Taxation For Decision Makers, 2017th Edition Solution Manual

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Solutions to Chapter 1 Problem Assignments
Check Your Understanding
1. [LO 1.1] What is a tax?
What is a tax? How does a tax differ from a fine?
Solution: A tax is a payment that is not voluntary but is required to be paid to a governmental
unit to support its operations; it is not based on the value of goods or services the
person or business receives, however. A fine is levied as a result of an unlawful act.
2. [LO 1.1] Constitutional Authority
What Constitutional Amendment allowed implementation of an income tax? In what year was
it ratified?
Solution: The federal income tax system as we know it today did not begin until 1913 when
the 16th Amendment to the U.S. Constitution was ratified. The 16th Amendment
gave Congress the power to lay and collect taxes “on income, from whatever source
derived,” without the previous requirement that all direct taxes be imposed based
on population.
3. [LO 1.1] Current Tax Code
Which version of the tax code is applicable today?
Solution: The Tax Reform Act of 1986 was so extensive, the Code was renamed the Internal
Revenue Code of 1986. Any current changes to the tax laws are now amendments
to the Internal Revenue Code of 1986.
4. [LO 1.1] Tax Expenditures
Define tax expenditure?
Solution: Tax expenditures can take the form of special exclusions, deductions, credits or
preferential rates for specific activities. These tax expenditures result in a reduction
in the revenue that would be collected under a more comprehensive income tax.
5. [LO 1.1] SALT
What is a SALT practice?
Solution: The practice of state and local taxation is commonly referred to as a SALT practice.
6. [LO 1.1] Franchise Tax
How does a franchise tax differ from an income tax?
Solution: A franchise tax is an excise tax based on the right to do business or own property in
a state. It is, however, usually determined based on corporate income so would, in
effect, simply be another name for the income tax.
7. [LO 1.1] State Income Allocation
What three factors determine the percentage of corporate income allocated to a particular
state?
Solution: The three-factor allocation formula uses a percentage of corporate sales, payroll

2 Solutions Manual for Taxation for Decision Makers
costs, and tangible property allocated to the state.
8. [LO 1.1] Employment Taxes
What employment taxes are imposed on an employee and an employer?
Solution: An employee pays the Social Security and Medicare (FICA) tax; the employer also
pays an equivalent Social Security and Medicare (FICA) tax, but the employer also
may have to pay an unemployment tax.
9. [LO 1.1] Wealth Taxes
What is the most common wealth tax and how is it levied?
Solution: The most common wealth tax is the real property tax based on the fair market value
of property owned by an individual or a business.
10. [LO 1.1] Intangible Tax
What property is subject to the intangible tax?
Solution: The intangible tax is levied on intangible property such as receivables, stocks,
bonds, and other forms of investment instruments owned by businesses and
individuals.
11. [LO 1.1] Estate and Gift Tax
Explain the integration of the gift and estate taxes.
Solution: Property that is given away during a lifetime that exceeds a certain amount is
subject to a gift tax after using up a lifetime exemption. When the person passes
away, property that the person still owned (had not given away) is now subject to
the estate tax. Any gift tax exemption that has not been used by the decedent is then
available as an exemption from the estate tax. Thus, a decedent’s estate escapes
taxation unless his or her total lifetime taxable gifts plus taxable transfers at death
exceed the lifetime exclusion.
12. [LO 1.1] Consumption vs Income Tax
Differentiate a consumption based tax from an income tax and illustrate with an example.
Solution: A consumption tax is levied on purchases of goods or services that are going to be
used or consumed. The most common consumption tax is the sales tax, but the
value-added tax is another form used in many countries outside the United States.
The income tax is based on the value of money or goods that are received, whether
it is spent or saved. An income tax will tax money that is going to be saved rather
than spent while the consumption tax only taxes money that is spent. The
consumption tax is thought to encourage savings.
13. [LO 1.1] Wealth Taxes
Differentiate a wealth tax from a wealth transfer tax and give examples of each.
Solution: A wealth tax is based on the value of wealth that a person has at a particular point
in time. The real or personal property taxes are wealth taxes. The wealth transfer
tax is based on the value of money or property that is passed on to another person.
The estate, gift, and inheritance taxes are wealth transfer taxes.

Chapter 1: An Introduction to Taxation 3
14. [LO 1.1] Income Taxes
Over what ranges of taxable income in 2016 will the total income tax liability two persons
with equal incomes who file as single individuals equal their income tax liability if they file
jointly as a married couple?
Solution: Two persons with taxable income of $75,950 each will pay the same total tax as a
married couple with taxable income of $151,900. Above $151,900 the married
couple’s rate increases to 28% while each of the single persons does not reach that
rate until taxable income is over $91,150.
15. [LO 1.2] Types of Taxes
Differentiate a progressive tax system from a proportional and a regressive system and give
examples of each.
Solution: The income tax system in the United States is a progressive system; that is, as
income increases, the tax rate increases and the person pays a greater percentage of
income as a tax. A person who has $9,000 of taxable income will pay $900 in taxes
(10%). A person who makes $18,000 will pay $2,236.25 ($927.50 + .15 ($18,000 -
$9,275). $2,236.25/$18,000 = 12.42%. A regressive tax system imposes a lower tax
rate as income increases; that is, a person pays a decreasing percentage of their
income in taxes as income increases. The Social Security portion of the FICA tax is
a regressive tax; as the taxpayer’s income on which the tax is based exceeds a
maximum, the tax is no longer collected and the rate declines. A proportional tax
would collect the same percentage of tax on the tax base, regardless of the size of
the base. The sales tax is a proportional tax as the same percent tax is collected
regardless of the amount spent.
16. [LO 1.2] Income Tax Rates
What basic tax rates apply to the ordinary income, dividend income, and interest income of an
individual? What are they for a corporation?
Solution: Individuals have basic tax rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%
that apply to their ordinary income and their interest income. The basic tax rates for
their dividend income are 0%, 15%, and 20%. Corporations have no tax-favored
incomes so they pay tax on all income at rates of 15%, 25%, 34%, and 35%,
excluding surtaxes on certain portions of income that ultimately produce a flat tax
of 35% on income above $18,333,333.
17. [LO 1.2] Income Tax Rates
What tax rates apply to an individual’s capital gains and to which tax brackets do each of this
rates apply?
Solution: Individual’s short-term capital gains tax rates are the same as the tax rates on
ordinary income. A single individual’s long-term capital gains rates are 0% on
long-term capital gains (LTCG) from 0 to $37,650; 15% on LTCG from $37,651 to
$415,050, and 20% on LTCG exceeding $415,050.
18. [LO 1.3] Canons of Taxation
Briefly explain Adam Smith’s four canons of taxation.

4 Solutions Manual for Taxation for Decision Makers
Solution: The basic idea of equity is that persons with similar incomes will face similar taxes.
Thus, individuals each with $200,000 in taxable income will pay the same amount
of tax. A tax meets the criterion of economy when the amount of revenue it raises is
at an optimum level after the costs of administration and compliance are
considered. The canon of certainty would dictate that a taxpayer know with
reasonable accuracy the tax consequences of a transaction at the time the
transaction takes place. The last canon of convenience states that a convenient tax
is one that would be readily determined and paid with little effort.
19. [LO 1.3] Equity Concepts
Differentiate horizontal from vertical equity.
Solution: Horizontal equity would require persons with equal incomes pay equal amounts of
taxes. Vertical equity would require persons with higher incomes to pay a higher
percentage of their income than persons with lower incomes. This is the basis of the
U.S. tax system.
20. [LO 1.4] Taxable Persons
Which three taxable persons pay all of the income taxes?
Solution: Only individuals, regular (or C) corporations, and fiduciaries (estates and trusts)
pay income taxes.
21. [LO 1.4] Gross Income
Define gross income.
Solution: The term gross income is an all-inclusive term that includes income from all
sources that are not specifically excluded.
22. [LO 1.4] Basic Tax Model
Briefly describe the basic elements of the tax model.
Solution: The basic elements of the tax model are gross income, less deductions, that equal
taxable income or loss. To this it applies the applicable tax rate to determine the
gross tax liability. From this tax credits and prepayments are deducted to determine
the tax liability owed or the refund due.
23. [LO 1.4] Capital Losses
Differentiate the tax treatment of an individual’s capital losses from the tax treatment of
corporate capital losses.
Solution: An individual may deduct up to $3,000 of capital losses in excess of capital gains
annually; the excess may be carried forward to succeeding years. A corporation can
only offset capital losses against capital gains; they are not deductible against other
income. Instead the corporation first carries the losses back to the three previous
years and then forward for 5 years.
24. [LO 1.4] Basic Income Tax Rates
What are the basic tax rates for an individual and a corporation?
Solution: Individuals have basic tax rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%

Chapter 1: An Introduction to Taxation 5
that are applied to their ordinary income. A corporation’s basic tax rates rates are
15%, 25%, 34%, and 35%, excluding surtaxes.
25. [LO 1.4] Fiduciaries
What are two fiduciary entities and how are they created? Define grantor, trustee, and
beneficiary for a trust.
Solution: Trusts and estates are two fiduciary entities; a trust is established by a grantor who
appoints a trustee to manage the assets for the benefit of the trust’s beneficiaries.
An estate is an entity that is created on the death of a person that provides
management for the assets in the decedent’s estate until they can be distributed to
the beneficiaries. A grantor is the person who creates the trust when assets are
placed in the trust for the benefit of the beneficiaries. The trustee is the person
selected by the grantor to oversee the assets and ensure the trust functions as
specified by the grantor. The beneficiary of the trust is the person for whom the
trust was established and who is to benefit from the income from the trust (an
income beneficiary) or receive the assets when the trust is closed (the
remainderman).
26. [LO 1.5] Sole Proprietorships
What are three characteristics of a sole proprietorship? Are these characteristics the same as
or different from those of a partnership? What are three characteristics of a limited liability
company that differ from those of a partnership?
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 and must pay self-employment
tax. 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
and general partners are required to pay self-employment tax. Although
partnerships 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. Partners pay any taxes owing on the income items but loss is
deductible only if a partner has sufficient basis. A partner’s basis begins with his or
her investment in the partnership and is increased for the partner’s share of
partnership liabilities.
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. Only
the managing members of a limited liability company may be subject to self-

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employment taxes.
27. [LO 1.5] Corporations
Compare a C corporation to an S corporation.
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
28. [LO 1.1] Property Taxes
Dane City's total assessed valuation for all of the property in its jurisdiction is
$4,000,000,000. It needs $20,000,000 in revenue for the services it provides its citizens. Joe
owns property that is assessed at $150,000. How much will he pay in 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
29. [LO 1.1] FICA Tax
If a taxpayer has $40,000 of employee salary in 2016, how much will be withheld for the
Social Security and Medicare taxes?
Solution: $40,000 x 7.65% = $3,060
30. [LO 1.1] FICA Taxes
If a taxpayer has $140,000 of employee salary, how much will be withheld for the Social
Security and Medicare taxes in 2016?
Solution: 9,377 is withheld for FICA taxes in 2016.
$118,500 x 6.2% = $7,347
$140,000 x 1.45% = 2,030
Total $9,377
31. [LO 1.4] Taxable Income
Determine Amy's taxable income for 2016 if she has $40,000 of salary income, is single, and
has $10,350 in total allowable deductions.

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Chapter 1: An Introduction to Taxation 7
Solution: Taxable income = $29,650
$40,000 Salary
minus 10,350 Deductions
equals $29,650 Taxable income
32. [LO 1.4] Taxable Income
Marlee is a single parent with $25,450 in total allowable deductions and qualifies as head of
household for 2016. Determine her taxable income if she has a salary of $71,000 and interest
income of $1,500.
Solution: Taxable income = $47,050
$71,000 Salary
plus 1,500 Interest income
minus 25,450 Deductions
equals $47,050 Taxable income
33. [LO 1.4] Taxable Income
Determine a corporation's taxable income if it has $450,000 of gross receipts, $145,000 cost
of goods sold, $276,000 of deductible business expenses, $20,000 of gain on the sale of
machinery, and $500 of interest income from State of New York bonds.
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.
34. [LO 1.4] Taxable Income
The Warner Corporation has gross income of $560,000. It has business expenses of $325,000,
a capital loss of $20,000, and $2,500 of interest income on temporary investments. What is
the corporation's 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.
35. [LO 1.4] Taxable Income
Determine George and Mary's taxable income and tax liability for 2016 if George has $65,000
and Mary has $45,000 of salary income, they have $36,200 of total allowable deductions, and
they file a joint tax return.

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8 Solutions Manual for Taxation for Decision Makers
Solution: Taxable income = $73,800
George's salary $65,000
plus Mary's salary 45,000
equals Gross income $110,000
minus Deductions 36,200
equals Taxable income $73,800
36. [LO 1.4] Determining Tax Liability
Refer to the information in problem 31. Determine Amy's income tax liability for 2016.
Solution: Taxable income = $29,650; income tax = $4,023.75.
Income Tax: ($9,275 x 10%) + ($20,375 x 15%) = $3,983.75.
37. [LO 1.4] Determining Tax Liability
Refer to the information in problem 32. Determine Marlee's income tax liability for 2016.
Solution: Taxable income = $47,050; income tax = 6,395.
Income Tax: [($47,050 - $13,250) x 15%] + $1,325 = $6,395
38. [LO 1.4] Determining Tax Liability
Refer to the information in problem 33. Determine the corporation's income tax liability.
Solution: Taxable income = $49,000; income tax = $7,350.
Income Tax: $49,000 x 15% = $7,350.
39. [LO 1.4] Determining Tax Liability
Refer to the information in problem 34. Determine Warner Corporation's income tax liability.
Solution: Taxable income = $237,500; Income tax = $75,875
[($237,500 - $100,000) x 39%] + $22,250 = $75,875
(The $20,000 capital loss is not deductible currently.)
40. [LO 1.4] Marriage Penalty
Sally and Jim are married and have taxable income in 2016 of $160,000. If they could file
their income tax as single individuals, each of them would have taxable income of $80,000.
Do they have a marriage penalty when they file their joint return? If so, what is the amount of
the penalty?
Solution: They have a marriage penalty of $243 ($31,785.50 - $31,542.50).
MFJ: [($160,000 - $151,900) x 28%] + $29,517.50 = $31,785.50
Single: [($80,000 - $37,650) x 25%] + $5,183.75 = $15,771.25 x 2 = $31,542.50
41. [LO 1.4] Joint vs. Single Filing
Conrad and Anita (a college student with no income) plan to marry on December 21, 2016.
Filing jointly, they expect to have $180,000 of taxable income for the year. If they wait until
January of 2017 to marry, Conrad will file as a single person and report the $180,000 of
taxable income on his separate return.

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Chapter 1: An Introduction to Taxation 9
a. Will it be to their advantage to marry before the end of 2016 or should they wait until
2017?
b. How much in tax will they save or have to pay extra if they marry in 2016?
c. How would your answers change if Conrad and Anita each expect $90,000 of taxable
income in 2016?
Solution: a. It will be to their advantage to marry in 2016.
b. By marrying before the end of 2016 and filing jointly, they save $6,051.25
($43,436.75 - $37,385.50) in taxes.
MFJ: [($180,000 - $151,900) x 28%] + $29,517.50 = $37,385.50
Single: [($180,000 - $91,150) x 28%] + $18,558.75 = $43,436.75
c. If they each have $90,000 of income, they would each pay $18,271.25 in taxes and
they would then have a marriage penalty of $842.50 ($37,385 - $36,542.50). In this
case, they would be slightly better off by postponing their wedding until 2016.
Tax on $90,000 (Single): [($90,000 - $37,650) x 25%] + $5,183.75 = $18,271.25
$18,271.25 x 2 = $36,542.50
42. [LO 1.4] Income Tax Liability
Carrie and Stephen have gross salary and wages of $76,000 in 2016 and file a joint return.
They have $27,150 of total allowable deductions and a $240 child care credit. Determine
their taxable income and their tax liability.
Solution: Taxable income = $48,850 and the net tax liability = $6,160.
$76,000 salary and wages - $27,150 allowable deductions = $48,850 taxable income.
Income tax liability is: $1,855 + .15 x [$48,850 - $18,550] = $6,400
$6,400 - $240 credit = $6,160
43. [LO 1.4] Tax Liability
An estate has $20,000 of taxable income in 2016. What amount of tax will the estate pay if it
fails to distribute the income to the beneficiaries?
Solution: The estate will pay $6,215.60.
$2,550 x 15% = $382.50
$3,400 x 25% = 850.00
$3,100 x 28% = 868.00
$3,350 x 33% = 1,105.50
$7,600 x 39.6 = 3,009.60
Total tax $6,215.60
44. [LO 1.4] Tax Rates
Perform the calculations to prove that the 5 percent surtax on corporate income between
$100,000 and $335,000 equals the benefit that the corporation enjoys on income of no more
than $100,000.
Solution: .05 x ($335,000 - $100,000) = $11,750
$50,000 (.34 - .15) = $9,500
($75,000 - $50,000)(.34 - .25) = $2,250.

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$9,500 + $2,250 = $11,750
45. [LO 1.4] Tax Rates
Perform the calculation to prove that the 3 percent surtax on corporate income between
$15,000,000 and $18,333,333 equals the benefit of the 34 percent tax rate on income of no
more than $10,000,000.
Solution: .03 x ($18,333,333 - $15,000,000) = $100,000
(.35 - .34)($10,000,000) = $100,000
46. [LO 1.5] Tax Liability
John has taxable income of $30,000. William has taxable income of $60,000. Determine their
2016 income taxes if they are both single individuals. Compare their incomes and their
income taxes. What does this illustrate?
Solution: William’s income is twice John’s, but his taxes are 2.67 ($10,771.25/$4,036.25)
times John’s. This illustrates the progressive nature of the tax system as well as
vertical equity.
[($30,000 - $9,275) x 15%] + $927.50 = $4,036.25
[($60,000 - $37,650) x 25%] + $5,183.75 = $10,771.25
47. [LO 1.5] Net Operating Loss
Lilikoi Corporation began business in 2014. Lilikoi earned taxable income of $40,000 in
2014 and $120,000 in 2015. For 2016, Lilikoi Corporation has a net operating loss of
$50,000 and decides to carry the loss back, filing a refund claim. Compute the amount of
corporate income tax that Lilikoi paid for 2014 and 2015 and then determine the amount of
tax that will be refunded from carrying back the 2016 NOL.
Solution: Lilikoi paid $6,000 tax for 2014 and $30,050 tax for 2015. Lilikoi will have a
refund of $9,900 from carrying back $40,000 of the 2016 loss to 2014 and $10,000
of the loss to 2015. (Note that Lilikoi cannot carry the loss back to only 2015
without first carrying it back to 2014.)
Tax paid for 2014 on $40,000 was $40,000 x 15% = $6,000
Tax paid for 2015 on $120,000 was [($20,000 x 39%) + $22,250] = $30,050.
The $10,000 loss that is carried back to 2015 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 2016 loss is ($40,000 x 15%) + ($10,000 x 39%) = $9,900
48. [LO 1.5] Determining Tax Liability
Hunter Corporation has $250,000 in gross income, $125,000 in deductible business expenses,
and a $12,000 business tax credit. Determine the corporation's net tax liability.
Solution: The net tax liability is $20,000.
$250,000 gross income - $125,000 expenses = $125,000 taxable income.

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Chapter 1: An Introduction to Taxation 11
The income tax liability is: [($25,000 x 39%) + $22,250] = $32,000 gross tax
$32,000 - $12,000 tax credit = $20,000 net tax
49. [LO 1.5] Determining Tax Liability
Carolyn has a 50 percent interest in a general partnership that has a $14,000 loss for the year.
She materially participates in the partnership. Her basis in the partnership is $10,000. She
also has salary from other employment of $46,000. If she is single with $10,350 in allowable
deductions, what is her taxable income and her tax liability in 2016?
Solution: Taxable income = $28,650 and the tax liability is $3,833.75
$46,000 Salary
minus 7,000 Partnership loss (50% x $14,000)
equals $39,000 Gross income
minus 10,350 Deduction
equals $28,650 Taxable income
Tax: [($28,650 - $9,275) x 15%] + $927.50 = $3,833.75
50. [LO 1.4 & 1.5] Tax Liability Comparisons
June and John decide to form a business. They each plan to contribute $20,000 in exchange
for a 50 percent interest in the business. They will then take out a bank loan for $30,000 to
cover the balance of their working capital needs. They expect that the business will make a
profit of $64,000 in the first year and that it will not make any cash distributions that year.
Excluding the business income, June, who files as head of household, has $475,000 of other
ordinary taxable income. John is married and files a joint return; he and his wife have
$130,000 of other ordinary taxable income. They want to know how much tax the business
will pay and how much additional tax they will personally pay in 2016 if they form the
business as a partnership, S corporation, or C corporation. Consider only income taxes.
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 $441,000. 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 $151,900 – the 25% tax bracket. Thus, $21,900 is taxed at 25%
and $10,100 ($162,000 - $151,900) 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 = [$21,900 x 25% = $5,475] + [10,100 x 28% = $2,828] = $8,303.
Together they pay a total of $20,975 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 $20,975 in taxes.

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C Corporation: The corporation pays a tax of $11,000
[$7,500 + ($64,000 - $50,000) x 25%] = $11,000
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.
51. [LO 1.4 & 1.5] Tax Liability Comparisons
Assume the same facts as problem 50, except that the business expects to make a cash
distribution of $28,000 each to June and John the first year. Determine how much tax the
business will pay and how much additional tax they will personally pay if they form the
business as a partnership, S corporation, or C corporation. Consider only income taxes.
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
no tax. Thus, June’s tax is still $12,672 and John’s tax is $8,303 for a total of
$20,975 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 $8,303 for a total of
$20,975 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.
52. [LO 1.4 & 1.5] Tax Liability Comparisons
Assume the same facts as problem 50, except that John and June expect the business will
have a $44,000 loss in the first year (instead of a $64,000 profit) and will not make any cash
distributions. Determine the income tax savings in the current year for the business and for
them personally if they form the business as a partnership, S corporation, or C corporation.
(They both materially participate in the business and their marginal tax bracket will not
change because of the business loss.)
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

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Chapter 1: An Introduction to Taxation 13
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.
53. [LO 1.4 & 1.5 Choice of Business Entity]
Clara and Charles decide to form a business. They each plan to contribute $15,000 in
exchange for a 50 percent interest. The business will borrow $20,000 to cover the balance of
its working capital needs. In their business plan, Clara and Charles show that the business
will have a loss of $54,000 in its first year. In the second year, however, the business will
have a profit of $60,000 and they will each be able to withdraw $5,000 from the business.
Clara is in the 28 percent marginal tax bracket and Charles is in the 25 percent marginal tax
bracket.
a. Determine the taxes paid by the business (if any) in the first and second year if they
organize the business as (1) a partnership, (2) an S corporation and (3) a C corporation.
b. Determine Clara's and Charles's income tax savings in the first year and their bases in the
business at year-end if they organize the business as (1) a partnership, (2) an S
corporation, and (3) a C corporation.
c. Determine the income tax Clara and Charles will pay in the second year from business
operations and their bases in the business at year-end if they organize the business as (1)
a partnership, (2) an S corporation, and (3) a C corporation.
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.
(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.

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14 Solutions Manual for Taxation for Decision Makers
b. (1) Tax savings for first year of partnership: Clara and Charles are each allocated
$27,000 of loss and each can deduct $25,000 of the loss (the extent of basis [$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 the basis 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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Chapter 1: An Introduction to Taxation 15
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.
54. [LO 1.5] Partnership Basis
Carl is a 30 percent partner in the CCF Partnership. At the beginning of the year, his basis in
the partnership is $4,000. The partnership reports $7,000 of ordinary income and distributes
$3,000 to the partners. What is Carl's basis at the end of the year?
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
Develop Planning Skills
55. [LO 1.4] Single vs. Married Filing Status
John and Martha are planning to be married. Both are professionals each with taxable
incomes of $89,700 annually. They are deciding on a wedding date. They have two dates to
choose from: December 14, 2016, or January 11, 2017. If they marry on December 14, 2016,
they will have to choose between married filing separately and married filing jointly. Is there
an advantage to either method of filing? If they postpone their wedding until the January date
and file as single persons, will they reduce their tax bill for 2016?
Solution:
Married Filing Separately: [($89,700 - $75,950) x 28%] + $14,758.75 = $18,608.75
$18,608.75 x 2 = $37,217.50
Married Filing Jointly: [($179,400 - $151,900) x 28%] + $29,517.50 = $37,217.50
Single: [($89,700 - $37,650) x 25%] + $5,183.75 = $18,196.25 x 2 = $36,392.50
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 $825 ($37,217.50
- $36,392.50) in taxes filing as single individuals this year.
56. [LO 1.4 & 1.5] Total Tax Comparison
Jeremy is setting up a service business. He can either operate the business as a sole
proprietorship or he can incorporate as a regular C corporation. He expects that the business
will have gross income of $80,000 in the first year with expenses of $12,000 excluding the

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