Taxation of Individuals answers1.docx

Taxation of Individuals answers1.docx

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TaxationofIndividualsanswers1

Chapter1

AnIntroductiontoTax

SOLUTIONSMANUAL

DiscussionQuestions:

（1）[LO1]Jessica’sfriendZacharyoncestatedthathecouldn’tunderstandwhysomeonewouldtakeataxcourse.Whyisthisarathernaïveview?

Taxesareapartofeverydaylifeandhaveafinancialeffectonmanyofthemajorpersonaldecisionsthatindividualsface（e.g.,investmentdecisions,evaluatingalternativejoboffers,savingforeducationexpenses,giftorestateplanning,etc.）.

（2）[LO1]Whataresomeaspectsofbusinessthatrequireknowledgeoftaxation?

Whataresomeaspectsofpersonalfinancethatrequireknowledgeoftaxation?

Taxesplayanimportantroleinfundamentalbusinessdecisionssuchasthefollowing:

∙Whatorganizationalformshouldabusinessuse?

∙Whereshouldthebusinesslocate?

∙Howshouldbusinessacquisitionsbestructured?

∙Howshouldthebusinesscompensateemployees?

∙Whatistheappropriatemixofdebtandequityforthebusiness?

∙Shouldthebusinessrentorownitsequipmentandproperty?

∙Howshouldthebusinessdistributeprofitstoitsowners?

Onemustconsideralltransactioncosts（includingtaxes）toevaluatethemeritsofatransaction.

Commonpersonalfinancialdecisionsthattaxesinfluenceinclude:

choosinginvestments,retirementplanning,choosingtorentorbuyahome,evaluatingalternativejoboffers,savingforeducationexpenses,anddoinggiftorestateplanning.

（3）[LO1]DescribesomewaysinwhichtaxesaffectthepoliticalprocessintheUnitedStates.

U.S.presidentialcandidatesoftendistinguishthemselvesfromtheiropponentsbasedupontheirtaxrhetoric.Likewise,themajorpoliticalpartiesgenerallyhaveverydiverseviewsoftheappropriatewaytotaxthepublic.Determiningwhoistaxed,whatistaxed,andhowmuchistaxedaredifficultquestions.Votersmusthaveabasicunderstandingoftaxesto

evaluatethemeritsofalternativetaxproposalsofferedbyopposingpoliticalcandidatesandtheirpoliticalparties.

（4）[LO2]Courtneyrecentlyreceivedaspeedingticketonherwaytotheuniversity.Herfinewas$200.Isthisconsideredatax?

Whyorwhynot?

The$200speedingticketisnotconsideredatax.Instead,itisconsideredafineorpenalty.Taxesdifferfromfinesandpenaltiesbecausetaxesarenotintendedtopunishorpreventillegalbehavior.

（5）[LO2]MarlonandLatoyarecentlystartedbuildingahouse.Theyhadtopay$300tothecountygovernmentforabuildingpermit.Isthe$300paymentatax?

Whyorwhynot?

Thebuildingpermitisnotconsideredataxbecause$300paymentisdirectlylinkedtoabenefitthattheyreceived（i.e.,theabilitytobuildahouse）.

（6）[LO2]ThecityofBirminghamrecentlyenacteda1percentsurchargeonhotelroomsthatwillhelppayforthecity’snewstadium.Isthisatax?

Whyorwhynot?

The1percentsurchargeisatax.The1percentsurchargeisanearmarkedtax–i.e.,collectedforaspecificpurpose.Thesurchargeisconsideredataxbecausethetaxpaymentsmadebytaxpayersdonotdirectlyrelatetothespecificbenefitreceivedbythetaxpayers.

（7）[LO2]AsnotedinExample1-2,tolls,parkingmeterfees,andannuallicensingfeesarenotconsideredtaxes.Canyouidentifyotherfeesthataresimilar?

Thereareseveralpossibleanswerstothisquestion.Somecommonexamplesincludeentrancefeestonationalparks,tagfeespaidtolocal/stategovernmentforautomobiles,boats,etc.

（8）[LO2]Ifthegeneralobjectiveofourtaxsystemistoraiserevenue,whydoestheincometaxallowdeductionsforcharitablecontributionsandretirementplancontributions?

Inadditiontothegeneralobjectiveofraisingrevenue,Congressusesthefederaltaxsystemtoencouragecertainbehavioranddiscourageotherbehavior.Thecharitablecontributiondeductionisintendedtoencouragetaxpayerstosupporttheinitiativesofcharitableorganizationswhereasdeductionsforretirementcontributionsareintendedtoencourageretirementsavings.

（9）[LO2]Onecommonargumentforimposingso-calledsintaxesisthesocialgoalofreducingdemandforsuchproducts.Usingcigarettesasanexample,istherea

segmentofthepopulationthatmightbesensitivetopriceandforwhomhightaxesmightdiscouragepurchases?

Themostobvioussegmentsensitivetopricemaybeteenagersandyoungeradults,althoughpricesensitivitywillvarybytaxpayer.

（10）[LO3]Dontaestatedthathedidn’twanttoearnanymoremoneybecauseitwould“puthiminahighertaxbracket.”WhatiswrongwithDontae’sreasoning?

AlthoughearningadditionaltaxableincomemayincreaseDontae’smarginaltaxrate（i.e.,puthiminahighertaxbracket）,theadditionalincomeearneddoesnotaffectthetaxesthatDontaewillpayonhisexistingincome.MovingtoahighertaxbracketsimplymeansthatDontaewillpayahighertaxrateontheadditionalincomeearned（notincomethathealreadyhas）.

（11）[LO3]Describethethreedifferenttaxratesdiscussedinthechapterandhowtaxpayersmightusethem.

Themarginaltaxrateisthetaxratethatappliestothetaxpayer’sadditionaltaxableincomeordeductionsthatthetaxpayerisevaluatinginadecision.Specifically,

MarginalTaxRate=

=

Themarginaltaxrateisparticularlyusefulintaxplanningbecauseitrepresentstherateoftaxationorsavingsthatwouldapplytoadditionaltaxableincomeortaxdeductions.

Theaveragetaxraterepresentsthetaxpayer’saverageleveloftaxationoneachdollaroftaxableincome.Specifically,

AverageTaxRate=

Theaveragetaxrateisoftenusedinbudgetingtaxexpenseasaportionofincome（i.e.,whatpercentoftaxableincomeearnedispaidintax）.

Theeffectivetaxraterepresentsthetaxpayer’saveragerateoftaxationoneachdollaroftotalincome（i.e.,taxableandnontaxableincome）.Specifically,

EffectiveTaxRate=

Relativetotheaveragetaxrate,theeffectivetaxrateprovidesabetterdepictionofataxpayer’staxburdenbecauseitdepictsthetaxpayer’stotaltaxpaidasaratioofthesumofbothtaxableandnontaxableincomeearned.

（12）[LO3]Whichisamoreappropriatetaxratetousetocomparetaxpayers’taxburdens–theaverageortheeffectivetaxrate?

Why?

Relativetotheaveragetaxrate,theeffectivetaxrateprovidesabetterdepictionofataxpayer’staxburdenbecauseitdepictsthetaxpayer’stotaltaxpaidasaratioofthesumofbothtaxableandnontaxableincomeearned.

（13）[LO3]Describethedifferencesbetweenaproportional,progressive,andregressivetaxratestructure.

Aproportional（flat）taxratestructureimposesaconstanttaxratethroughoutthetaxbase.Inotherwords,asthetaxbaseincreases,thetaxespaidincreases,butthemarginaltaxrateremainsconstant.Becausethemarginaltaxrateisconstantacrossalllevelsofthetaxbase,theaveragetaxrateremainsconstantacrossthetaxbaseandalwaysequalsthemarginaltaxrate.Commonexamplesofproportionaltaxesincludesalestaxesandexcisetaxes（i.e.,taxesbasedonquantitysuchasgallonsofgaspurchased）.

Aprogressivetaxratestructureimposesanincreasingmarginaltaxrateasthetaxbaseincreases.Inotherwords,asthetaxbaseincreases,boththemarginaltaxrateandthetaxespaidincrease.Commonexamplesofprogressivetaxratestructuresincludefederalandstateincometaxesandfederalestateandgifttaxes.

Aregressivetaxratestructureimposesadecreasingmarginaltaxrateasthetaxbaseincreases.Inotherwords,asthetaxbaseincreases,thetaxespaidincreases,butthemarginaltaxratedecreases.Regressivetaxratestructuresarenotcommon.IntheUnitedStates,theSocialSecuritytaxandthefederalemploymenttaxemployaregressivetaxratestructure.However,thereareotherregressivetaxeswhenthetaxisviewedintermsofeffectivetaxrates.Forexample,asalestaxbydefinitionisaproportionaltax–i.e.,astaxablepurchasesincrease,thesalestaxrate（i.e.,themarginaltaxrate）remainsconstant.Nonetheless,whenyouconsiderthattheproportionofone’stotalincomespentontaxablepurchaseslikelydecreasesastotalincomeincreases,thesalestaxmaybeconsideredaregressivetax.

（14）[LO3]ArnoldandLillyhaverecentlyhadaheateddiscussionaboutwhetherasalestaxisaproportionaltaxoraregressivetax.Lillyarguesthatasalestaxisregressive.Arnoldcountersthatthesalestaxisaflattax.Whoiscorrect?

ArnoldandLillyarebothcorrect.Asalestaxbydefinitionisaproportionaltax–i.e.,astaxablepurchasesincrease,thesalestaxrate（i.e.,themarginaltaxrate）remainsconstant.Forthisreason,Arnoldiscorrect.Nonetheless,whenyouconsiderthattheproportionofone’stotalincomespentontaxablepurchaseslikelydecreasesastotalincomeincreases,thesalestaxmaybeconsideredaregressivetax.Forthisreason,Lillyiscorrect.

（15）[LO4]WhichisthelargesttaxcollectedbytheU.S.government?

Whattypesoftaxpayersaresubjecttothistax?

ThefederalincometaxisthelargesttaxcollectedbytheU.S.government.Currently,federalincometaxesareleviedonindividuals,corporations,estates,andtrusts.

（16）[LO4]WhatisthetaxbasefortheSocialSecurityandMedicaretaxesforanemployeeoremployer?

WhatisthetaxbaseforSocialSecurityandMedicaretaxesforaself-employedindividual?

Istheself-employmenttaxinadditiontoorinlieuoffederalincometax?

EmployeewagesisthetaxbasefortheSocialSecurityandMedicaretaxes.Netearningsfromself-employmentisthetaxbasefortheself-employmenttax.Theself-employmenttaxisinadditiontothefederalincometax.

（17）[LO4]Whatareunemploymenttaxes?

Employersarerequiredtopayfederalandstateunemploymenttaxes,whichfundtempora