoint d. Tax Management Portfolios 77. Which publisher offers the United States Tax Reporter? a. Thomson Reuters Checkpoint (Research Institute of America) b. Wolters Kluwer (Commerce Clearing House) c. LexisNexis Powered by Cognero

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Chapter 02: Working with the Tax Law d. Tax Analysts 78. When searching on an electronic (online) tax service, which approach is more frequently used? a. Internal Revenue Code section approach b. Keyword approach c. Table of contents approach d. Index 79. Which is not a judicial citation? a. CCA 200909002. b. T.C. Memo 2008-289. c. 39 TCM 32 (1979). d. 592 F.Supp.18. 80. Which of the following is the lowest authority in the Federal tax law system? a. Revenue Ruling. b. Proposed Regulation. c. Interpretive Regulation. d. Revenue Procedure. 81. Which tax-related website probably gives the best policy-orientation results? a. taxalmanac.org b. irs.gov c. EY.com d. taxanalysts.com 82. Which court decision would probably carry more weight? a. Regular U.S. Tax Court decision b. Reviewed U.S. Tax Court decision c. U.S. District Court decision d. Tax Court Memorandum decision 83. Which Regulations have the force and effect of law? a. Procedural Regulations b. Finalized Regulations c. Legislative Regulations d. Interpretive Regulations 84. Which items tell taxpayers the IRS’s reaction to certain court decisions? a. Notices b. Revenue Procedures c. Revenue Rulings d. Actions on Decisions Powered by Cognero

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Chapter 02: Working with the Tax Law 85. Which is not a primary source of tax law? a. Notice 89-99, 1989-2 C.B. 422. b. Estate of Harry Holmes v. Comm., 326 U.S. 480 (1946). c. Rev. Rul. 79-353, 1979-2 C.B. 325. d. Prop. Reg. § 1.752-4T(f). 86. Which of the following statements is incorrect as it relates to the redesigned 2024 CPA exam? a. The redesigned 2024 CPA exam now has three Core sections and three Discipline sections. b. There are no longer task-based simulations on the exam. c. A candidate must select a Discipline section. d. The previous BEC section material has been spread over other sections. 87. Which of the following court decisions carries more weight? a. Federal District Court b. Second Circuit Court of Appeals c. U.S. Tax Court decision d. Small Cases Division of U.S. Tax Court 88. Which company does not publish citators for tax purposes? a. John Wiley & Sons b. Wolters Kluwer (Commerce Clearing House) c. Thomson Reuters (RIA) d. Westlaw 89. Interpret the following citation: 64-1 USTC ¶9618, aff’d in 344 F.2d 966. a. A U.S. Tax Court Small Cases Division decision that was affirmed on appeal. b. A U.S. Tax Court decision that was affirmed on appeal. c. A U.S. District Court decision that was affirmed on appeal. d. A U.S. Circuit Court of Appeals decision that was affirmed on appeal. 90. Which citation refers to a Second Circuit Court of Appeals decision? a. 40 T.C. 1018. b. 159 F.2d 848 (CA-2, 1947). c. 354 F. Supp. 1003 (D.Ct. GA. 1972). d. 914 F.2d 396 (CA-3, 1990). 91. Which citation refers to a U.S. Tax Court decision? a. Apollo Computer, Inc. v. U.S., 95-1 (USTC ¶50,015 (Fed.Cl., 1994) b. Westreco, Inc., T.C. Memo. 1992-561 (1992). c. Bausch & Lomb, Inc. v. Comm., 933 F.2d 1084 (CA-2, 1991). d. Portland Manufacturing Co. v. Comm., 35 AFTR2d 1439 (CA-9, 1975). 92. If these citations appeared after a trial court decision, which one means that the decision was overruled? a. Aff’d 633 F.2d 512 (CA-7, 1980). Powered by Cognero

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Chapter 02: Working with the Tax Law b. Rem’d 399 F.2d 800 (CA-5, 1968). c. Aff’d 914 F.2d 396 (CA-3, 1990). d. Rev’d 935 F.2d 203 (CA-5, 1991). 93. Memorandum decision of the U.S. Tax Court could be cited as: a. T.C. Memo. 1990-650. b. 68-1 USTC ¶9200. c. 37 AFTR.2d 456. d. All of these choices are correct. 94. Which is a primary source of tax law? a. Serverino R. Nico, Jr., 67 T.C. 647 (1977). b. Article by a Federal judge in Tax Notes. c. An IRS publication. d. Written determination letter. 95. Which of the following statements about a nonacquiescence is correct? a. A nonacquiescence is issued in the Federal Registrar. b. Nonacquiescences are published only for certain regular decisions of the U.S. Tax Court. c. A nonacquiescence is published in the Internal Revenue Bulletin. d. The IRS does not issue nonacquiescences to adverse decisions that are not appealed. Essay 96. What are Treasury Department Regulations? 97. Compare Revenue Rulings with Revenue Procedures. 98. How can Congressional Committee Reports be used by a tax researcher? 99. What is a Technical Advice Memorandum? 100. Discuss the advantages and disadvantages of the Small Cases Division of the U.S. Tax Court. 101. Distinguish between the jurisdiction of the U.S. Tax Court and a U.S. District Court. 102. How do treaties fit within tax sources?

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Chapter 02: Working with the Tax Law Answer Key 1. False 2. False 3. False 4. False 5. False 6. True 7. False 8. False 9. False 10. False 11. True 12. False 13. True 14. True 15. True 16. False 17. True 18. True 19. True 20. True 21. False 22. False 23. False 24. True 25. False Powered by Cognero

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Chapter 02: Working with the Tax Law 26. False 27. False 28. True 29. False 30. False 31. False 32. True 33. True 34. False 35. True 36. False 37. True 38. False 39. True 40. False 41. True 42. False 43. True 44. False 45. True 46. True 47. False 48. False 49. False 50. True Powered by Cognero

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Chapter 02: Working with the Tax Law 51. False 52. False 53. True 54. False 55. c 56. b 57. c 58. a 59. c 60. d 61. c 62. d 63. b 64. a 65. a 66. c 67. a 68. a 69. a 70. d 71. c 72. c 73. d 74. d 75. b 76. b Powered by Cognero

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Chapter 02: Working with the Tax Law 77. a 78. b 79. a 80. b 81. d 82. b 83. c 84. d 85. d 86. b 87. b 88. a 89. c 90. b 91. b 92. d 93. a 94. a 95. c 96. Regulations are issued by the U.S. Treasury Department under authority granted by Congress. Interpretive by nature, they provide taxpayers with considerable guidance on the meaning and application of the Internal Revenue Code. Regulations may be issued in proposed, temporary, or final form. Regulations carry considerable authority as the official interpretation of tax statutes. They are an important factor to consider in complying with the tax law. Courts generally ignore Proposed Regulations. 97. Revenue Rulings are official pronouncements of the National Office of the IRS. They typically provide one or more examples of how the IRS would apply a law to specific fact situations. Like Regulations, Revenue Rulings are designed to provide interpretation of the tax law. However, they do not carry the same legal force and effect as Regulations and usually deal with more restricted problems. Regulations are approved by the Secretary of the Treasury, whereas Revenue Rulings generally are not. Powered by Cognero

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Chapter 02: Working with the Tax Law Revenue Procedures are issued in the same manner as Revenue Rulings, but deal with the internal management practices and procedures of the IRS. Familiarity with these procedures can increase taxpayer compliance and help the IRS administer the tax laws more efficiently. A taxpayer’s failure to follow a Revenue Procedure can result in unnecessary delay or, in a discretionary situation, can cause the IRS to decline to act on behalf of the taxpayer.

98. Congressional Committee Reports often explain the provisions of proposed legislation and are a valuable source of ascertaining the intent of Congress. The intent of Congress is the key to interpreting new legislation by taxpayers, especially before Regulations are published. 99. The National Office of the IRS releases Technical Advice Memoranda (TAMs) weekly. TAMs resemble letter rulings in that they give the IRS’s determination of an issue. However, they differ in several respects. Letter rulings deal with proposed transactions and are issued to taxpayers at their request. In contrast, TAMs deal with completed transactions. Furthermore, TAMs arise from questions raised by IRS personnel during audits and are issued by the National Office of the IRS to its field personnel. TAMs are often requested for questions relating to exempt organizations and employee plans. TAMs are not officially published and may not be cited or used as precedent. 100. There is no appeal from the Small Cases Division. The jurisdiction of the Small Cases Division is limited to cases involving amounts of $50,000 or less. The proceedings of the Small Cases Division are informal (e.g., no necessity for the taxpayer to be represented by a lawyer or other tax adviser). Often, special trial judges rather than Tax Court judges preside over these proceedings. The decisions of the Small Cases Division are not precedents for any other court decision and are not reviewable by any higher court. Proceedings can be more timely and less expensive in the Small Cases Division. Some of these cases can now be found on the U.S. Tax Court Internet Website. 101. The U.S. Tax Court hears only tax cases and is the most popular tax forum. The U.S. District Court hears a wide variety of nontax cases, including drug crimes and other Federal violations, as well as tax cases. Some Tax Court justices have been appointed from IRS or Treasury Department positions. For these reasons, some people suggest that the U.S. Tax Court has more expertise in tax matters. 102. The U.S signs certain tax treaties (sometimes called tax conventions) with foreign countries to render mutual assistance in tax enforcement and to avoid double taxation. Tax legislation enacted in 1988 provided that neither a tax law nor a tax treaty takes general precedence. Thus, when there is a direct conflict with the Internal Revenue Code and a treaty, the most recent item will take precedence. A taxpayer must disclose on the tax return any position where a treaty overrides a tax law. There is a $1,000 penalty per failure to disclose for individuals and a $10,000 per failure to disclose penalty for corporations.

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Chapter 03: Gross Income True / False 1. The realization requirement gives an incentive to own assets that have increased in value and to sell assets whose value has decreased. a. True b. False 2. Judy is a cash basis attorney. This year, she performed services in connection with the formation of a corporation and received stock with a value of $4,000 for her services. By the end of the year, the value of the stock had decreased to $2,000. She continued to hold the stock. Judy must recognize $4,000 of gross income from the stock for the current year. a. True b. False 3. Barney painted his house, which saved him $3,000. According to the realization requirement, Barney must recognize $3,000 of income. a. True b. False 4. Nicholas owned stock that decreased in value by $20,000 during the year, but he did not sell the stock. He earned $45,000 salary but received only $34,000 because $11,000 in taxes were withheld. Nicholas saved $10,000 of his salary and used the remainder for personal living expenses. Nicholas’s economic income for the year exceeded his gross income for tax purposes. a. True b. False 5. The fact that the accounting method the taxpayer uses to measure income is consistent with GAAP does not ensure that the method will be acceptable for tax purposes. a. True b. False 6. The financial accounting principle of conservatism is not well suited to the task of measuring taxable income. a. True b. False 7. A cash basis taxpayer purchased a certificate of deposit for $1,000 on July 1, 2024 that will pay $1,100 upon its maturity on June 30, 2026. The taxpayer must recognize a portion of the income in 2024. a. True b. False 8. Ralph purchased his first Series EE bond during the year. He paid $709 for a 10-year bond with a $1,000 maturity value. The yield to maturity on the bonds was 3.5%. Ralph is not required to recognize the $291 ($1,000 – $709) original issue discount until the bond matures. However, Ralph can elect to amortize the discount over the 10-year period. a. True b. False 9. A sole proprietor purchased an asset for $1,000 in 2024. Its value was $1,500 at the end of 2024. In 2025, the taxpayer sold the asset for $1,400. In 2025, the proprietor realized a taxable gain of $400 but an economic loss of $100. Powered by Cognero

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Chapter 03: Gross Income a. True b. False 10. At the beginning of 2024, Mary purchased a 3-year certificate of deposit (CD) for $8,760. The maturity value of the certificate was $10,000 and it was to yield 4.5%. She also purchased a Series EE bond for $6,400 with a maturity value in 10 years of $10,000. Mary must recognize $1,240 of income from the certificate of deposit in 2024, and $3,600 from the Series EE bonds in 2033. a. True b. False 11. In 2012, DeAndre purchased land for $150,000. He also received $10,000 from a local cable television company in exchange for allowing the company to run an underground cable across his property. DeAndre is not required to recognize income from receiving the $10,000 because it was a return of his capital invested in the land. a. True b. False 12. In December 2023, Adriana collected the December 2023 and January 2024 rent from a tenant. Adriana is a cash basis taxpayer. The amount collected in December 2023 for the 2024 rent should be included in her 2024 gross income. a. True b. False 13. On December 1, 2024, Daniel, an accrual basis taxpayer, collects $12,000 rent for December 2024 and $12,000 for January 2025. Daniel must include the $24,000 in 2024 gross income. a. True b. False 14. On January 1, 2024, an accrual basis taxpayer entered into a contract to provide termite inspection service each month for 24 months. The amount received for the contract was $2,400. The taxpayer reported $1,200 as income on its financial statement for 2024 and should do the same for its tax return. a. True b. False 15. An advance payment received in June 2024 by an accrual basis and calendar year taxpayer for services to be provided over a 36-month period can be spread over four tax years. a. True b. False 16. In 2024, Juan, a cash basis taxpayer, was offered $3,000,000 for signing a professional baseball contract. He counteroffered that he would receive $900,000 per year for four years beginning in 2025. The team accepted the counteroffer. Juan constructively received $3,000,000 in 2024. a. True b. False 17. The constructive receipt doctrine does not apply to accrual basis taxpayers. a. True b. False Powered by Cognero

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Chapter 03: Gross Income 18. Fred is a full-time teacher. He has written a book and receives royalties from it. Fred’s mother, Mabel, is age 65 and lives on her Social Security benefits and gifts from her son. This year Fred directed the publisher to make the royalty check payable to Mabel because she needs the money for support. Fred must include the amount of the royalty check in his gross income. a. True b. False 19. Jessica is a cash basis taxpayer. When she failed to repay a loan, the bank garnished her salary. Each week $60 was withheld from Jessica’s salary and paid to the bank. Jessica is required to include the $60 each week in her gross income even though it is the creditor that benefits from the income. a. True b. False 20. ABC Corporation declared a dividend for shareholders of record as of December 24, 2023. The dividend checks were mailed on December 31, 2023. Ed, a cash basis shareholder, received the dividend check on January 2, 2024. Ed can delay reporting the income from the dividend until 2024. a. True b. False 21. Tom, a cash basis taxpayer, purchased a bond on March 31 for $10,000, plus $100 accrued interest. In December, he collected $500 interest from the bond. Tom’s interest income from the bond for the year is $500. a. True b. False 22. When stock is sold after the date a dividend is declared but before the record date, the buyer must recognize as income the dividend declared. a. True b. False 23. Himari delivers pizzas for a pizza shop. On Wednesday, December 31, 2024, Himari made several deliveries and collected $400 from customers. However, Himari forgot to turn in the proceeds for the day to her employer until the following Friday, January 2, 2025. The pizza shop owner recognizes the income of $400 when he receives it from Himari in 2025. a. True b. False 24. Father made an interest-free loan of $25,000 to Son who used the money to buy an SUV. Son had $1,600 interest income from a certificate of deposit for the year. Father is not required to impute interest income. a. True b. False 25. In the case of a below-market gift loan for which there is no exception to the imputed interest rules, the lender is deemed to have received interest income even though no interest is charged and collected. a. True b. False 26. In the case of a gift loan of less than $100,000, the imputed interest rules apply if the donee has net investment income Powered by Cognero

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Chapter 03: Gross Income of over $1,000. a. True b. False 27. Frank sold his personal use automobile for a loss of $9,000. He also sold a personal coin collection for a gain of $10,000. As a result of these sales, $10,000 is subject to income tax. a. True b. False 28. Gain on the sale of collectibles held for more than 12 months always is subject to a tax rate of 28%. a. True b. False 29. Stuart has a short-term capital loss, a collectible long-term capital gain, and a long-term capital gain from land held as investment. The short-term loss is first applied to the collectible capital gain. a. True b. False 30. For a person who is in the 35% marginal tax bracket, $1,000 of tax-exempt income is equivalent to $1,350 of income that is subject to tax. a. True b. False 31. Mel was the beneficiary of a $45,000 group term life insurance policy on his deceased wife. His wife’s employer had paid all of the premiums on the policy. Mel used the life insurance proceeds to purchase a U.S. government bond, which paid him $2,500 interest during the current year. Mel’s Federal gross income from this is $2,500. a. True b. False 32. Zack was the beneficiary of a life insurance policy on his deceased wife. Zack had paid $20,000 in premiums on the policy. He collected $50,000 on the policy when his wife died from a terminal illness. Because it took several months to process the claim, the insurance company paid Zack $53,000, the face amount of the policy plus $3,000 interest. Zack must include $23,000 in his gross income. a. True b. False 33. Laura died while employed by Violet Company. Her wife collected $40,000 on a group term life insurance policy that Violet provided its employees and $6,000 of accrued salary Laura had earned prior to her death. All of the premiums on the group term life insurance policy were excluded from Laura’s gross income. Laura’s wife is required to recognize as gross income only the $6,000 she received for the accrued salary. a. True b. False 34. Gary cashed in an insurance policy on his life. He needed the funds to pay for his terminally ill wife’s medical expenses. He had paid $12,000 in premiums and he collected $30,000 from the insurance company. Gary is not required to include the gain of $18,000 ($30,000 – $12,000) in gross income. a. True Powered by Cognero

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Chapter 03: Gross Income b. False 35. When Betty was diagnosed as having a terminal illness, she sold her life insurance policy to Insurance Purchase, Inc., a company that is licensed to invest in these types of contracts. Betty sold the policy for $32,000, and Insurance Purchase, Inc. became the beneficiary. She had paid total premiums of $19,000. Betty died eight months after the sale. Insurance Purchase, Inc., collected $50,000 on the policy. The company had paid additional premiums of $4,000 on the policy. Betty's estate is not required to recognize a $13,000 gain from the sale of her life insurance policy; and Insurance Purchase, Inc. is required to recognize a $14,000 gain from the insurance policy. a. True b. False Multiple Choice 36. On a particular Saturday, Tom had planned to paint a room in his house, but his employer gave him the opportunity to work that day. If Tom works, he must hire a painter for $120. Assuming Tom is in the 24% marginal tax bracket, what is the least amount he must get paid to be able to pay the painter and still have a positive cash flow from working? a. $0. b. $120. c. $158. d. $500. 37. The tax concept and economic concept of income are in agreement on which of the following? a. The fair rental value of an owner-occupied home should be included in income. b. The increase in value of assets held for the entire year should be included in income for the year. c. Rent income for 2024 collected in 2023 is income for 2023. d. Income includes the value of things grown or produced by the taxpayer for the taxpayer's own consumption. 38. The Blue Utilities Company paid Sue $2,000 for the right to lay an underground electric cable across her property anytime in the future. a. Sue must recognize $2,000 gross income in the current year if the company did not install the cable during the year. b. Sue is not required to recognize gross income from the receipt of the funds. c. Sue must recognize $2,000 gross income in the current year regardless of whether the company installed the cable during the year. d. Sue must recognize $2,000 gross income in the current year, and when the cable is installed, she must reduce her cost basis in the land by $2,000. 39. For purposes of determining gross income, which of the following is true? a. A mechanic completed repairs on an automobile during the year and collected money from the customer. The customer was not satisfied with the repairs and sued the mechanic for a refund. The mechanic can defer recognition of the income until the suit has been settled. b. A taxpayer who finds and keeps a wallet full of money is required to recognize income. c. An employee receives stock worth $1,000 from her employer as compensation for her services. The employee cannot sell the stock for three years and must forfeit the stock if she leaves her job before she is able to sell it. The employee must include $1,000 in her gross income in the year she receives the stock. d. All of these choices are false. Powered by Cognero

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Chapter 03: Gross Income 40. Asia, a successful executive, is negotiating a compensation plan with her potential employer. The employer has offered to pay Asia a $600,000 annual salary, payable at the rate of $50,000 per month. Asia counteroffers to receive a monthly salary of $40,000 ($480,000 annually) and a $180,000 bonus in five years when Asia will be age 65. a. If the employer accepts Asia’s counteroffer, Asia will recognize $660,000 at the time the offer is accepted. b. If the employer accepts Asia’s counteroffer, Asia will recognize as gross income $55,000 per month [($480,000 + $180,000)/12]. c. If the employer accepts Asia’s counteroffer, Asia will recognize $40,000 income each month for the year and $180,000 in year 5. d. If the employer accepts Asia’s counteroffer, Asia must recognize imputed interest income on the $180,000 to be received in five years. 41. Maroon Corporation expects its employees’ income tax rates to increase next year. The employees use the cash method. The company presently pays on the last day of each month. The company is considering changing its policy so that the December salaries will be paid on the first day of the following year. What would be the effect on an employee of the proposed change in company policy beginning December 2024? a. The employee would be required to recognize the December 2024 salary in December 2024 because it is constructively received at the end of the month. b. The employee would be required to recognize the December 2024 salary in December 2024 because the employee has a claim of right to the income when it is earned. c. The employee will not be required to recognize the December 2024 salary until it is received, in 2025. d. The employee can elect to either include the December 2024 salary in 2024 or 2025. 42. The annual increase in the cash surrender value of a life insurance policy: a. Is taxed according to the original issue discount rules. b. Is not included in gross income because the policy must be surrendered to receive the cash surrender value. c. Reduces the deduction for life insurance expense. d. Is exempt because it is life insurance proceeds. 43. Assume a cash basis taxpayer purchased a three-year certificate of deposit on January 1 of the current year. Under the original issue discount (OID) rules, which of the following is true? a. All of the income must be recognized in the year of maturity. b. The OID will be included in gross income for the year of purchase. c. The interest income will be recognized equally over three years. d. The interest income will be recognized over three years but will be greater in the third year than in the first year. 44. Freddy purchased a certificate of deposit for $20,000 on July 1, 2024. The certificate’s maturity value in two years (June 30, 2026) is $21,218, yielding 3% before-tax interest. a. Freddy must recognize $1,218 gross income in 2024. b. Freddy must recognize $1,218 gross income in 2026. c. Freddy must recognize $690 ($1,218 x 0.5) gross income in 2026. d. Freddy must recognize $300 (0.03 × $20,000 × 0.5) gross income in 2024. 45. Jerry purchased a U.S. Series EE savings bond for $744. The bond has a maturity value in 10 years of $1,000 and yields 3% interest. This is the first Series EE bond that Jerry has ever owned. a. Jerry can defer the interest income until the bond matures in 10 years. Powered by Cognero

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Chapter 03: Gross Income b. Jerry must report $25.60[($1,000 – $744)/10] interest income each year he owns the bond. c. The interest on the bonds is exempt from Federal income tax. d. Jerry can report all of the $256 as a capital gain in the year it matures. 46. Office Palace, Inc., signed a contract to lease an all-in-one printer to a new customer, Ashley, on December 27, 2024. The contract called for rent of $600 per month for a period of 36 months beginning January 1, 2025. Ashley was required to pay the first and last month’s rent at the time the lease was signed. Ashley was also required to pay a $1,500 damage deposit. Office Palace must recognize as income for the lease: a. $0 in 2024, if Office Palace is an accrual basis taxpayer. b. $7,800 in 2025, if Office Palace is a cash basis taxpayer. c. $2,700 in 2024, if Office Palace is a cash or accrual basis taxpayer. d. $1,200 in 2024. 47. Maroon & Orange Gym, Inc., uses the accrual method of accounting. The corporation sells memberships that entitle the member to use the facilities at any time. A one-year membership costs $480 ($480/12 = $40 per month); a two-year membership costs $720 ($720/24 = $30 per month). Cash payment is required at the beginning of the membership period. On July 1, 2024, the company sold a one-year membership and a two-year membership. For financial reporting purposes, Maroon reports the membership income ratably over the number of months involved. How much gross income should the company report as gross income from the two contracts in 2025, the year following payment? a. $-0-. b. $600. c. $780. d. $1,200. 48. Orange Cable TV Company, an accrual basis taxpayer, allows its customers to pay by the year in advance ($600 per year) or two years in advance ($960). In September 2024, the company collected the following amounts applicable to future services: October 2024-September 2026 services (200 two-year contracts) October 2024-September 2025 services (200 one-year contracts) Total

$192,000 120,000 $312,000

As a result of this, Orange Cable should report as gross income for 2025, the year following receipt: a. $54,000. b. $78,000. c. $258,000. d. $312,000. 49. With respect to the unearned income from services, which of the following is true? a. The treatment of unearned income is the same for tax and financial accounting for accrual basis taxpayers. b. A cash basis taxpayer must report all of the income in the year received. c. An accrual basis taxpayer can spread the income over the period services are to be provided if all of the services will be completed within three years following the year of receipt. d. An accrual basis taxpayer can spread the income over the period services are to be provided on a contract for three years or less. Powered by Cognero

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Chapter 03: Gross Income 50. With respect to unearned income from services, which of the following is true? a. An accrual basis taxpayer will always recognize the income over the period the services will be rendered. b. A cash basis taxpayer can spread the income from a 24-month service contract over the contract period. c. If an accrual basis taxpayer sells a 36-month service contract on July 1, 2024 for $3,600, the taxpayer’s 2024 gross income from the contract is $600. d. If an accrual basis taxpayer sells a 24-month service contract on July 1, 2024, one-half (12/24) the income is recognized in 2025. 51. Green Company, an accrual basis taxpayer, provides business-consulting services. Clients generally pay a retainer at the beginning of a 12-month period. This entitles the client to no more than 40 hours of services. Once the client has received 40 hours of services, Green charges $500 per hour. Green Company allocates the retainer to income based on the number of hours worked on the contract. At the end of 2024, the company reported as a liability in its financial statements $50,000 of unearned revenues from these contracts. The company also reported $10,000 in unearned rent income received in 2024 from excess office space leased to other companies. Considering only this information, how much gross income must Green report in 2025 for tax purposes? a. $60,000. b. $50,000. c. $10,000. d. $-0-. 52. On January 2, 2024, Tim purchased a bond paying interest at 6% for $30,000. On March 31, 2024, he gave the bond to Jane. The bond pays $1,800 interest on December 31. Tim and Jane are cash basis taxpayers. When Jane collects the interest in December 2024: a. Tim must include all of the interest in his gross income. b. Jane must report $1,800 gross income. c. Jane reports $1,350 of interest income, and Tim reports $450 of interest income. d. Jane reports $450 of interest income, and Tim reports $1,350 of interest income. 53. Teal company is an accrual basis taxpayer. On December 1, 2024, a customer paid for an item that was on hand, but the customer wanted the item delivered in early January 2025. Teal delivered the item on January 4, 2025. Teal properly included the sale in its 2024 income for financial accounting purposes. a. Teal must recognize the sale in its gross income in 2024. b. Teal must recognize the sale in its gross income in the year title to the goods passed to the customer, as determined under the state laws in which the store is located. c. Teal can elect to recognize the sale in its gross income in either 2024 or 2025. d. Teal must recognize the sale in its gross income in 2025. 54. As a general rule: I. Income from property is taxed to the person who owns the property. II. Income from services is taxed to the person who earns the income. III. The assignee of income from property must pay tax on the income. IV. The person who receives the benefit of the income must pay the tax on the income. a. Only I and II are true. b. Only III and IV are true. c. I, II, and III are true, but IV is false. d. I, II, III, and IV are true. Powered by Cognero

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Chapter 03: Gross Income 55. On November 1, 2024, Bob, a cash basis taxpayer, gave Dave common stock. On October 30, 2024, the corporation had declared a dividend payable to shareholders of record as of November 22, 2024. The dividend was paid on December 15, 2024. The corporation has paid the $1,200 dividend once each year for the past ten years, during which Bob owned the stock. When Dave collected the dividend on December 15, 2024: a. Bob must include $1,000 (10/12 x $1,200) of the dividend in his gross income. b. Bob must include all of the dividend in his gross income. c. Dave must include all of the dividend in his gross income. d. Dave should treat the $1,200 as a recovery of capital. 56. Daniel purchased a bond on July 1, 2024, at par of $10,000 plus accrued interest of $300. On December 31, 2024, Daniel collected the $600 interest for the year. On January 1, 2025, Daniel sold the bond for $10,200. a. Daniel must recognize $300 interest income for 2024 and a $200 gain on the sale of the bond in 2025. b. Daniel must recognize $600 interest income for 2024 and a $200 gain on the sale of the bond in 2025. c. Daniel must recognize $600 interest income for 2024 and a $100 loss on the sale of the bond in 2025. d. Daniel must recognize $300 interest income for 2024 and a $100 loss on the sale of the bond in 2025. 57. Theresa, a cash basis taxpayer, purchased a bond on July 1, 2019, for $10,000, plus $400 of accrued interest. The bond paid $800 of interest each December 31. On March 31, 2024, she sold the bond for $9,800, which included $200 of accrued interest. a. Theresa has $200 interest income and a $400 loss from the bond in 2024. b. Theresa has $200 interest income and a $200 gain from the bond in 2024. c. Theresa has a $100 loss from the sale of the bond and no interest income. d. Theresa’s loss on the sale of the bond is $600. 58. The purpose of the tax rules that apply to below-market loans between family members is to: a. Discourage loans between related parties. b. Prevent shifting of income among family members. c. Prevent gifts from being disguised as bad debt expenses. d. Prevent the artificial deferral of income recognition. 59. Darryl, a cash basis taxpayer, gave 1,000 shares of Copper Company common stock to his daughter on September 29, 2024. Copper Company is a publicly held company that has declared a $2.00 per share dividend on September 30th every year for the last 20 years. Just as Darryl had expected, Copper Company declared a $2.00 per share dividend on September 30th, 2024 payable on October 15th, to stockholders of record as of October 10th. The daughter received the $2,000 dividend on October 18, 2024. a. The daughter must recognize the income because she owned the stock on October 10th. b. Darryl must recognize the income of $2,000 because the purpose of the gift was to avoid taxes. c. Darryl must recognize $1,500 of the dividend because he owned the stock for three-fourths of the year. d. Darryl must recognize the $2,000 dividend as his income because he constructively received the dividend. 60. On January 1, Dave loaned his daughter, Debra, $200,000 to purchase a new car and to pay off college loans. There were no other loans outstanding between Dave and Debra. The relevant Federal rate on interest was 3 percent. The loan was outstanding for the entire year. a. If Debra has $15,000 of investment income, Dave must recognize $6,045 of imputed interest income. b. Dave must recognize $6,045 of imputed interest income regardless of the amount of Debra’s investment Powered by Cognero

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Chapter 03: Gross Income income. c. Debra must recognize $6,045 of imputed interest income. d. Debra must recognize $6,045 of imputed interest income if Dave has at least $6,045 of investment income. 61. Sarah, a majority shareholder in Teal, Inc., made a $200,000 interest-free loan to the corporation. Sarah is not an employee of the corporation. a. Sarah must recognize imputed interest expense and the corporation must recognize imputed interest income. b. Sarah must recognize imputed interest income and the corporation must recognize imputed interest expense. c. Sarah must recognize imputed dividend income and the corporation may recognize imputed interest expense. d. Neither Sarah’s nor the corporation’s gross income is affected by the loans because no interest was charged. 62. What are the effects of a below-market loan for $100,000 made by a corporation to its chief executive officer as an enticement to get him to remain with the company? a. The corporation has imputed interest income and the employee is deemed to have received a gift. b. The corporation has imputed interest income and dividends paid. c. The employee has no income unless the funds are invested and produce investment income for the year. d. The employee has imputed compensation income and the corporation has imputed interest income. 63. Jasmine made a $60,000 interest-free loan to her son, Farhad, who used the money to start a new business. Farhad’s only sources of income were $25,000 from the business and $490 of interest on his checking account. The relevant Federal interest rate was 5%. Based on this information: a. Farhad’s business net profit will be reduced by $3,000 (0.05 × $60,000) of interest expense. b. Jasmine must recognize $3,000 (0.05 × $60,000) of imputed interest income on the below-market loan. c. Farhad’s gross income must be increased by the $3,000 (0.05 × $60,000) imputed interest income on the below-market loan. d. Jasmine does not recognize any imputed interest income and Farhad does not recognize any imputed interest expense. 64. Our tax laws create an incentive for taxpayers to ____ assets that have appreciated in value and ____ assets that have declined in value. a. sell; keep. b. sell; sell. c. keep; sell. d. keep; keep. 65. Margaret owns land that appreciates at the rate of 5% each year. Luis owns a zero-coupon (i.e., all of the interest is paid at maturity) corporate bond with a yield to maturity of 5%. At the end of 10 years, the bond will mature and the land will be sold. At the end of the 10 years, a. Margaret and Luis will have accumulated the same after-tax amounts. b. Luis will have accumulated a greater after-tax amount because the interest on the bond is tax-exempt. c. Margaret will have accumulated the greater after-tax amount because the gain on the land is tax-exempt. d. Margaret will accumulate the greater after-tax amount because she earns a return on the deferred taxes. 66. During the year, Kim sold the following assets: business auto for a $1,000 loss, stock investment for a $1,000 loss, and pleasure yacht for a $1,000 loss. Presuming adequate income, how much of these losses may Kim claim? a. $0. Powered by Cognero

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Chapter 03: Gross Income b. $1,000. c. $2,000. d. $3,000. 67. Perry, a single taxpayer, has taxable income of $198,000 and is in the 32% tax bracket. During 2024, he had the following capital asset transactions: Gain from the sale of a stamp collection (held for 10 years) Gain from the sale of an investment in land (held for 4 years) Gain from the sale of stock investment (held for 8 months)

$30,000 10,000 4,000

Perry’s tax consequences from these gains are as follows: a. (15% × $30,000) + (32% × $4,000). b. (15% × $10,000) + (28% × $30,000) + (32% × $4,000). c. (0% × $10,000) + (28% × $30,000) + (32% × $4,000). d. (15% × $40,000) + (32% × $4,000). 68. Kirby, a single taxpayer, has taxable income of $40,000 and is in the 12% tax bracket. During 2024, she had the following capital asset transactions: Long-term gain from the sale of a coin collection Long-term gain from the sale of a land investment Short-term gain from the sale of a stock investment

$11,000 10,000 2,000

Kirby’s tax consequences from these gains are as follows: a. (5% × $10,000) + (12% × $13,000). b. (12% × $13,000) + (28% × $11,000). c. (0% × $10,000) + (12% × $13,000). d. (12% × $23,000). 69. For the current year, David has wages of $80,000 and the following property transactions: Stock investment sales— Long-term capital gain Short-term capital loss Loss on sale of camper (purchased four years ago and used for family vacations)

$ 9,000 (12,000) (2,000)

What is David’s AGI for the current year? a. $76,000. b. $77,000. c. $78,000. d. $89,000. 70. During 2024, Trevor has the following capital transactions: LTCG Powered by Cognero

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Chapter 03: Gross Income Long-term collectible gain STCG STCL

2,000 4,000 10,000

After the netting process, the following results: a. Long-term collectible gain of $2,000. b. LTCG of $6,000, long-term collectible gain of $2,000, and a STCL of $6,000. c. LTCG of $6,000, long-term collectible gain of $2,000, and a STCL carryover to 2023 of $3,000. d. LTCG of $2,000. 71. Carin, a widow, elected to receive the proceeds of a $150,000 life insurance policy on the life of her deceased husband in 10 installments of $17,500 each. Her husband had paid premiums of $60,000 on the policy. In the first year, Carin collected $17,500 from the insurance company. She must include in gross income: a. $0. b. $2,500. c. $10,000. d. $25,000. 72. Iris collected $150,000 on her deceased husband’s life insurance policy. The policy was purchased by the husband’s employer under a group policy. Iris’s husband had included $5,000 in gross income from the group term life insurance premiums during the years he worked for the employer. She elected to collect the policy in 10 equal annual payments of $18,000 each. a. None of the payments must be included in Iris’s gross income. b. The amount she receives in the first year is a nontaxable return of capital. c. For each $18,000 payment that Iris receives, she can exclude $500 ($5,000/$180,000 × $18,000) from gross income. d. For each $18,000 payment that Iris receives, she can exclude $15,000 ($150,000/$180,000 × $18,000) from gross income. 73. Turquoise Company purchased a life insurance policy on the company’s chief executive officer, Joe. After the company had paid $400,000 in premiums, Joe died, and the company collected the $1.5 million face amount of the policy. The company also purchased group term life insurance on all its employees. Joe had included $16,000 in gross income for the group term life insurance premiums. Joe’s widow, Rebecca, received the $100,000 proceeds from the group term life insurance policy. a. Rebecca can exclude the life insurance proceeds of $100,000, but Turquoise must include $1,100,000 ($1,500,000 – $400,000) in gross income. b. Turquoise and Rebecca can exclude the life insurance proceeds of $1,500,000 and $100,000, respectively, from gross income. c. Turquoise can exclude $1,100,000 ($1,500,000 – $400,000) from gross income, but Rebecca must include $84,000 in gross income. d. Turquoise must include $1,100,000 ($1,500,000 – $400,000) in gross income, and Rebecca must include $100,000 in gross income. 74. Swan Finance Company, an accrual method taxpayer, requires all of its customers to carry credit life insurance. If a customer dies, the company receives from the insurance company the balance due on the customer’s loan. Ali, a customer, died owing Swan $1,500. The balance due included $200 accrued interest that Swan has included in income. When Swan collects $1,500 from the insurance company, Swan: Powered by Cognero

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Chapter 03: Gross Income a. Must recognize $1,500 income from the life insurance proceeds. b. Must recognize $1,300 income from the life insurance proceeds. c. Does not recognize income because life insurance proceeds are tax-exempt. d. Does not recognize income from the life insurance because the entire amount is a recovery of capital. 75. In the case of interest income from state and Federal bonds: a. Interest on U.S. government bonds received by a state resident can be subject to that state’s income tax. b. Interest on U.S. government bonds is subject to Federal income tax. c. Interest on bonds issued by State A received by a resident of State B cannot be subject to income tax in State B. d. All of these choices are correct. 76. Margarita’s interest and gains on investments for the current year are as follows: Interest on Madison County school bonds Interest on U.S. government bonds Interest on a Federal income tax refund Gain on the sale of Madison County school bonds

$600 700 200 500

Margarita must report gross income in the amount of: a. $2,000. b. $1,800. c. $1,400. d. $1,300. 77. Imani is in the 35% marginal tax bracket. She can purchase a York County school bond yielding 3.5% interest, which is not subject to a 5% state tax. But she is interested in earning a higher return for comparable risk. Which of the following is correct: a. If she buys a corporate bond that pays 6% interest, her after-tax rate of return will be less than if she had purchased the York County school bond. b. If she buys a U.S. government bond paying 5%, her after-tax rate of return will be less than if she had purchased the York County school bond. c. If she buys a common stock paying a 4% dividend, her after-tax rate of return will be higher than if she had purchased the York County school bond. d. All of these choices are correct. 78. Doug and Manuel received the following interest income in the current year: Savings account opened at Greenbacks Bank U.S.Treasury bonds Interest on State of Iowa bonds Interest on Federal tax refund Interest on state income tax refund

$4,000 250 200 150 75

Greenbacks Bank also gave Doug and Manuel a cellular phone (worth $100) for opening the savings account. What amount of interest income should they report on their joint income tax return? a. $4,775. Powered by Cognero

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Chapter 03: Gross Income b. $4,675. c. $4,575. d. $4,300. 79. George, an unmarried cash basis taxpayer, received the following amounts this year: Interest on savings accounts Interest on a state tax refund Interest on City of Salem school bonds Interest portion of proceeds of a 5% bank certificate of deposit purchased last year on July 1 and matured on June 30 of this year Dividends on USG common stock

$2,000 600 350 250 300

What amount should George report as gross income from dividends and interest this year? a. $2,300. b. $2,550. c. $3,150. d. $3,500. 80. In December 2024, Todd, a cash basis taxpayer, paid $1,200 of fire insurance premiums for the calendar year 2025 on a building he held for rental income. Todd deducted the $1,200 of insurance premiums on his 2024 tax return. He had $150,000 of taxable income that year. On June 30, 2025, he sold the building and, as a result, received a $500 refund on his fire insurance premiums. As a result of the above: a. Todd should amend his 2024 return and claim $500 less insurance expense. b. Todd should include the $500 in 2025 gross income in accordance with the tax benefit rule. c. Todd should add the $500 to his sales proceeds from the building. d. Todd should include the $500 in 2025 gross income in accordance with the claim of right doctrine. 81. Tonya is a cash basis taxpayer. In 2024, she paid state income taxes of $8,000 and property taxes of $5,500. In early 2025, she filed her 2024 state income tax return and received a $900 refund. a. If Tonya itemized her deductions in 2024 on her Federal income tax return, she should amend her 2024 return and reduce her itemized deductions by $900. b. If Tonya itemized her deductions in 2024 on her Federal income tax return, the refund will not affect her 2025 tax return. c. If Tonya itemized her deductions in 2024 on her Federal income tax return, she must amend her 2024 Federal income tax return and use the standard deduction. d. If Tonya itemized her deductions in 2024 on her Federal income tax return and her itemized deductions exceeded the standard deduction by more than $900, she must recognize $900 income in 2025 under the tax benefit rule. 82. Harold bought land from Jewel for $150,000. Harold paid $50,000 cash and gave Jewel an 8% note for $100,000. The note was to be paid over a five-year period. When the balance on the note was $80,000, Jewel began having financial difficulties. To accelerate her cash inflows, Jewel agreed to accept $60,000 cash from Harold in final payment of the note principal. a. Harold must recognize $20,000 ($80,000 – $60,000) of gross income. b. Harold is not required to recognize gross income but must reduce his cost basis in the land to $130,000. Powered by Cognero

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Chapter 03: Gross Income c. Harold is not required to recognize gross income since he paid the debt before it was due. d. Jewel must recognize gross income of $20,000 ($80,000 – $60,000) from discharge of the debt. 83. Barry, a solvent individual but a recovering alcoholic, embezzled $6,000 from his employer. In the same year that he embezzled the funds, his employer discovered the theft. His employer did not fire him and told him he did not have to repay the $6,000 if he would attend Alcoholics Anonymous. Barry met the conditions and his employer canceled the debt. a. Barry did not realize any income because his employer made a gift to him. b. Barry must include $6,000 in gross income from discharge of indebtedness. c. Barry must include $6,000 in gross income under the tax benefit rule. d. Barry may exclude the $6,000 from gross income because the debt never existed. 84. Gold Company was experiencing financial difficulties but was not bankrupt or insolvent. National Bank, which held a mortgage on other real estate owned by Gold, reduced the principal from $110,000 to $85,000. The bank had made the loan to Gold when it purchased the real estate from Silver, Inc. Pink, Inc., the holder of a mortgage on Gold’s building, agreed to accept $40,000 in full payment of the $55,000 due. Pink had sold the building to Gold for $150,000 that was to be paid in installments over eight years. As a result of the above, Gold must: a. Include $40,000 in gross income. b. Reduce the basis in its assets by $40,000. c. Include $25,000 in gross income and reduce its basis in its assets by $15,000. d. Include $15,000 in gross income and reduce its basis in the building by $25,000. 85. On January 1, 2014, Cardinal Corporation issued 5% 25-year bonds at par and used the $12,000,000 proceeds to finance the construction of a new plant. On January 1, 2024, the company acquired the bonds on the open market for $11,500,000. Assuming that Cardinal is neither bankrupt nor insolvent, the acquisition and retirement of the bonds results in which of the following? a. The company must recognize a $500,000 gain. b. The company can make an election to recognize a $500,000 gain or reduce the company’s basis in the plant by $500,000. c. The company must recognize a $500,000 gain and increase its basis in the plant by $500,000. d. The company can amortize the $500,000 gain, recognizing income over the remaining life of the bonds. 86. Flora Company owed $95,000, a debt incurred to purchase land that serves as security for the debt. a. If Flora had borrowed the funds from a bank, the bank accepts $85,000 in full payment of the debt, and Flora is solvent after the transfer, Flora does not recognize income, but the company must reduce the cost of the land by $10,000. b. If Flora had borrowed the funds from a bank and the bank accepts $85,000 in full payment of the debt, when the value of the property is $80,000, Flora can deduct a loss. c. If Flora transfers to the bank other property with a basis of $90,000 and a fair market value of $95,000 in full payment of the debt, Flora can recognize a $5,000 loss. d. If the $95,000 is owed to the person who sold the property to Flora and that person accepts $85,000 in full payment for the debt, Flora does not recognize gain but must reduce its basis in the land. Subjective Short Answer 87. Ted was shopping for a new automobile. He found one that met his needs and agreed to purchase it for $23,000. He had shopped around and concluded that he could not get a better price from another dealer. After he had paid for the automobile, the dealer called to notify Ted that he was entitled to a manufacturer’s rebate of $1,500. The next week he Powered by Cognero

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Chapter 03: Gross Income received a $1,500 check from the manufacturer. How much should Ted include in gross income? 88. Determine the proper tax year for gross income inclusion in each of the following cases. a.

b.

c.

d.

A cash basis landlord makes new tenants pay first and last month's rent at the start of the lease. When does the landlord report these items? Purple Corporation, an exterminating company, is a calendar year taxpayer. It contracts to provide service to homeowners once a month under a one-, two-, or three-year contract. For financial reporting purposes, Purple reports the income ratably over the months of the contract. On April 1 of the current year, the company sold a customer a one-year contract for $120. How much of the $120 is taxable in the current and subsequent years if the company is an accrual basis taxpayer? If the $120 is payment on a two-year contract, how much is taxed in the year the contract is sold and in the following years? If the $120 is payment on a threeyear contract, how much is taxed in the year the contract is sold and in the following years? Pink, Inc., an accrual basis taxpayer, owns an amusement park whose fiscal year ends September 30. To increase business during the fall and winter months, Pink sold passes that would allow the holder to ride “free” during the months of October through March. During the month of September, $6,000 was collected from the sale of passes for the upcoming fall and winter. When will the $6,000 be taxable to Pink? A taxpayer is in the office equipment rental business and uses the accrual basis of accounting. In December he collected $5,000 in rents for the following January. When is the $5,000 taxable?

89. José, a cash method taxpayer, is a partner in J&T Accounting Services, a calendar year partnership. Under the partnership agreement, José is to receive 20% of the partnership’s profits or losses. Each partner is allowed to withdraw $10,000 each month for their living expenses. José withdrew $120,000 during the current year as his monthly draw. However, in December, the partnership was short on cash and José was required to invest an additional $10,000 in the partnership. In March, José received $40,000 as his share of the previous year's profits. The partnership's current year earnings before partners’ withdrawals totaled $1,000,000. Compute José’s gross income from the partnership for the current year. 90. On January 1, 2024, Faye gave Walt, her son, a 36-month certificate of deposit she had purchased on December 31, 2022, for $8,638. The certificate had a maturity value of $10,000 and the yield to maturity was 5%. On December 1, 2024, Faye gave Walt 200 shares of stock in ABC, Inc. On November 30, 2024, ABC, Inc., had declared a dividend of $1.00 payable to stockholders of record on December 5th. How much interest and dividends should Walt include in his gross income for 2024? 91. Margaret made a $90,000 interest-free loan to her son, Adam, who used the money to retire a mortgage on his personal residence and to buy a certificate of deposit. Adam’s only income for the year is his salary of $35,000 and $1,400 interest income on the certificate of deposit. Assume the relevant Federal interest rate is 4% compounded semiannually. The loan is outstanding for the entire year. a.

Based on this information, what is the effect of the loan on Margaret’s gross income for the year?

b.

The facts are the same as above except that you discovered that Margaret had made an additional loan of $15,000 to Adam in the previous year. Adam used the funds to pay his

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Chapter 03: Gross Income child’s private school tuition. What are the effects of the loans on Margaret’s gross income? 92. Arnold was employed during the first six months of 2024 and earned a $90,000 salary. During the next six months, he collected $7,200 of unemployment compensation. He borrowed $6,000 (using his personal residence as collateral) and withdrew $1,000 from his savings account (on which he had earned $60 interest). Arnold’s parents loaned him $10,000 (interest-free) on July 1 of the current year, when the Federal rate was 3%. Arnold did not repay the loan during the year and used the money for living expenses. Calculate Arnold’s adjusted gross income for the year. 93. Javier is considering purchasing land for $10,000. He expects the land to appreciate in value 8% each year (compounded), and he will sell it at the end of 10 years. Alternatively, he is considering purchasing a bond for $10,000. The bond does not pay any annual interest but will pay $21,589 at maturity in 10 years. The before-tax rate of return on the bond is 8%. Javier is in the 40% (combined Federal and state) marginal tax bracket. He has other investments that earn an 8% before-tax rate of return. Given that the compound interest factor at 8% is 2.1589 and at 4.8% is 1.5981, how much after-tax income will Javier have after ten years if he invests in the land? In the bond? 94. On January 2, 2024, Tammy purchased a corporate bond due in 24 months. The cost of the bond is $857 and its maturity value is $1,000. No interest is paid each year, but the compound interest rate on the bond is 8%. Tammy also purchased a Series EE United States Government bond for $558 with a maturity value in 10 years of $1,000. This is the only Series EE bond she has ever owned. The Series EE bond is sold to yield 6% interest. Tammy is 13 years old and has no other source of income. She is claimed as a dependent by her parents. Compute Tammy’s gross income from the bond and Series EE bond for 2024. 95. During the year, Irv had the following transactions: Long-term loss on the sale of business use equipment Long-term loss on the sale of personal use camper Long-term gain on the sale of personal use boat Short-term loss on the sale of stock investment Long-term loss on the sale of land investment How are these transactions handled for income tax purposes?

$7,000 6,000 3,000 4,000 5,000

96. During 2024, Addison, a single taxpayer, has the following gains and losses: LTCG LTCL STCG STCL a. b.

$10,000 3,000 2,000 7,000

How much is Addison’s tax liability if she has taxable income of $34,000 and is in the 12% tax bracket? How much is Addison's tax liability if her taxable income is $195,000 and her tax bracket is 32% (not 12%)?

97. During 2024, Jackson, a single taxpayer, had the following capital gains and losses: Gain from the sale of coin collection (held three years) Gain from the sale of land held as an investment for six years Gain from the sale of stock held as an investment (held for 10 months) Powered by Cognero

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Chapter 03: Gross Income a. b.

How much is Jackson’s tax liability if his taxable income is $32,000 and he is in the 12% tax bracket? How much is his tax liability if his taxable income is $200,000 and his tax bracket is 32% (not 12%)?

98. During 2024, Madison had salary income of $80,000 and the following capital transactions: LTCG LTCL STCG STCL

$13,000 15,000 13,000 6,000

How are these transactions handled for income tax purposes? 99. Juan was considering purchasing an interest in a tax-exempt bond fund for $100,000 when he discovered that the interest must be included on his state income tax return. The interest rate is 5%. His marginal Federal tax rate is 35%, and his marginal state income tax rate is 10%. Juan itemizes his deductions on his Federal income tax return. As an alternative, Juan can purchase a state bond (a double-exempt bond) yielding 4.9% interest that is exempt from both Federal and state income tax. Which investment would yield the greater after-tax return? 100. Gull Corporation was undergoing reorganization under the bankruptcy laws. Its shareholders, who had made loans of $300,000 to the corporation, agreed to accept additional stock with a value of $200,000 instead of repayment on the debt. The Old Line Insurance Company, which had a $400,000 mortgage on the building, agreed to reduce the principal to $250,000. A trade creditor with a receivable of $150,000 from the company agreed to accept $70,000 in full payment for the debt incurred to purchase goods that were still on hand. Finally, the company transferred some equipment with an adjusted basis of $90,000 in satisfaction of a liability for $120,000. Compute the corporation’s gross income and other adjustments necessary as a result of the above transactions. Essay 101. In some foreign countries, the tax law specifically designates the types of income items that are includible in gross income. How does this approach compare with the U.S. Internal Revenue Code (§ 61)? What is a major advantage to the approach used in the U.S. tax law? 102. Katherine is 60 years old and is bargaining with her employer over deferred compensation. In exchange for reducing her current year’s salary by $50,000, she can receive a lump-sum amount in five years when she will retire. If she receives the $50,000 in the current year, she will invest in certificates of deposit that yield 5%. Katherine is in the 24% marginal tax bracket in all relevant years. What is the minimum amount Katherine should accept as a deferred pay option? [Hint: the compound interest factor is 1.1934.] 103. Rachel owns rental properties. When she rents to a new tenant, she usually requires the tenant to pay an amount in addition to the first month’s rent. The additional amount serves as security for damages to the property and the tenant’s failure to pay future rents. How should the payments be characterized (e.g., on lease documents) to minimize Rachel’s current tax liability? 104. In the case of a zero interest below-market loan by a corporation to a shareholder-employee, what difference does it make to the corporation and the shareholder whether the loan is characterized as a corporation’s loan to its shareholder or a corporation’s loan to its employee? 105. Your client is considering transferring $25,000 from his savings account in a local bank paying 2% interest Powered by Cognero

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