AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FEDERAL TAX LAW.doc

1 1 CHAPTER 1 AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FEDERAL TAX LAW Instructor The test items in both the print Test Bank and ExamView test creation software are numbered by question type within each chapter Thus users of ExamView can more easily preview their selections using the printed Test Bank in the same numbering system Learning Objective Level of Difficulty Estimated Time to Completion and the AACSB s and AICPA s Core Competencies for each test item are located within the item itself Status Q P Question Presentin Prior ProblemTopicEditionEdition TRUE OR FALSE 1Relationship of the 16th Amendment to the incomeModified1 tax on corporations 2Income taxes revenues raisedUnchanged2 3Adam Smith and canons of taxationUnchanged3 4Examples of proportional taxesModified4 5Examples of progressive taxesUnchanged5 6Progressiveness of Federal income tax in pointUnchanged6 of time 7Ad valorem tax effect of residence conversionModified7 8Ad valorem tax fixturesUnchanged8 9Ad valorem tax effect of conservation easementNew 10Ad valorem tax taxpayer compliance in typesUnchanged10 of personalty 11Ad valorem tax imposed on intangiblesUnchanged11 12Federal excise tax transaction no longer coveredModified12 13Federal and state excise tax on tobacco productsModified13 14Federal gas guzzler taxUnchanged14 15Excise tax on gasoline Federal state contrastUnchanged15 16Hotel occupancy tax and car rental surcharge Unchanged16 current status 17Sales tax and use taxUnchanged17 18Mail order sales and the sales or use taxUnchanged18 19Sales tax and local leviesUnchanged19 20State sales tax and state income taxUnchanged20 21Sales tax holidaysUnchanged21 22Local and state sales taxes avoidance ofUnchanged22 23Estate tax versus inheritance taxUnchanged23 24Incidence of the estate taxUnchanged24 1 22010 Comprehensive Volume Test Bank Status Q P Question Presentin Prior ProblemTopicEditionEdition 25Federal estate tax and purpose thereofUnchanged25 26Effect of the marital and charitable deductionsUnchanged26 on the Federal estate tax 27Mechanics of state inheritance taxUnchanged27 28Annual exclusions availabilityUnchanged28 29Disguised gift bargain sale of property to familyUnchanged29 member 30Election to split gift and annual exclusionUnchanged30 31Lifetime giving motivation forUnchanged31 32Effect of the Tax Relief Reconciliation Act of 2001Modified32 on estate and gift taxes 33Individual versus corporate income tax formulaModified33 34State income tax jock taxModified34 35State income tax and repeated amnesty programsUnchanged35 36Federal income tax and amnesty policyUnchanged36 37State income tax and amnesty provisionsUnchanged37 38State income tax and effect of decouplingUnchanged38 39Objective of FUTA taxUnchanged39 40Social Security component of FICA and limitationNew 41FICA application to childrenModified41 42FICA and FUTA compared government regulatory Unchanged42 bodies involved 43Flat tax disadvantageNew 44VAT acceptance in other countriesUnchanged44 45Selection of returns for audit amount of charitableModified45 deduction 46Office audit and field audit comparedUnchanged46 47IRS audit and meaning of an agent s RARUnchanged47 48IRS audit and significance of a special agentUnchanged48 49Statute of limitations on assessments by the IRSNew 50Statute of limitations and substantial omission ofUnchanged50 gross income 51Statute of limitations when no return filedUnchanged51 52Statute of limitations when fraud is involvedUnchanged52 53Determination of interest rate Unchanged53 54Interest on a tax refund when dueUnchanged54 55Interest on tax refunds versus interest on assessmentsUnchanged55 56Imposition of the failure to file penaltyUnchanged56 57Interest on a deficiency and failure to pay penaltyUnchanged57 58Negligence penalty definedModified58 59Negligence penalty determinedModified59 60Negligence versus fraud penaltiesUnchanged60 61Civil fraud versus criminal fraud penaltiesUnchanged61 62Ethical considerations of tax return preparers Unchanged62 63Tax practice ethical guidelinesNew 64Tax practice ethical guidelinesNew 65Revenue neutrality tax cuts and revenue offsetsUnchanged63 66Tax cuts and role of sunset provisionUnchanged64 67Justification for education incentivesUnchanged66 Status Q P Question Presentin Prior ProblemTopicEditionEdition An Introduction to Taxation and Understanding the Federal Tax Law1 3 68Retirement plans justification forUnchanged67 69Multiple taxation and handling of foreign incomeUnchanged68 taxes 70Wherewithal to pay conceptUnchanged69 71Justification for the deduction for state and localUnchanged70 sales taxes 72Installment sales and the wherewithal to pay conceptUnchanged71 73Prepaid income and accounting principlesModified72 74Administrative convenience effect of theNew standard deduction 75Influence of the courts judicial conceptsNew relating to taxation 76Judicial interpretations of the tax law congressional Unchanged73 response MULTIPLE CHOICE 1History of Federal income taxationUnchanged1 2Adam Smith s cannons of taxationNew 3Progressive versus proportional taxesUnchanged3 4Ad valorem taxes on realty increase ofNew 5Ad valorem taxes on personalty characteristics Unchanged5 6Federal excise taxes still imposedNew 7Taxes not imposed by the Federal governmentNew 8Taxes levied by all statesUnchanged8 9Imposition of the use taxUnchanged9 10Gift tax annual exclusionNew 11Lifetime gifts versus death transfers motivationUnchanged11 for choosing gifts 12Characteristics of state income taxesUnchanged12 13Characteristics of state income taxesUnchanged13 14Characteristics of FICAUnchanged14 15Characteristics of FUTAUnchanged15 16Characteristics of a flat taxUnchanged16 17Characteristics of a VATUnchanged17 18Characteristics of national sales taxUnchanged18 19Probability of not being selected for IRS auditUnchanged19 20Characteristics of the audit processNew 21Failure to file and pay penaltiesNew 22Characteristics of the fraud penaltiesModified22 23Tax practice ethical guidelinesNew 24Economic and social considerations in the tax lawUnchanged23 25Social considerations in the tax lawUnchanged24 26Domestic production activities deduction Unchanged25 justification for 27Energy conservation and global warmingUnchanged26 considerations 28Procedures that increase administrative feasibilityUnchanged27 29Wherewithal to pay conceptUnchanged28 Status Q P Question Presentin Prior ProblemTopicEditionEdition MATCHING 1 42010 Comprehensive Volume Test Bank 1 15Justification for various provisions of the FederalUnchanged1 11 tax law 16 30State and local taxes audit process justification for Modified16 27 various provisions of the Federal tax law 31 42 Tax practice audits penalties interest statute of Unchanged28 39 limitation PROBLEMS 1Making use of the annual exclusion and the electionNew to split gifts in a program of lifetime giving 2Application of the statute of limitations onUnchanged2 deficiency assessments 3Penalties for failure to file and to payNew 4Negligence and fraud penalties contrastedUnchanged4 5Wherewithal to pay concept and involuntaryUnchanged5 conversion 6Arm s length concept applied to rental arrangementsUnchanged6 between related parties 7Tax treatment of leasehold improvementsUnchanged7 ESSAY 1Federal income tax as a mass tax meaning ofNew pay as you go 2Adam Smith s canons of taxation Federal incomeNew tax tested as to equality 3Fixtures and their effect on ad valorem taxesUnchanged 1 4Ad valorem tax and exempt charitiesUnchanged 2 5Ad valorem tax and conversion to rental realtyUnchanged 3 6Use taxes lack of compliance enforcement Unchanged 5 remedies 7Tax holiday on ad valorem property taxes hotelUnchanged 6 occupancy tax and rental car surcharge evaluation of these approaches to state and local taxation 8Effect of severance taxNew 9Tax Relief Reconciliation Act of 2001 effect on Unchanged 7 Federal estate and gift taxes 10Incentives for making lifetime giftsUnchanged 8 11Increasing state and local tax revenues evaluationUnchanged 9 of two approaches 12IRS audit causal factorsUnchanged11 13Application or nonapplication of the statute ofUnchanged12 limitations on assessments Status Q P Question Presentin Prior ProblemTopicEditionEdition 14Fraud penalties civil and criminal fraud comparedUnchanged13 in terms of penalties imposed and burden of proof 15Knowledge of a client s error on a prior returnUnchanged14 16Tax practice audit lotteryNew 17Concept of revenue neutrality revenue offsets Unchanged15 tax cut phase ins and sunset provisions An Introduction to Taxation and Understanding the Federal Tax Law1 5 18Justification for home ownershipUnchanged17 19Justification for tax treatment of certain state andUnchanged18 local sales taxes and income taxes 20Justification for tax treatment of involuntary Unchanged19 conversions 21Factors facilitating the administration of the tax lawUnchanged20 by the IRS 22Judicial interpretations of the tax law reactions byUnchanged21 Congress 1 62010 Comprehensive Volume Test Bank TRUE FALSE 1 The ratification of the Sixteenth Amendment to the U S Constitution was necessary to validate the Federal income tax on corporations ANS F The Sixteenth Amendment validated the tax on individuals The income tax on corporations had been previously sanctioned by the courts PTS 1DIF 1REF p 1 3OBJ 2 NAT AICPA FN Research AACSB Reflective ThinkingMSC 2 min 2 The Federal income tax on corporations generates more revenue than the Federal income tax on individuals ANS F Just the opposite is the case PTS 1DIF 1REF Figure 1 1OBJ 2 NAT AICPA FN Research AACSB Reflective ThinkingMSC 2 min 3 The pay as you go feature of the Federal income tax on individuals conforms to Adam Smith s canon of convenience ANS T Pay as you go refers to the withholding provisions applicable to wages and other types of income and adds convenience to the tax system PTS 1DIF 1REF p 1 4 p 1 5 OBJ 3NAT AICPA FN Reporting AACSB Reflective Thinking MSC 2 min 4 The FICA tax Medicare component on wages is progressive since the tax due increases as wages increase ANS F The FICA tax Medicare component is proportional because the rate is constant regardless of the wages earned PTS 1DIF 1REF Example 1OBJ 3 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 5 The Federal estate and gift taxes are examples of progressive taxes ANS TPTS 1DIF 1REF p 1 6 OBJ 3NAT AICPA FN Measurement AACSB Analytic MSC 2 min An Introduction to Taxation and Understanding the Federal Tax Law1 7 6 Currently the Federal income tax is more progressive than it has been in the past ANS F Currently the Federal income tax has six rates At one time it had fifteen rates PTS 1DIF 1REF p 1 6OBJ 3 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 7 Marie inherits her mother s personal residence which she converts to a furnished rent house This change should affect the amount of ad valorem property taxes levied on the properties ANS T Conversion from residential to rental use will increase the taxes Furthermore Marie s mother may have had a senior citizen exemption on the property which will no longer be appropriate Lastly the furnishings in the rent house could now be subject to an ad valorem tax on personalty PTS 1DIF 1REF p 1 7OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 8 A fixture will be subject to the ad valorem tax on realty rather than the ad valorem tax on personalty ANS T By definition a fixture becomes part of the real estate to which it is attached PTS 1DIF 1REF p 1 7OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 9 Polly issues a conservation easement on the family vacation home Because the easement reduces the value to the property Polly s property taxes should decrease ANS T Since the easement places a restriction on the use of the property its value should decrease Many taxing jurisdictions allow a special valuation discount in these situations PTS 1DIF 1REF p 1 7OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 10 The ad valorem tax on personal use personalty is more often avoided by taxpayers than the ad valorem tax on personalty devoted to business use ANS TPTS 1DIF 1REF p 1 8 OBJ 4NAT AICPA FN Reporting AACSB Reflective Thinking MSC 2 min 1 82010 Comprehensive Volume Test Bank 11 As the tax is difficult to avoid many states levy an ad valorem tax on intangibles e g stocks and bonds ANS F The statement is incorrect in several respects First the tax on intangibles is easily avoided e g make use of an out of state broker Second very few not many states impose such a tax PTS 1DIF 1REF p 1 8OBJ 4 NAT AICPA FN Reporting AACSB Reflective ThinkingMSC 2 min 12 Federal excise tax is no longer imposed on the sale of jewelry ANS T Such tax existed in the past but was rescinded PTS 1DIF 1REF p 1 9OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 13 The retail sales of alcoholic products are subject to both Federal and state excise taxes ANS TPTS 1DIF 1REF p 1 9 OBJ 4NAT AICPA FN Measurement AACSB Analytic MSC 2 min 14 The Federal gas guzzler tax applies only to automobiles manufactured overseas and imported into the U S ANS F No such restriction is imposed Although many of the European luxury and sports car manufacturers were initially hit hard by the tax the law is silent on this matter PTS 1DIF 1REF p 1 9 Footnote 9 OBJ 4NAT AICPA FN Measurement AACSB Analytic MSC 2 min 15 Unlike the Federal counterpart the state excise taxes on gasoline do vary from state to state ANS T The state excise tax rates on gasoline are not constant PTS 1DIF 1REF p 1 9OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 16 Because they are politically unpopular many cities are reducing or eliminating their hotel occupancy and car rental surcharges ANS F As visitors cannot vote these taxes are popular with residents Since they are often used to finance large capital improvements e g athletic stadiums these taxes are not decreasing and their rates are becoming formidable PTS 1DIF 1REF p 1 9OBJ 4 NAT AICPA FN Measurement AACSB Reflective ThinkingMSC 2 min 17 If a state imposes a general sales tax it will have a use tax An Introduction to Taxation and Understanding the Federal Tax Law1 9 ANS T Every state that has a general sales tax also has a use tax There are no states with only a sales or use tax PTS 1DIF 1REF p 1 10OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 18 Sales made by mail order are exempt from the application of a general sales or use tax ANS F They are not exempt but compliance is sporadic PTS 1DIF 1REF p 1 10OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 19 Two persons who live in the same state but in different counties may not be subject to the same general sales tax rate ANS T This possibility could exist if local jurisdictions exact additional sales taxes PTS 1DIF 1REF Example 5OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 20 States impose either a state income tax or a general sales tax but not both types of taxes ANS F Many states impose both PTS 1DIF 1REF p 1 10 p 1 14 OBJ 4NAT AICPA FN Measurement AACSB Analytic MSC 2 min 21 Canceling a scheduled sales tax holiday has proven to be an easy way to generate more state and local revenue ANS F These special holidays are very popular with both merchants and consumers both of which have a strong voter impact at the polls PTS 1DIF 1REF p 1 11OBJ 4 NAT AICPA FN Measurement AACSB Reflective ThinkingMSC 2 min 1 102010 Comprehensive Volume Test Bank 22 A safe and easy way for a taxpayer to avoid local and state sales taxes is to have the purchase sent to an address in another state that levies no such taxes ANS F A review of the Example 4 discussion shows that this may not always be a successful way to go PTS 1DIF 1REF Example 4OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 23 The Federal government imposes an estate tax while many states may impose either inheritance or estate taxes or both ANS T The Federal government imposes an estate tax while many states impose an estate tax an inheritance tax or both PTS 1DIF 1REF Example 6OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 24 An estate tax is a tax on a decedent s right to pass property at death ANS TPTS 1DIF 1REF p 1 11 OBJ 4NAT AICPA FN Measurement AACSB Analytic MSC 2 min 25 One of the major reasons for the enactment of the Federal estate tax was to raise large amounts of revenue ANS F The estate tax was never intended to be a large source of revenue PTS 1DIF 1REF p 1 11OBJ 4 NAT AICPA FN Measurement AACSB Reflective ThinkingMSC 2 min 26 Under Clint s will all of his property passes to either the Lutheran Church or to his wife No Federal estate tax will be due on Clint s death ANS T A combination of the charitable and marital deductions will eliminate Clint s taxable estate PTS 1DIF 2REF p 1 11OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 27 Under a state inheritance tax two heirs a cousin and a son of the deceased would not be taxed at the same rate ANS T The more closely related the heir is to the decedent the larger the exemption allowed and or the lower the tax rate imposed PTS 1DIF 1REF p 1 12OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min An Introduction to Taxation and Understanding the Federal Tax Law1 11 28 The annual exclusion currently 13 000 is available for both gift and estate tax purposes ANS F The annual exclusion is not available for estate tax purposes PTS 1DIF 1REF p 1 13OBJ 4 NAT AICPA FN Measurement AACSB AnalyticMSC 2 min 29 In 2009 Jos a widower sells land fair market value of 100 000 to his daughter Linda for 50 000 Jos has made a taxable gift of 37 000 ANS T 100 000 value of land 50 000 consideration received 13 000 per donee annual exclusion 37 000 taxable gift PTS 1DIF 2REF Example 8 Example 9 OBJ 4NAT AICPA FN Measurement AACSB Analytic MSC 5 min 30 Julius a married taxpayer makes gifts to each of his six children A maximum of six annual exclusions could be allowed as to these gifts ANS F If Julius can obtain the consent of his wife to make the election to split the gifts twelve per donee annual