of answers to the questions and problems in this chapter. This is indicated by REFERENCE TABLES

1 Chapter 1 Introduction to Taxation

Note to Instructor: The reference tables in the appendix of the text may be required for a limited number of answers to the questions and problems in this chapter. This is indicated by “REFERENCE TABLES REQUIRED” after the learning objective.

True-False: Insert T for True and F for False before the questions.

______ 1. A hidden tax is one that is included with a payment but not specifically identified.

ANSWER True LO 1.1

DIFFICULTY: Easy

_____ 2. Both sales and use taxes are collected in the state in which the sale takes place.

ANSWER False LO 1.1

DIFFICULTY: Easy

_____ 3. The person receiving the gift pays the gift tax.

ANSWER False LO 1.1

DIFFICULTY: Easy

_____ 4. The value added tax is a type of consumption tax.

ANSWER True LO 1.1

DIFFICULTY: Easy

_____ 5. The type and degree of connection between a business and a state necessary for a state to impose a tax is referred to as nexus.

ANSWER True LO 1.1

DIFFICULTY: Easy

_____ 6. The 16 th Amendment to the US Constitution that provided for an income tax was ratified in 1939.

ANSWER False LO 1.1

DIFFICULTY: Easy

_____ 7. Any current changes to the tax laws are now amendments to the Internal Revenue Code of 2019.

ANSWER False LO 1.1

DIFFICULTY: Easy

_____ 8. A flat tax generally would be considered a regressive tax.

(Taxation for Decision Makers, 2020, 10e Dennis-Escoffier, Fortin) (Test Bank all Chapters) 1 / 4

• Taxation for Decision Makers Test Bank

ANSWER False LO 1.2

DIFFICULTY: Easy

_____ 9. Adam Smith’s four canons of taxation are Equity, Certainty, Economy and Convenience.

ANSWER True LO 1.3

DIFFICULTY: Easy

_____ 10. Vertical equity asserts that persons in similar circumstances should face similar tax burdens.

ANSWER False LO 1.3

DIFFICULTY: Easy

_____ 11. There are three basic taxable entities: the individual, the fiduciary, and the C corporation.

ANSWER True LO 1.4

DIFFICULTY: Easy

_____ 12. All interest paid to a taxpayer must be included in gross income.

ANSWER False LO 1.4

DIFFICULTY: Moderate

_____ 13. The lowest tax rate on the tax rate schedules for taxable incomes is the same for individuals and C corporations.

ANSWER False LO 1.4 REFERENCE TABLES REQUIRED

DIFFICULTY: Easy

_____ 14. A $100 tax deduction is more valuable to a taxpayer than a $100 tax credit.

ANSWER False LO 1.4

DIFFICULTY: Easy

_____ 15. A corporation incurring a net operating loss in 2019 can only carry that loss forward to offset profits in future years.

ANSWER True LO 1.5

DIFFICULTY: Moderate

_____ 16. All limited liability companies (LLCs) can file their tax returns as partnerships.

ANSWER False LO 1.5

DIFFICULTY: Moderate

_____ 17. Partnerships and S corporations are flow-through entities.

ANSWER True LO 1.5

DIFFICULTY: Easy

• / 4

Chapter 1: Introduction to Taxation 3

Short-Answer Questions: Provide a brief written answer to each of the following questions.

• Name and describe two types of taxes other than the income tax. Give an example of each.

ANSWER Wealth taxes are those taxes levied on the value of property owned by a taxpayer.Examples include real estate taxes, tangible taxes, intangible taxes, and inventory taxes.Wealth transfer taxes are those taxes levied on the value of property transferred to another. Examples are the gift, estate, and inheritance taxes. Consumption taxes are taxes levied on the value of goods or services that are purchased for consumption. Examples include sales, use, excise, and value added taxes.

LO 1.1

DIFFICULTY: Easy

• Compare a sales tax to a use tax.

ANSWER A sales tax is levied on a purchase at the point of sale regardless of the state of residence of the purchaser. A use tax is levied on a purchased item brought into a different state for use when a sales tax is not paid by the purchaser in the state where the item was purchased. Normally the sales and use taxes in a specific state are levied at identical rates.

LO 1.1

DIFFICULTY: Moderate.

• Differentiate a wealth tax from a wealth transfer tax and give an example of each.

ANSWER: A wealth tax is a tax levied on the value of a person’s possessions at a specific point in time; common wealth taxes would be real estate taxes that are levied on the owner of real property or intangible taxes on stocks. The wealth transfer tax is levied on the value of a person’s possessions that are transferred to another person; the gift and estate taxes are examples of wealth transfer taxes.

LO 1.1

DIFFICULTY: Moderate

• Compare progressive, proportional, and regressive taxes.

ANSWER The tax rate in a progressive system of taxation increases at a greater rate than the rate of increase in income. The higher the income, the greater the percentage of taxes paid. The tax in a proportional system of taxation increases at the same rate as the rate of increase in income. The percentage of taxes paid would be the same over all income levels. The tax rate in a regressive system of taxation increases at a slower rate than the rate of increase in income. The higher the income, the smaller the percentage of taxes paid.

LO 1.2

DIFFICULTY: Moderate

• What are Adam Smith’s four canons of taxation? Briefly describe each.

ANSWER Certainty—a taxpayer knows what the tax consequences of a transaction will be when the transaction is undertaken. Equity—the tax is fair relative to the taxpayer’s level of income and circumstances. Economy—the costs of administering and complying with the tax are small relative to the amount of taxes collected. Convenience—the payment of taxes is simple and easy.

LO 1.3

DIFFICULTY: Easy

• / 4

• Taxation for Decision Makers Test Bank

• Explain how horizontal equity differs from vertical equity.

ANSWER Horizontal equity would require taxpayers with similar incomes to pay a like amount of taxes. Vertical equity would require taxpayers with greater (lesser) incomes to pay a greater (lesser) amount of taxes.

LO 1.3

DIFFICULTY: Easy

• What tax provision encourages the fiduciary of an estate or a trust to distribute the income annually to

the beneficiaries?

ANSWER: The tax rates applicable to the income that a trust or an estate receives are far more progressive than any other entity; they have no 12 or 32 percent tax rates and the highest tax rate (37%) begins at $12,750 of taxable income ($12,500 in 2018).

LO 1.4 REFERENCE TABLES RECOMMENDED

DIFFICULTY: Easy

• Briefly compare a sole proprietorship to a corporation as a business entity.

ANSWER A sole proprietorship has only one owner; a corporation can have one or an unlimited number of owners. The corporation has limited liability; the sole proprietor is responsible for the liabilities of the business. There generally are few if any legal requirements to establish a sole proprietorship; a corporation must be incorporated under the laws of one of the states and can issue different classes of stock and bonds. The sole proprietor cannot take advantage of employee status, must pay self-employment taxes, and reports all results of operations on his or her own tax return. A shareholder-employee of a corporation is eligible for most employee fringe benefits and the corporation files a completely separate tax return from that of any owner. The sole proprietor is fully liable for all debts of the business; shareholders are only at risk for their capital investment and are not liable for the debts of the corporation. There are other differences as well, too numerous to mention.

LO 1.5

DIFFICULTY: Moderate

• Why are S corporations and partnerships called flow-through entities?

ANSWER S corporations and partnerships are called flow-through entities because they do not pay taxes on their incomes and gains. Instead the revenue and expense items flow through to the entity’s owners and are included in and taxed along with the owners’ other income.

LO 1.5

DIFFICULTY: Easy

• What are the fiduciary entities and how are they created?

ANSWER The two fiduciary entities are the trust and the estate. A trust is created by a grantor who places assets in trust for the benefit of another person. A trustee manages the trust assets. An estate is created anytime a person who owns or has an interest in assets subject to estate taxes dies.

LO 1.5

DIFFICULTY: Easy

• / 4