3
Taxable Entities; Tax Formula; Introduction to Property Transactions
Solutions to Tax Research Problems
3-56 The purpose for this problem is to allow one to gain an appreciation for the
organization of the Internal Revenue Code and the differing authorities for taxing
income, deducting items, and classifying them. The specific questions are
answered as follows:
a. Congress defined the word “income” in § 61(a) by using the word “income.”
The section states that “income” includes income from all sources. This
definition is enhanced by listing numerous examples, such as salaries and
wages, commissions, interest, dividends, and alimony.
b. Under § 63, the deductions allowed by 151-152 are properly deducted from
A.G.I, in arriving at taxable income. The only other deductions from A.G.I,
are the larger of the itemized deductions or the appropriate standard
deduction.
c. Ordinary and necessary expenses incurred in the operation of a trade or
business are deductible under the authority of § 162. Section 62 defines A.G.I,
by specifying which deductions are allowable in calculating A.G.I. It specifies
that the trade or business expenses of a self-employed person shall be allowed
as deductions for adjusted gross income. Only reimbursed expenses of an
employee are deductible for A.G.I. Other employee business expenses are
miscellaneous itemized deductions.
d. Alimony is deductible within limits, as will be demonstrated in Chapter 7. The
deductible amount is allowable for A.G.I, under § 62, as explained for trade or
business expenses above. It is important to realize that the authority for the
deduction and the authority for the classification thereof are separate.
Note: The sections that classify income and deduction items, formula”
developed in this chapter.
3
Taxable Entities; Tax Formula; Introduction to Property Transactions
Test Bank
True or False
________ 1. A single taxpayer will pay the same amount of tax (or less) as a head of
household when their taxable incomes are equal.
________ 2. The income of a child under age 19 is taxed to the parent.
________ 3. Citizens and residents of the United States generally are taxed on income
earned in a foreign country.
________ 4. The sole proprietorship business of an individual taxpayer is treated as a
separate entity for tax purposes.
________ 5. F operates his computer repair business as a sole proprietorship. His sole
proprietorship’s taxable income is subject to tax using the corporate tax
rates since it is a business.
________ 6. B and D are beneficiaries of a trust that distributed $6,000 out of its
taxable earnings to each of them in 20X0. The trust had $11,000 of
taxable net income in 20X0. The trust is not required to pay income tax
for 20X0.
________ 7. The partnership entity does not pay a Federal income tax on its taxable
income.
________ 8. A partnership is taxed at the same rates as estates and trusts for Federal
income tax purposes.
________ 9. An S corporation generally pays no tax on the taxable income it
generates.
________ 10. A corporation does not distinguish between deductions for adjusted
gross income and itemized deductions.
________ 11. A corporation is generally entitled to an income tax deduction for cash
dividends paid to shareholders because the shareholders are required to
include the dividend in gross income.
________ 12. For 2012, the highest income tax rate for corporations with the highest
incomes is the same as the highest marginal individual income tax rate.
________ 13. Gross income is total income before subtracting exclusions.
________ 14. Deductions for adjusted gross income (A.G.I.) can only be deducted if
they exceed the standard deduction.
________ 15. An increase in adjusted gross income can cause a decrease in certain
otherwise allowable itemized deductions.
________ 16. All employee business deductions of an individual are deductions for
adjusted gross income.
________ 17. The standard deduction is an amount that one deducts in addition to
one’s itemized deductions.
________ 18. V is single for tax purposes, has itemized deductions totaling $5,600 and
is entitled to one $3,800 exemption deduction for 2012. V should itemize
her deductions in 2012.
________ 19. John, a widower of four years who is supporting his two young (under
age 19) daughters, will have a larger standard deduction in 2012 than
will Kate, who is single and sharing an apartment with two friends.
________ 20. A taxpayer who itemizes receives no special tax break for being 65 years
of age or older.
________ 21. The exemption amount is the same for both personal and dependency
exemptions.
________ 22. Brent, a 19-year-old student at Private University, is financially
supported by his parents and does not have a regular job. Brent most
likely cannot claim any personal exemption on his return for the current
year.
________ 23. W, a U.S. citizen, earned $6,000 from foreign sources on which she paid
tax of $1,200 to the foreign government. W’s U.S. tax was $4,000,
$1,500 of which was on the foreign income. W must pay $2,800, after
the foreign tax credit, to the United States.
________ 24. H and W are married with twins, eight years of age. H and W can elect
to claim either exemption deductions for each of their dependents or a
child tax credit for each child but not both exemptions and credits.
________ 25. Assuming the selling price remains constant, the gain realized on the
sale of a property decreases if the adjusted basis of the property sold
increases.
________ 26. The amount realized on the sale of property is reduced by any related
selling costs.
________ 27. T sold the family car at a $400 loss. T can claim the $400 loss as an
itemized deduction.
________ 28. A taxpayer’s motor home, which is used for personal enjoyment, is a
capital asset.
________ 29. Capital losses of individuals in excess of the $3,000 annual limit may be
carried forward indefinitely to future tax years, but may not be carried
back to prior years.
________ 30. Short-term capital gains in excess of capital losses are treated just like
other income.
________ 31. Long-term capital gains may be taxed at 15 percent for a taxpayer whose
gains would otherwise be taxed at 31 percent.
Multiple Choice
________ 32. Which of the following is not a tax-paying entity under the Federal
income tax?
a. The regular corporation
b. The estate of a deceased individual
c. The partnership entity
d. A trust for the benefit of a minor child
________ 33. Foreign income earned by U.S. citizens is
a. Nontaxable
b. Taxable, but the U.S. tax may be reduced by taking a credit for
foreign taxes paid
c. Is not affected by any applicable treaty
d. Both b. and c.
________ 34. Which one of the following is not true of the tax treatment of
fiduciaries?
a. Income is taxed to the beneficiary of the trust or estate to the extent
of current distributions of income.
b. The trust or estate is entitled to a deduction for current distributions
of income.
c. Distributions to beneficiaries are treated like corporate dividends.
d. Distributions from corpus generally are not taxable to beneficiaries.
________ 35. A trust established for the benefit of A, age 23, and B, age 13, generated
$8,000 of dividend income. The trustee distributed $2,000 to A and
$1,500 to B. The taxable income of the trust (before the exemption
deduction) is
a. $8,000
b. $6,000
c. $4,500
d. $0
________ 36. Sandy and Dave formed a law partnership, agreeing to split the income
50:50. The partnership had net income of $100,000. Dave withdrew
$55,000 throughout the year, and Sandy withdrew $50,000. Dave and
Sandy had no other income. Because of the partnership activities, Dave’s
A.G.I, increased by
a. $100,000
b. $55,000
c. $50,000
d. $35,000
________ 37. Sandy and Dave formed a law partnership, agreeing to split the income
50:50. The partnership had net income of $100,000. Dave withdrew
$35,000 throughout the year, and Sandy withdrew $30,000. Dave and
Sandy had no other income. Because of the partnership activities,
Sandy’s A.G.I, increased by
a. $100,000
b. $80,000
c. $50,000
d. $30,000
________ 38. Sandy and Dave formed a law partnership, agreeing to split the income
50:50. The partnership had net income of $100,000. Dave withdrew
$35,000 throughout the year, and Sandy withdrew $30,000. Dave and
Sandy had no other income. The partnership must pay taxes on income
of
a. $0
b. $35,000
c. $65,000
d. $100,000
________ 39. An S corporation’s tax treatment is most similar to the
a. Sole proprietorship
b. Partnership
c. Individual
d. Corporation
________ 40. F’s share of income from various sources is as follows for the current
year:
Source F’s Share of Entity’s Net Income F’s Share of
Distributions
ABC Partnership after deducting partner’s salary $ 6,000 $ 9,000
F’s salary from ABC Partnership n/a 30,000
XYZ Corporation, a C corporation 80,000 10,000
Interest from bank savings account 40,000 n/a
F’s A.G.I, (ignoring the deduction for one-half of any self-employment
tax) is how much?
a. $89,000
b. $156,000
c. $86,000
d. $56,000
________ 41. G is an 11-year-old heiress whose share of income from various sources
is as follows for the current year:
Source Gs Share of Entity’s Net Income G’s Share of
Distributions
LM Trust $ 45,000 $30,000
ABC Partnership 80,000 22,000
XYZ Corporation, a C corporation 480,000 76,000
Interest from bank savings account 50,000
G’s A.G.I, (ignoring the deduction for one-half of any self-employment
tax, if any) is how much?
a. $178,000
b. $605,000
c. $251,000
d. $236,000
________ 42. G had income and expenses as follows for the current taxable year:
Total income $32,400
Exclusions (municipal bond interest) 2,000
Deductions for A.G.I. 1,200
Total itemized deductions 9,920
Standard deduction 5,150
Exemption deductions 6,600
What are G’s adjusted gross income and her taxable income,
respectively? Assume all amounts are correct.
a. $29,200; $12,680
b. $31,200; $14,680
c. $29,200; $17,050
d. $28,000; $12,680
________ 43. The following represent elements of the tax formula for individual
taxpayers:
A. Income from any source
B. Personal and dependency exemptions
C. Itemized deductions
D. Deductions for A.G.I.
E. Exclusions from gross income
F. Standard deduction amount
Which of the items listed are considered in arriving at A.G.I.?
a. A, D, and E
b. A, D, E, and F
c. A, B, and D
d. A, E, and F
________ 44. The following represent elements of the tax formula for individual
taxpayers:
A. Income from any source
B. Personal and dependency exemptions
C. Itemized deductions
D. Deductions for A.G.I.
E. Exclusions from gross income
F. Standard deduction amount
Which of the above are subtracted from A.G.I, in the computation of
taxable income?
a. B, D, and F
b. B, C, and F
c. B and C or B and F
d. C and F or B and C
________ 45. The following represent elements of the tax formula for individual
taxpayers:
A. Income from any source
B. Personal and dependency exemptions
C. Itemized deductions
D. Deductions for A.G.I.
E. Exclusions from gross income
F. Standard deduction amount
Which of the above are not included in the formula for corporate
taxpayers?
a. B, D, and E
b. B, C, and F
c. B, C, and E
d. B, D, and F
________ 46. Which of the following income is generally excluded from gross
income?
a. Alimony
b. Unemployment compensation
c. Hobby income
d. Social Security benefits
e. All of the above
________ 47. Why are deductions of individual taxpayers broken down into these two
groups: (1) deductions for A. G.I. and (2) deductions from A.G.I.?
a. To separate business and nonbusiness deductions
b. To distinguish self-employment expenses from employee expenses
c. To provide for simplification and reduce the number of taxpayers
who itemize their deductions
d. To distinguish corporate taxpayers from non-corporate taxpayers
________ 48. M, age 65 and single, has no dependents and an A.G.I, of $50,000 and
these expenses: medical expenses of $2,200, personal casualty losses of
$5,000, real estate taxes of $2,000, and residence mortgage interest of
$1,000. In 2012 the taxpayer should deduct which of the following total
amounts from A.G.I.?
a. $10,200
b. $14,000
c. $11,200
d. Some other amount
________ 49. Which of the following is not true of the standard deduction?
a. It is the amount that itemized deductions must exceed before a
taxpayer itemizes.
b. It is increased for elderly taxpayers.
c. The amount varies depending on the taxpayer’s filing status.
d. It is a deduction that is allowed for the taxpayer and any qualifying
dependents.
________ 50. Which one of the following is not true of itemized deductions of an
individual taxpayer?
a. Any deductions other than personal and dependency exemptions and
those for adjusted gross income are itemized deductions.
b. Itemized deductions are deductible only if they exceed a taxpayer’s
standard deduction.
c. Residential interest is a common example of an itemized deduction.
d. All employee trade or business expenses are itemized deductions.
________ 51. Which of the following is not true of A.G.I.?
a. A.G.I, is not computed for corporations.
b. The deduction for personal and dependency exemptions affects the
taxpayer’s A.G.I.
c. A.G.I, is sometimes referred to as “the line.’
d. The amount of certain deductions varies with A.G.I.
________ 52. Which of the following is true of the standard deduction amounts?
a. The amount is standard for all individual tax returns; that is, the
amount deducted on all individual tax returns is the same.
b. The standard deduction does not affect adjusted gross income.
c. The standard deduction for all taxpayers who file a joint return
provides the same tax benefit.
d. All of the above are true.
________ 53. Each of the following individual taxpayers is planning on making a
deductible $500 payment (e.g., a fully deductible charitable contribution)
either in December 20X1 or in January 20X2. Assume the standard
deduction for both years for joint filers is $10,000 and for single filers is
$4,000. Ignore the time value of money.
Abe Ben Cathy Diane Earl
Type of return Joint Joint Joint Single Single
Marginal tax rate 30% 20% 20% 20% 20%
Other itemized deductions for 20X1 $11,000 $9,000 $8,000
$4,000 $6,000
Expected other itemized deductions for 20X2$11,500 $11,000
$8,500 $4,500 $7,500
Assuming that between years there are no changes in tax rates and other
items (e.g., standard deduction, personal exemption, etc.) and ignoring
the time value of money, who would gain the greatest tax savings by
making the payment in 20X2 instead of 20X1?
a. Abe
b. Ben
c. Cathy
d. Diane
c. Earl
________ 54. After his great performance for the U.S. soccer team in the World Cup,
Alex, a U.S. citizen, signed a contract to play with the Italian team,
Parma, earning over $500,000 per year. While there, he met the great
English star, David. Which of the following statements is correct?
a. Assuming that Alex lives in Italy during all of the next year, his
Italian income (salary and interest from his Italian bank account)
would probably be subject to Italian taxes but he would not be
required to report any of his Italian income for U.S. income tax
purposes since he lived in Italy.
b. Assuming that Alex lives in Italy only for a few months during all of
next year, his income earned in Italy would effectively be taxed
twice, i.e., he would pay taxes to the Italian government and taxes to
the U.S. government, unless a treaty provided otherwise.
c. Assume David, the English star, comes to the U.S. in the next to play
in the U.S. professional soccer league. David would not be required
to file a regular income tax return on income earned in the U.S. if he
is considered a resident alien.
d. None of the above is correct.
________ 55. J and Z, husband and wife, created a trust for J’s aging mother, Betty.
This year the trust received dividend income of $15,000 and distributed
$10,000 to Betty. The taxable income of the trust and Betty is?
a. Trust $15,000, Betty $10,000
b. Trust $0, Betty $15,000
c. Trust $5,000, Betty $10,000
d. Trust $15,000, Betty $0
e. None of the above
________ 56. Barnum and Bailey incorporated their circus this year and elected to be
treated as an S corporation. Barnum owns 60% of the corporation’s stock
while Bailey owns the remaining 40%. This year, the corporation had net
income of $300,000 before the owners took any money out of the
business (e.g., before salaries, dividend distributions, etc.). Assuming the
corporation paid Barnum a deductible salary of $100,000 for managing
the business and made dividend distributions of $12,000 to Barnum and
$8,000 to Bailey, what is the amount of taxable income to be reported by
Barnum?
a. $220,000
b. $192,000
c. $180,000
d. $108,000
e. None of the above
________ 57. Ralph and Lauren incorporated their bagel business this year. For tax
purposes, the corporation operates as a regular C corporation. For the
year, the corporation was profitable, making $300,000 before the owners
took any money out of the business. Assuming the corporation paid
Ralph a salary of $40,000 and Lauren a salary of $60,000 and also paid
each a dividend of $20,000 to each ($40,000 in total), what is the
corporation’s taxable income? (Ignore payroll taxes)
a. $200,000
b. $300,000
c. $160,000
d. $340,000
e. Some other amount
________ 58. Last year, Ben and Jeri (unrelated) formed a partnership to operate a
restaurant. Ben contributed all of the money, $2,000,000, to the venture
for a 50% interest while Jeri agreed to work for the partnership for five
years without pay for her 50% interest. According to the agreement, Jeri
would receive 50% of the profits (or losses) of the business. During the
year, Jeri worked tirelessly, often 80 hours per week. On the other hand,
Ben did little, sitting back and watching the fruits of Jeri’s efforts. For
the year, the partnership reported a $900,000 loss (revenues $600,000,
deductible expenses $1,500,000). Ben and Jeri are both married and their
spouses have salaries from their jobs. Neither Ben nor Jeri have any
other investments. Which of the following statements is true?
a. None of the loss can be used by either Ben or Jeri; rather the loss is
carried forward to offset future profits of the partnership.
b. Both Ben and Jeri can use their share of the loss as a deduction to
offset their other income they might have on their own individual tax
return (Form 1040) such as the salary income of their spouses.
c. Ben can use his share of the loss as a deduction to offset his other
income he might have on his individual tax return (Form 1040) such
as the salary income of his spouse because he took the risk of
investing in the venture while Jeri did not take a similar risk.
d. Jeri can use her share of the loss as a deduction to offset her other
income she might have on her individual tax return (Form 1040)
such as the salary income of her spouse because she was regularly
and continuously involved on a substantial basis.
e. None of the above is correct.
________ 59. Jim Smith and Bob Jones recently decided to start their own car wash
business. Jim’s spouse and Bob’s spouse both work for the same law firm
each receives a salary exceeding $200,000 annually. Jim and Bob
anticipate that the business will not be profitable for a few years but
rather operate at a loss. Both Jim and Bob will both be working in the
business. Based on these facts, the best form of business organization for
the car wash would be:
a. A limited liability company
b. AC corporation
c. A partnership
d. A sole proprietorship
________ 60. Which of the following is not a correct observation related to the
comparison between a deduction and a credit?
a. A deduction of $100 is less valuable than a credit of $100.
b. A deduction of $100 is more valuable to a 40 percent bracket
taxpayer than is a $30 credit.
c. A deduction of $100 is more valuable to a 40 percent bracket
taxpayer than it is to a 30 percent bracket taxpayer.
d. A credit of $100 is more valuable to a 40 percent bracket taxpayer
than it is to a 30 percent bracket taxpayer.
________ 61. Which one of the following taxes does not have to be reported and paid
with the Federal income tax?
a. Alternative minimum tax
b. Federal excise tax
c. Self-employment tax
d. More than one of the above
________ 62. Which one of the following individuals likely would not have to make
quarterly estimated payments?
a. A child with $10,000 trust income
b. An individual whose only income is salaries and wages
c. A self-employed individual with net income of $15,000
d. An individual with a large stock and bond portfolio
________ 63. W sold a parcel of land that he had owned for three years for $4,000
cash, and the buyer assumed a note secured by the property in the
amount of $6,000. W originally paid $7,500 for the land. What is his
gain (or loss) realized on the sale?
a. $10,000
b. $6,000
c. $2,500
d. $(3,500)
________ 64. Susan sold her car at a $5,000 loss and her stereo for a $500 loss. Susan
is a factory worker. Susan will be able to deduct how much?
a. $5,500 loss
b. $5,000 loss
c. $3,000 loss
d. $0
________ 65. A sold 100 shares of F corporation stock for $32,500. A had to pay a
sales commission of $940. F had originally paid $14,750 for the shares
and a purchase commission of $420. How much are A’s amount realized
and gain realized, respectively?
a. $32,500; $16,390
b. $31,140; $16,390
c. $31,560; $16,390
d. $31,140; $17,750
________ 66. Which of the following is a capital asset?
a. A camera used in a trade or business
b. A computer held for sale to customers
c. A taxpayer’s principal residence
d. An account receivable from a client of an attorney
________ 67. Which one of the following losses is not at least partially deductible?
a. Earthquake damage to a vacation home
b. Loss on sale of 100 shares of A Corporation stock held for
investment
c. Theft of silver coin collection
d. Loss on sale of personal residence
________ 68. J sold the following capital assets during the current year:
100 shares of X Corp. held 14 months $(500) loss
50 shares of T Corp. held four months (240) loss
City lot held seven years for speculation 900 gain
How much is J’s overall net capital gain, if any?
a. $740
b. $660
c. $400
d. $160
________ 69. Which of the following is not true of capital gains and losses?
a. Capital gains and losses are always netted before the treatment of the
excess is determined.
b. Net short-term capital gains in excess of net long-term capital losses
are subject to tax at ordinary rates.
c. Net capital losses in excess of net capital gains are fully deductible
within an annual limitation.
d. A capital gain deduction is allowed for a portion of net long-term
capital gains in excess of net short-term capital losses.
________ 70. In 20X2, T, an individual taxpayer, had a net short-term capital loss of
$3,000 and a net long-term capital loss of $3,000. The capital loss
carryover is
a. $3,000 net short-term capital loss
b. $3,000 net long-term capital loss
c. $1,500 net short-term and $1,500 net long-term capital loss
d. $0; losses cannot be carried over
________ 71. In 20X3, B sold 200 shares of K Inc., which she had owned for three
years, for $1,230 (net of $75 commission). B’s basis in the shares, which
were held for investment, was $7,300. How much of the loss may B
deduct against her other 20X3 income if she had no other sales or
exchanges?
a. $6,070
b. $1,000
c. $3,000
d. $3,035
3
Taxable Entities; Tax Formula; Introduction to Property Transactions
Solutions to Test Bank
True or False
3
Taxable Entities; Tax Formula; Introduction to Property Transactions
Comprehensive Problems
