Solutions to Chapter 1 Problem Assignments
Check Your Understanding
1. [LO 1.1] Consumption Taxes
Solution: Consumption taxes are “spending” taxes. They are taxes that are not levied until a
person decides to expend funds (whether from income or from savings) for goods
or services. The most common consumption tax is the sales tax. Other consumption
taxes include excise taxes, value added taxes, and use taxes.
2. [LO 1.4] Horizontal vs. Vertical Equity
Solution: Horizontal equity is the concept that argues that persons in the same economic
situation should pay equivalent amounts of taxes. The concept of vertical equity
states that persons with greater economic wealth should pay a greater amount of
taxes and is the foundation for a progressive rate system; conversely, a person with
less wealth would pay less tax.
3. [LO 1.4] Constitutional Authority
Solution: The 16th amendment to the United States Constitution was passed in 1913.
4. [LO 1.4] Type of Tax
Solution: A tax that is designed to discourage the use of a good or service considered
undesirable is called a sin tax.
5. [LO 1.5] Objectives of Taxation
Solution: There are numerous objectives of taxation; some of the more common goals besides
raising revenue to support the functions of government are to promote wealth
redistribution, price stability, economic growth, full employment, and desirable
social goals.
6. [LO 1.5] Taxable Persons
Solution: Only individuals, regular (or C) corporations, and fiduciaries (estates and trusts) pay
income taxes.
7. [LO 1.5.] Gross Revenue vs. Gross Income
Solution: A business’s gross revenue includes all of its receipts from the sale of goods or
services; a business’s gross income is its gross receipts from sales less the cost of
goods sold.
8 [LO 1.5] Tax Models
Solution: The individual tax model includes an intermediate income concept called adjusted
gross income. As a result, an individual can have deductions both for and from
adjusted gross income. Deductions from adjusted gross income include personal and
dependency exemptions and either a standard deduction or itemized deductions.
None of these items appear in the corporate tax model. The corporate and individual
tax models both include gross income; they are both permitted deductions from
gross income to determine taxable income; they both may have additions to tax and

2 Solutions Manual for Taxation for Decision Makers
tax credits applied before the final tax liability is determined. Both taxpayers are
generally required to make tax prepayments.
9. [LO 1.5] Adjusted Gross Income
Solution: Adjusted gross income is used to provide either a threshold or limitation for most of
an individual’s itemized deductions. It is also used to determine at what point an
individual’s exemptions and itemized deductions will begin to be phased out.
10. [LO 1.5] Filing Status
Solution: The four filing statuses are single, married filing jointly, married filing separately,
and head of household. (The surviving spouse category included within the married
filing jointly category is discussed in Chapter 11.) The standard deduction for a
dependent is subject to limitation although there is no separate filing status for the
dependent.
11. [LO 1.5] Exemptions
Solution: The personal exemption is the deduction a self-supporting person takes for him or
herself on his or her own tax return. The dependency exemption is the deduction an
individual takes for another person, a dependent, whose support is provided by that
individual.
12. [LO 1.5] Property Dispositions
Solution: To determine the gain or loss on business or investment property, the taxpayer
subtracts the adjusted basis of the property sold from the amount received on the
sale. If the result is positive, there is a gain. If the adjusted basis exceeds the
amount received, there is a loss.
13. [LO 1.5] Deductions vs. Credits
Solution: A tax credit is a dollar for dollar reduction in a tax liability. A tax deduction only
reduces a person’s tax in an amount equal to the deduction times the marginal tax
rate. Compare a $1,000 deduction with a $1,000 credit for a person with a $20,000
tax liability whose marginal tax rate is 28 percent. The $1,000 credit reduces the
person’s tax to $19,000. The $1,000 deduction, however, will only reduce the
person’s tax by $280 ($1,000 x 28%) to $19,720. The value of a tax deduction is
dependent upon the person’s marginal tax rate; the value of a tax credit is
independent of the marginal tax rate and benefits all taxpayers equally.
14. [LO 1.6] Sole Proprietorship
Solution: Only one taxable person, who must be an individual, can own a sole
proprietorship. The sole proprietor is personally liable for all debts of the business.
The sole proprietor cannot be an employee of the business. The results of
operations of the sole proprietorship are reported on the Schedule C and these are
then included in the owner’s personal tax return. A partnership must have more
than one owner. A general partner is liable for partnership debts but limited
partners are only liable for their investment in the partnership. Like sole
proprietors, partners cannot be employees of the partnership. Although partnerships

Chapter 1: An Introduction to Taxation 3
do not pay taxes directly, they must file information tax returns. The income/loss
from the partnership flows through to the partners and is reported on their own tax
returns. If the partners are individuals, these results are reported on Schedule E
(included in the personal tax return) and they pay any taxes owing on the income
items.
Partnerships and limited liability companies differ in a number of ways. Owners of
partnerships are partners while owners of limited liability companies are called
members. There are no legal requirements to set up a partnership but a limited
liability company must be established according to the laws of the state of
domicile. Limited liability companies can elect to be taxed as corporations while
partnerships do not have that option. In some states, a limited liability company
may have only one owner but a partnership must have two or more owners. General
partners are normally required to pay self-employment taxes while only the
managing member of a limited liability company may be subject to self-
employment taxes. Other items of comparison could be drawn from the table in the
text comparing business entity attributes.
15. [LO 1.6] Corporations
Solution: The principal difference between a C corporation and an S corporation is in the
method of taxation. A corporation pays a tax directly on its income. Any net after-
tax income that is distributed to its shareholders as dividends is subject to a second
level of tax. Thus, these corporate earnings are said to be subject to double taxation.
An S corporation’s income flows directly through to its shareholders (whether there
is an actual distribution of this income in cash or not) undiminished by taxes at the
corporate level. The income is then taxed once only at the shareholder level. The
corporation can then make actual distributions of this previously-taxed income to
the S corporation shareholders without any additional taxes due. There are a
number of other differences in that the number and type of S corporation
shareholders is limited; it can only have one class of stock outstanding, and its
choice of tax year is restricted. None of these restrictions apply to a C corporation.
Other items of comparison could be drawn from the table in the text comparing
business entity attributes.
Crunch the Numbers
16. [LO1.1] Property Taxes
Solution: He will pay $750. $20,000,000 / $4,000,000,000 = .005 or 5 mills per $1 of
valuation. $150,000 x .005 = $750 in tax
17. [LO 1.2] FICA Taxes
Solution: 2015: $40,000 x 7.65% = $3,060
No change for 2014: $40,000 x 7.65% = $3,060
18. [LO 1.2] FICA Taxes
Solution: 9,377.00 is withheld for FICA taxes in 2015.
$118,500 x 6.2% = $7,347.00
$140,000 x 1.45% = 2,030.00

4 Solutions Manual for Taxation for Decision Makers
Total $9,377.00
$9,284 is withheld for FICA taxes in 2014.
$117,000 x 6.2% = $7,254.00
$140,000 x 1.45% = 2,030.00
Total $9,284.00
In 2014, the taxpayer would have paid $93 less in Social Security taxes than in 2015
due to the $1,500 lower wage base on which the tax was levied.
19. [LO 1.5] Taxable Income
Solution: Taxable income = $29,700
$40,000 Salary
minus 6,300 Standard deduction
minus 4,000 Personal exemption
equals $29,700 Taxable income
20. [LO 1.5] Taxable Income
Solution: Taxable income = $47,250
$71,000 Salary
Plus 1,500 Interest income
minus 9,250 Standard deduction
minus 16,000 Personal and dependency exemptions ($4,000 x 4)
equals $47,250 Taxable income
21. [LO 1.5] Taxable Income
Solution: Taxable income = $49,000
$450,000 Gross receipts
minus 145,000 Cost of goods sold
equals $305,000 Gross income
plus 20,000 Gain on sale
minus 276,000 Expenses
equals $49,000 Taxable income
The $500 interest on State of New York bonds is tax-exempt.
22. [LO 1.5] Taxable Income
Solution: Taxable income = $237,500
$560,000 Gross income
plus 2,500 Interest income
minus 325,000 Expenses
equals $237,500 Taxable income
The $20,000 capital loss is not deductible currently.

Chapter 1: An Introduction to Taxation 5
23. [LO 1.5] Taxable Income
Solution: Taxable income = $74,000
George's salary $65,000
plus Mary's salary 45,000
equals AGI $110,000
minus Itemized deductions 20,000
minus Standard deduction 0
minus Personal & dependency exemptions ($4,000 x 4) 16,000
equals Taxable income $74,000
24. [LO 1.5] Determining Tax Liability
Solution: Taxable income = $29,700; income tax = $3,993.75
Income Tax: ($9,225 x 10%) + ($20,475 x 15%) = $3,993.75.
25. [LO 1.5] Determining Tax Liability
Solution: Taxable income = $47,250; income tax = 6,430.
Income Tax: ($13,150 x 10%) + ($34,100 x 15%) = $6,430
26. [LO 1.5] Determining Tax Liability
Solution: Taxable income = $49,000; income tax = $7,350.
Income Tax: $49,000 x 15% = $7,350.
27. [LO 1.5] Determining Tax Liability
Solution: Taxable income = $237,500; Income tax = $75,875
$50,000 x 15% = $7,500
$25,000 x 25% = 6,250
$25,000 x 34% = 8,500
$137,500 x 39% = 53,625
Total tax $75,875
28. [LO 1.5] Determining Tax Liability
Solution: They save $1,760 ($11,937.50 - $10,177.50) by itemizing their deductions.
Taxable income with itemizing = $74,000; Taxable income taking standard deduction =
$81,400 ($110,000 in salaries - $12,600 standard deduction - $16,000 exemptions).
Income Tax Calculation:
Itemizing Standard Deduction
$18,450 x 10% = $1,845.00 $18,450 x 10% = $1,845.00
$55,550 x 15% = $8,332.50 $56,450 x 15% = $8,467.50
------------- $ 6,500 x 25% = $1,625.00
$10,177.50 $11,937.50

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6 Solutions Manual for Taxation for Decision Makers
29. [LO 1.5] Marriage Penalty
Solution: They have a marriage penalty of $264 ($31,851.50 - $31,587.50).
Tax on $160,000 (MFJ) Tax on $80,000 (Single)
$18,450 x 10% = $ 1,845.00 $ 9,225 x 10% = $ 922.50
$56,450 x 15% = 8,467.50 $28,225 x 15% = 4,233.75
$76,300 x 25% = 19,075.00 $42,550 x 25% = 10,637.50
$8,800 x 28% = 2,464.00 Total = $15,793.75
Total = $31,851.50 Total x 2 = $31,587.50
30. [LO 1.5] Joint vs. Single Filing
Solution: a. It will be to their advantage to marry in 2015.
b. By marrying before the end of 2015 and filing jointly, they save $6,019.75
($43,471.25 - $37,451.50) in taxes.
Tax on $180,000 (MFJ) Tax on $180,000 (Single-Conrad)
$18,450 x 10% = $ 1,845.00 $9,225 x 10% = $ 922.50
$56,450 x 15% = 8,467.50 $28,225 x 15% = 4,233.75
$75,300 x 25% = 19,075.00 $53,350 x 25% = 13,325.00
$28,800 x 28% = 8,064.00 $89,250 x 28% = 24,990.00
Total = $37,451.50 Total = $43,471.25
c. If they each have $90,000 of income, they would each pay $18,293.75 in taxes and
they would then have a marriage penalty of $864 ($37,451.50 - $36,587.50). In this
case, they would be slightly better off by postponing their wedding until 2016.
Tax on $90,000 (Single)
$ 9,225 x 10% = $ 922.50
$28,225 x 15% = 4,233.75
$52,550 x 25% = 13,137.50
--------------
Total = $18,293.75
Total x 2 = $36,587.50
31. [LO 1.5] Tax Liability
Solution: William’s income is twice John’s, but his taxes are 2.67 ($10,793.75/$4,038.75)
times John’s. This illustrates the progressive nature of the tax system as well as
vertical equity.
John’s tax on $30,000 William’s tax on $60,000
$9,225 x 10% = $ 922.50 $ 9,225 x 10% = $ 922.50
$20,775 x 15% = 3,116.25 $28,225 x 15% = 4,233.75
_______ $22,550 x 25% = 5,637.50
Total = $4,038.75 Total = $10,793.75
32. [LO 1.5] Tax Liability
Solution: Lilikoi paid $6,000 tax for 2013 and $30,050 tax for 2014. Lilikoi will have a
refund of $9,900 from carrying back $40,000 of the 2015 loss to 2013 and $10,000
of the loss to 2014. (Note that Lilikoi cannot carry the loss back to only 2014
without first carrying it back to 2013.)
Tax paid for 2013 on $40,000 was $40,000 x 15% = $6,000

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Chapter 1: An Introduction to Taxation 7
Tax paid for 2014 on $120,000 was ($50,000 x 15%) + ($25,000 x 25%) + ($25,000
x 34%) + ($20,000 x 39%) = $30,050.
The $10,000 loss that is carried back to 2014 reduces the taxable income for that
year from $120,000 to $110,000 saving tax at the 39% rate that applies to income
between $110,000 and $120,000.
Tax refund from 2015 loss is ($40,000 x 15%) + ($10,000 x 39%) = $9,900
33. [LO 1.5] Tax Liability
Solution: The net tax liability is $20,000.
$250,000 gross income - $125,000 expenses = $125,000 taxable income.
The income tax liability is:
$50,000 x 15% = $7,500
$25,000 x 25% = 6,250
$25,000 x 34% = 8,500
$25,000 x 39% = 9,750
Gross tax = $32,000
Less tax credit 12,000
Net tax = $20,000
34. [LO 1.5] Tax Liability
Solution: Taxable income = $49,000 and the net tax liability = $6,187.50.
$76,000 salary and wages - $15,000 itemized deductions - $12,000 ($4,000 x 3)
personal and dependency exemptions = $49,000 taxable income.
Income tax liability is:
$18,450 x 10% = $1,845.00
$31,550 x 15% = 4,582.50
Tax before credit = $6,427.50
Less tax credit 240.00
Net tax = $6,187.50
35. [LO 1.5] Alternative Minimum Tax
Solution: The regular tax is $153,000 and the alternative minimum tax is $27,400.
Regular tax: $450,000 x 34% = $153,000. Note that this $153,000 is the same tax
that would be computed by going through all of the tax brackets as follows:
($50,000 x 15%) + ($25,000 x 25%) + ($25,000 x 34%) + ($235,000 x 39%) +
($115,000 x 34%) = $153,000. This illustrates that for corporations with taxable
income between $335,000 and $10,000,000, the benefit of the lower tax brackets is
completely eliminated by the 5% surtax on income between $100,000 and $335,000.
Tentative alternative tax: $902,000 x 20% = $180,400
Alternative minimum tax: $180,400 - $153,000 = $27,400
The corporation will pay a total tax of $180,400 ($153,000 regular tax + $27,400
AMT)

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8 Solutions Manual for Taxation for Decision Makers
36. [LO 1.5] Alternative Minimum Tax
Solution: The alternative minimum tax would be $21,420.75
Regular tax on $140,000:
$ 9,225 x 10% = $922.50
$28,225 x 15% = 4,233.75
$5,300 x 25% = 13,325.00
$49,250 x 28% = 13,790.00
$32,271.25
Tentative alternative minimum tax on $205,000: ($185,400 x 26%) + ([$205,000 -
$185,400] 28%) = $48,204 + $5,488 = $53,692.
The alternative minimum tax: $53,692 - $32,271.25 = $21,420.75
Betty will pay a total tax of $53,692 ($32,271.25 regular tax + $21,420.75 AMT)
37. [LO 1.5] Estate Income Tax
Solution: The estate will pay $6,228.70.
$2,500 x 15% = $375.00
$3,400 x 25% = 850.00
$3,150 x 28% = 882.00
$3,250 x 33% = 1,072.50
$7,300 x 39.6 = 3,049.20
Total tax $6,228.70
38. [LO 1.1 & 1.5] Differing Types of Taxes
Solution: a. Wealth taxes are levied on assets owned by an individual or a business; the most
common wealth tax is the property tax which comes in several forms such as real
property taxes, inventory taxes, or taxes on plant and equipment. Wealth transfer
taxes are only levied when the goods owned by one person are passed gratuitously
to another as a gift or a bequest. Estate and inheritance taxes are wealth transfer
taxes.
b. The most common consumption tax is the sales tax which is based on the
purchase price of goods or services when they are acquired by the spending of one’s
income or savings. An income tax is levied on the increase in wealth as it is earned
regardless of whether that income is actually spent or saved. If a single individual
has $37,450 of taxable income in 2015, he will pay taxes of $5,156.25 on this
amount even if he saves all or part of the after-tax income. In addition, any income
on savings would also be taxed when earned. If this same individual were able to
save all of the $37,450, under a consumption tax he would pay no taxes until he
actually spent that income. The money saved would be available for investment and
that income would not be taxed until it was spent.
c. The 25% tax bracket for a married couple extends to $151,200 in 2015. This
would be equivalent to two single individuals with equal incomes earning $75,600
each. Beyond $151,200, the married filing jointly rate increases to 28% and they
begin to be subject to the marriage penalty. Single individuals remain in the 25% tax
bracket until their income exceeds $90,750.

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Chapter 1: An Introduction to Taxation 9
39. [LO 1.6] Tax Liability
Solution: Taxable income = $28,700 and the tax liability is $3,843.75
$46,000 Salary
minus 7,000 Partnership loss (50% x $14,000)
equals $39,000 Gross income
minus 6,300 Standard deduction
minus 4,000 Personal exemption
equals $28,700 Taxable income
Tax calculation
$922.50 $9,225 x 10%
2,921.25 $19,475 x 15%
$3,843.75
Note that this solution assumes that Carolyn has at least $7,000 basis in her
partnership interest so that she can deduct her full loss this year.
40. [LO 1.6] Tax Liability Comparisons
Solution: Partnership: Pays no tax. June and John are each taxed on the $32,000 passed
through to them at their marginal tax rates.
To determine their marginal tax rates, find the tax bracket in which their other
taxable income falls. (Note that the “other ordinary taxable income” is provided;
either the standard or their itemized deductions and the personal exemptions have
already been subtracted.) June’s $475,000 of other ordinary taxable income puts her
in the 39.6% marginal tax bracket because she is a head of household with taxable
income over $439,000. John’s $32,000 straddles the 25% and 28% marginal tax
brackets because his $130,000 of taxable income plus the additional $32,000
exceeds $151,200 – the 25% tax bracket. Thus, $21,200 is taxed at 25% and $10,800
($162,000 - $151,200) is taxed at 28% for a married taxpayer filing a joint return.
June’s tax = $32,000 x 39.6% = $12,672.
John’s tax = [$21,200 x 25% = $5,300] + [10,800 x .28 = $3,024] = $8,324.
Together they pay a total of $20,996 in taxes.
S Corporation: Pays no tax. June and John are each taxed on the $32,000 passed
through to them at their marginal tax rates as shown above for the partnership and
together they pay $20,996 in taxes.
C Corporation: The corporation pays a tax of $11,000 [($50,000 x 15%) + ($14,000 x
25%)].
Neither June nor John pay any taxes as they received no distributions from the
corporation.
Note the problem specified only income taxes; employment taxes are not included in
the solution to this problem.
41. [LO 1.6] Tax Liability Comparisons
Solution: Partnership: The answer does not change because June and John are taxed fully on
their shares of income whether they are distributed or not and the partnership pays

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10 Solutions Manual for Taxation for Decision Makers
no tax. Thus, June’s tax is still $12,672 and John’s tax is $8,324 for a total of
$20,996 in taxes. They pay no additional tax on the $28,000 distribution.
S Corporation: The answer does not change because June and John are taxed fully
on their shares of income whether they are distributed or not and the S corporation
pays no tax. Thus, June’s tax is still $12,672 and John’s tax is $8,324 for a total of
$20,996 in taxes. They pay no additional tax on the $28,000 distribution.
C Corporation: The corporation pays the same tax of $11,000 [($50,000 x 15%) +
($14,000 x 25%)]. June and John, however, will now have to recognize $28,000 of
dividend income; John will be taxed at the 15% dividend rate but June will be taxed
at 20% (the dividend rate for taxpayers in the 39.6% marginal tax bracket).
June’s tax = $28,000 x 20% = $5,600.
John’s tax = $28,000 x 15% = $4,200.
The total tax for the corporation, June, and John is $20,800 ($11,000 + $5,600 +
$4,200).
Note the problem specified only income taxes; Medicare surtaxes and employment
taxes are not included in the solution to this problem.
42. [LO 1.6] Tax Liability Comparisons
Solution: Partnership: The partnership does not benefit from the loss. June and John are each
allocated $22,000 of loss and can deduct the loss against their other income because
they have sufficient basis in the partnership [$15,000 invested + ($30,000 bank loan
x 50%) = $30,000 basis before loss - $22,000 loss = $8,000 ending basis]. June’s
and John’s incomes are high enough for them to remain fully in their respective
marginal tax rates of 39.6% and 25%. June benefits from a reduction in taxes of
$8,712 ($22,000 x 39.6%) and John saves $5,500 ($22,000 x 25%) in taxes at his
marginal tax rate. The total tax savings for both are $14,212 ($8,712 + $5,500).
S Corporation: The S corporation does not benefit from the loss. June and John are
each allocated $22,000 of the loss but they can only deduct $15,000 of this loss
against their other income because their deduction is limited to their basis in their S
corporation stock (which does not include any of the corporation’s liabilities). Thus,
June benefits from a reduction in taxes of $5,940 ($15,000 x 39.6) at her marginal
tax rate. John reduces his taxes by $3,750 ($15,000 x 25%) at his marginal tax rate.
They will each carry their excess $7,000 loss forward; these losses can be deducted
in a future year when they have sufficient basis. The total tax savings for the current
year is $9,690 ($5,940 + $3,750).
C Corporation: Neither June nor John have any current tax savings from the $44,000
loss. As a new corporation, it can only carry its loss forward to offset income (and
realize tax savings) in a future year. Losses of a C corporation do not pass through to
shareholders.
Note the problem specified only income taxes; Medicare surtaxes and employment
taxes were not included in the solution.
43. [LO 1.6] Choice of Business Entity
Solution: a. (1) The partnership does not pay any tax in years 1 or 2.
(2) The S corporation does not pay any tax in years 1 or 2.

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Chapter 1: An Introduction to Taxation 11
(3) The C corporation pays no tax in year 1 but its year-1 loss can be carried
forward to year 2 to offset $54,000 of its year-2 $60,000 income; it will pay a tax of
$900 ($6,000 x 15%) on this remaining $6,000 income in year 2.
b. (1) Tax savings for first year of partnership: Clara and Charles are each allocated
$27,000 of loss and each can deduct loss to the extent of his or her basis of $25,000
[$15,000 investment + (50% x $20,000 loan)]. Clara’s tax savings will be $7,000
($25,000 deductible loss x 28%) and Charles’s tax savings will be $6,250 ($25,000
deductible loss x 25%). The excess loss is carried forward to the next year.
Partner’s basis computations:
$15,000 Partner’s original investment
+10,000 Partner’s share of liabilities ($20,000 loan x 50%)
$25,000 Basis before deducting loss
- 25,000 Deductible loss ($54,000 loss x 50% = $27,000 but limited to basis
and $2,000 excess loss carried forward)
0 Basis at end of first year
(2) Tax savings for first year of S corporation: Clara and Charles are each allocated
$27,000 of loss and can deduct loss to the extent of his or her basis of $15,000 in
the S corporation stock. Clara’s tax savings will be $4,200 ($15,000 deductible loss
x 28%) and Charles’s savings will be $3,750 ($15,000 deductible loss x 25%).
S corporation shareholder’s stock basis computations:
$15,000 Shareholder’s original investment
-15,000 Deductible loss ($54,000 loss x 50% = $27,000 but limited to basis
and $12,000 excess loss carried forward)
0 Basis at end of first year
Note that an S corporation shareholder does not increase stock basis for any
corporate liabilities.
(3) First year of C corporation: No effect on Clara or Charles. Their basis in stock
remains $15,000 each.
c. (1) Income tax for second year of partnership: Clara pays $7,840 income tax
[($30,000 profit - $2,000 loss carried forward) x 28%] and Charles pays $7,000
income tax [($30,000 profit - $2,000 loss carried forward) x 25%]. The cash
distribution is not taxed but is a reduction of basis.
Partner’s basis computations:
0 Basis at end of first year
$30,000 Year 2 profit ($60,000 x 50%)
- 5,000 Cash distribution
$25,000 Subtotal
- 2,000 Deduct loss carried forward from previous year
$23,000 Basis at end of second year
(2) Income tax for second year of S corporation: Clara pays $5,040 in tax [($30,000
profit - $12,000 loss carried forward) x 28%] and Charles pays $4,500 tax
[($30,000 profit - $12,000 loss carried forward) x 25%]. The cash distribution is not
taxed but is a reduction of basis.

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S corporation shareholder’s stock basis computations:
0 Basis at end of first year
$30,000 Year 2 profit ($60,000 x 50%)
- 5,000 Cash distribution
$25,000 Subtotal
- 12,000 Deduct loss carried forward from previous year
$13,000 Basis at end of second year
(3) Income tax for second year of C corporation: Clara and Charles each pay $750
tax on their dividend income ($5,000 dividend income x 15% dividend rate = $750
tax). Their basis in the corporate stock remains $15,000.
44. [LO 1.6] Partnership Basis
Solution: His basis is $5,200.
$4,000 beginning basis + (30% x $7,000 partnership income) – (30% x $3,000
distribution) = $4,000 + $2,100 - $900 = $5,200
45. [LO 1.6] Tax Rates
Solution: .05 x ($335,000 - $100,000) = $11,750
$50,000 (.34 - .15) = $9,500
($75,000 - $50,000)(.34 - .25) = $2,250.
$9,500 + $2,250 = $11,750
46. [LO 1.6] Tax Rates
Solution: .03 ($18,333,333 - $15,000,000) = $100,000
(.35 - .34)($10,000,000) = $100,000
Develop Planning Skills
47. [LO 1.6] Single vs. Married Filing Status
Solution:
Married Filing Separately Married Filing Jointly Single
Gross Income $100,000 $200,000 $100,000
Personal exemptions -4,000 -8,000 -4,000
Standard deduction -6,300 -12,600 -6,300
Taxable income $89,700 $179,400 $89,700
Tax Rates Tax for MFS Tax for MFJ Tax for Single
10% x $ 9,225 = $ 922.50 $18,450 = $1,845.00 $9,225 = $ 922.50
15% x 28,225 = 4,233.75 56,450 = 8,467.50 28,225 = 4,233.75
25% x 38,150 = 9,537.50 76,300 = 19,075.00 52,250 = 13,062.50
28% x 14,100 = 3,948.00 28,200 = 7,896.00 -----------
Total Tax 18,641.75 $37,283.50 $18,218.75
x 2 $37,283.50 $36,437.50
It makes no difference if they marry this year and file either as married filing jointly
or separately. If they postpone the wedding until next year, they will save $846.00
($37,283.50 - $36,437.50) in taxes filing as single individuals this year.

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Chapter 1: An Introduction to Taxation 13
48. [LO 1.7] Total Tax Comparisons
Solution: Sole Proprietorship: Jeremy will be taxed on the entire net income from the sole
proprietorship of $48,000 ($60,000 – $12,000) regardless of the “salary.” $48,000 - $4,000
personal exemption - $6,300 standard deduction = $37,700 taxable income; (10% x
$9,225) + (15% x $28,225) + ($250 x 25%) = $922.50 + $4,233.75 + $62.50 = $5,218.75
income tax.
Corporation: $60,000 - $12,000 - $30,000 = $18,000 taxable income; $18,000 x
15% = $2,700 income tax. Income tax on Jeremy’s $30,000 salary: Jeremy’s taxable
income = $30,000 - $6,300 standard deduction - $4,000 personal exemption =
$19,700. Tax on $19,700 = ($9,225 x 10%) + ($10,475 x 15%) = $922.50 +
$1,571.25 = $2,493.75. Total taxes as a corporation = $2,700 + $2,493.75 =
$5,193.75
Based solely on income taxes, Jeremy should incorporate because his taxes will be
$25 ($5,218.75 - $5,193.75) less than operating as a sole proprietorship.
49. [LO 1.6] Charitable Deduction
Solution: As a married couple, their standard deduction is $12,600 in 2015 and estimated at
$12,800 for 2016. The 10 percent they plan to give to charity is $13,500 in 2015 and
is expected to be $14,000 in 2016. Their total planned contribution is $27,500
($13,500 + $14,000) over the two years and they have saved sufficient funds to
contribute the entire amount in one year. If they contribute the entire $27,500 in
2015, their taxable income would be $99,500 ($135,000 - $8,000 personal
exemptions - $27,500 contribution) which is $14,900 less than their $114,400
taxable income if they claim the standard deduction ($135,000 - $8,000 personal
exemptions - $12,600 standard deduction). This $14,900 savings in taxable income
is within the 25% tax bracket. Their tax savings for 2015 are $3,725 [($14,900 x
25%) by doubling up their donations at the end of this year
Under the assumption of no change in tax rates and only a $200 increase in the
standard deduction, however, they would have reduced tax savings of $50 ($200 x
25%) in 2016, but one year later; in the meantime they could benefit from any
income earned on the contribution until made in 2016. This would have to be
compared to the additional income on their savings, however, if the contribution
were postponed.
50. [LO 1.7] After-Tax Return
Solution: The after-tax interest on the taxable bonds equals 6% (1 - .34) = 3.96%. The 4.5
percent interest rate on the tax-exempt bonds provides the better return.
51. [LO 1.7] Tax Liability Comparison
Solution: Regular C Corporation: FICA tax on Carol’s $60,000 salary is $4,590 ($60,000 x
7.65%). FUTA = $420 ($7,000 x 6%)
Corporate taxable income = $200,000 - $75,000 - $60,000 salary - $4,590 FICA -
$420 FUTA= $59,990.
Income tax on $59,990 = ($50,000 x 15%) + ($9,990 x 25%) = $7,500 + $2,497.50
= $9,997.50.
Total corporate taxes = $4,590 + $420 +$9,997.50 = $15,007.50.

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14 Solutions Manual for Taxation for Decision Makers
Carol’s taxes: Carol also pays $4,590 ($60,000 x 7.65%) in FICA taxes on her
salary but she cannot deduct these taxes.
Carol’s taxable income = $60,000 - $6,300 standard deduction - $4,000 personal
exemption = $49,700.
Income tax on $49,700 = ($9,225 x 10%) + ($28,225 x 15%) + ($12,250 x 25%) =
$922.50 + $4,233.75 + $3,062.50 = $8,218.75.
Carol’s total taxes = $8,218.75 + $4,590 = $12,808.75.
Total taxes = $15,007.50 + $12,808.75 = $27,816.25
S Corporation: FICA tax on Carol’s $60,000 salary is $4,590 ($60,000 x 7.65%).
FUTA = $420 ($7,000 x 6%).
The net S corporation income of $59,990 (same as the regular corporation) is passed
through to Carol for taxation along with her salary income.
Carol’s taxable income = $60,000 salary + $59,990 corporation income - $6,300
standard deduction - $4,000 exemption = $109,690.
Tax on Carol’s $109,690 taxable income = ($9,225 x 10%) + ($28,225 x 15%) +
($53,300 x 25%) + ($18,940 x 28%) = $922.50 + $4,233.75 + $13,325 + $5,303.20
= $23,784.45
Carol’s total tax = $23,784.45 + $4,590 = $28,374.45
Total taxes = $28,374.45 + $4,590 +$420 = $33,384.45
Based on 2015 total taxes only, Carol should not make the S corporation election
because the total taxes will be $5,568.20 ($33,384.45 - $27,816.25) less operating as
a regular C corporation.
Think Outside the Text
These questions require answers that are beyond the material that is covered in this chapter.
52. [LO 1.2] Tax Rates
Solution:
Income Tax Rate on salary Employment Tax Rate Capital Gains Tax Rate
15% 7.65% 0%
28% 6.2% up to $118,500
and 1.45% on $132,000
15%
28% 6.2% up to $118,500
and 1.45% on $176,000
salary
15% on the first $24,000
and 18.6% on the
remaining $115,000
33% 6.2% up to $118,500;
1.45% to $200,000;
2.35% above $200,000
18.6% on the first
$128,200 (up to AGI of
$413,200) and 23.6% on
remaining $119,800
53. [LO .3] Tax Fairness
Solution: No answer is suggested here as the purpose of this question is to require the student
to select an alternative and construct an argument to support that position.

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Chapter 1: An Introduction to Taxation 15
54. [LO 1.3] Property Tax
Solution: As an ad valorem tax, a property tax is proportional. If you look at any other taxing
base except the value of the property, the tax may be progressive for some group of
citizens and regressive for others. For example, senior citizens generally have lower
incomes than working persons. They may live in equivalently valued houses
because they have lived there a long time and have no mortgage, however. In this
case, based on a percentage of income, the property tax would be regressive.
Alternatively, a lower income person may spend only 25 percent of his or her
income on housing because of other necessities. A high-income person may be able
to spend 40 percent of his or her income on housing. The latter’s property taxes
will be much higher as a percent of income than the former. In this situation, the
tax is progressive when based on income. Thus, for a wealth tax such as a property
tax, wealth is the only base on which it is practical to evaluate it. It is generally
proportional, although a certain base amount may be excluded from the tax (for
example, a $25,000 homestead exemption for persons who own their own home
and this would make it somewhat progressive).
55. [LO 1.3] Canons of Taxation
Solution: The four canons of taxation are equity, economy, certainty, and convenience. In
general, with the exception of an evaluation based on equity, many persons believe
the sales tax that most states levy is superior to the income tax. The costs to collect
and comply with the sales tax are relatively small compared to the amounts
collected (although internet sales are a significant problem now); most persons
know that when they purchase certain items they are required to pay sales taxes; and
they pay at the point of sale without having to file end-of-year returns. Sales taxes
are considered regressive, however, and therefore not considered equitable. As a
percentage of income, lower income persons pay more sales tax than higher income
persons do because they are obliged to spend more of their income. As an absolute
amount, however, most wealthy persons spend more overall than poor persons, and,
as a result pay more sales taxes (vertical equity). Two persons with equal incomes
can pay different amounts of sales taxes, however, if one party chooses to save
money while the other spends; this would violate horizontal equity. The income tax
has far higher costs of collections and administration but its tax rates are progressive
and it contains provisions that exempt low-income taxpayers from paying any taxes.
Thus, it is generally seen as more equitable than a sales tax. It fails, however, on
convenience and certainty because of the annual filing requirements and constant
changing of the laws.
56. [LO 1.3] Flat Tax
Solution: Most students will agree that there will have to be some basic exclusions or
deductions to enact a viable flat tax. Comparisons can be drawn, however, to the
FICA taxes, which have been flat over incomes up to the Social Security base
amount ($118,500 for 2014), but only the Medicare portion applies above this base
amount; an income flat tax, on the contrary, could be structured to exempt a certain
base amount from tax with the tax applying on all income above that minimum

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Taxation For Decision Makers, 2016 6th Edition Solution Manual

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