Taxation of individual and business entities 2018 edtion by spilker

2018 EDITION

TAXATION of INDIVIDUALS AND
BUSINESS ENTITIES
McGraw-Hill’s

SPILKER • AYERS • BARRICK • OUTSLAY • ROBINSON • WEAVER • WORSHAM


McGraw-Hill’s

Taxation of Individuals
and Business Entities
Brian C. Spilker
Brigham Young University
Editor

Benjamin C. Ayers

John A. Barrick

The University of Georgia

Brigham Young University

Edmund Outslay

John R. Robinson

Michigan State University

Texas A&M University

Connie D. Weaver

Ron G. Worsham

Texas A&M University

Brigham Young University


McGRAW-HILL’S TAXATION OF INDIVIDUALS AND BUSINESS ENTITIES, 2018 EDITION, NINTH EDITION
Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2018 by McGraw-Hill Education. All rights
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Dedications
We dedicate this book to:
My entire family, whose love and support helped make this book possible, and to Professor Dave Stewart for his
great example and friendship over the last three decades.
Brian Spilker
My wife, Marilyn, daughters Margaret Lindley and Georgia, son Benjamin, and parents Bill and Linda.
Ben Ayers
My wife, Jill, and my children Annika, Corinne, Lina, Mitch, and Connor.

John Barrick
My family, Jane, Mark, Sarah, Chloe, Lily, Jeff, and Nicole, and to Professor James E. Wheeler, my mentor and friend.
Ed Outslay
JES, Tommy, and Laura.
John Robinson
My family: Dan, Travis, Alix, and Alan, and to Professor Dave Stewart.
Connie Weaver
My wife, Anne, sons Matthew and Daniel, and daughters Whitney and Hayley.
Ron Worsham


About the Authors
Brian Spilker (PhD, University of Texas at Austin, 1993) is the Robert Call/Deloitte Professor
in the School of Accountancy at Brigham Young University. He teaches taxation in the graduate and undergraduate programs at Brigham Young University. He received both BS (Summa
Cum Laude) and MAcc (tax emphasis) degrees from Brigham Young University before working as a tax consultant for Arthur Young & Co. (now Ernst & Young). After his professional
work experience, Brian earned his PhD at the University of Texas at Austin. In 1996, he was
selected as one of two nationwide recipients of the Price Waterhouse Fellowship in Tax
Award. In 1998, he was a winner of the American Taxation Association and Arthur Andersen
Teaching Innovation Award for his work in the classroom; he has also been awarded for his
use of technology in the classroom at Brigham Young University. Brian researches issues relating to tax information search and professional tax judgment. His research has been published in journals such as The Accounting Review, Organizational Behavior and Human
Decision Processes, Journal of the American Taxation Association, Behavioral Research in
Accounting, Journal of Accounting Education, Journal of Corporate Taxation, and Journal of
Accountancy.

Courtesy of Brian Spilker

Ben Ayers (PhD, University of Texas at Austin, 1996) holds the Earl Davis Chair in Taxation
and is the dean of the Terry College of Business at the University of Georgia. He received a
PhD from the University of Texas at Austin and an MTA and BS from the University of
­Alabama. Prior to entering the PhD program at the University of Texas, Ben was a tax

­manager at KPMG in Tampa, Florida, and a contract manager with Complete Health, Inc., in
Birmingham, Alabama.
Ben teaches tax planning and research courses in the undergraduate and graduate programs at
the University of Georgia. He is the recipient of 11 teaching awards at the school, college, and
university levels, including the Richard B. Russell Undergraduate Teaching Award, the highest teaching honor for University of Georgia junior faculty members. His research interests
include the effects of taxation on firm structure, mergers and acquisitions, and capital markets
and the effects of accounting information on security returns. He has published articles in
journals such as The Accounting Review, Journal of Finance, Journal of Accounting and Economics, Contemporary Accounting Research, Review of Accounting Studies, Journal of Law
and Economics, Journal of the American Taxation Association, and National Tax Journal.
Ben was the 1997 recipient of the American Accounting Association’s Competitive Manuscript Award, the 2003 and 2008 recipient of the American Taxation Association’s Outstanding Manuscript Award, and the 2016 recipient of the American Taxation Association’s Ray
M. Sommerfeld Outstanding Tax Educator Award.

Courtesy Ben Ayers

iii


iv

About the Authors

Courtesy John Barrick

Courtesy Ed Outslay

John Barrick (PhD, University of Nebraska at Lincoln, 1998) is currently an associate professor in the Marriott School at Brigham Young University. He served as an accountant at the
United States Congress Joint Committee on Taxation during the 110th and 111th Congresses.
He teaches taxation in the graduate and undergraduate programs at Brigham Young University. He received both BS and MAcc (tax emphasis) degrees from Brigham Young University
before working as a tax consultant for Price Waterhouse (now PricewaterhouseCoopers).
­After his professional work experience, John earned his PhD at the University of Nebraska at

Lincoln. He was the 1998 recipient of the American Accounting Association, Accounting,
Behavior, and Organization Section’s Outstanding Dissertation Award. John researches issues
relating to tax corporate political activity. His research has been published in journals such as
Organizational Behavior and Human Decision Processes, Contemporary Accounting
­Research, and Journal of the American Taxation Association.
Ed Outslay (PhD, University of Michigan, 1981) is a professor of accounting and the Deloitte/
Michael Licata Endowed Professor of Taxation in the Department of Accounting and Information Systems at Michigan State University, where he has taught since 1981. He received a
BA from Furman University in 1974 and an MBA and PhD from the University of Michigan
in 1977 and 1981. Ed currently teaches graduate classes in corporate taxation, multiunit enterprises, accounting for income taxes, and international taxation. In February 2003, Ed testified
before the Senate Finance Committee on the Joint Committee on Taxation’s Report on Enron
Corporation. MSU has honored Ed with the Presidential Award for Outstanding Community
Service, Distinguished Faculty Award, John D. Withrow Teacher-Scholar Award, Roland H.
Salmonson Outstanding Teaching Award, Senior Class Council Distinguished Faculty Award,
MSU Teacher-Scholar Award, and MSU’s 1st Annual Curricular Service-Learning and Civic
Engagement Award in 2008. Ed received the Ray M. Sommerfeld Outstanding Tax Educator
Award in 2004 and the Lifetime Service Award in 2013 from the American Taxation Association. He has also received the ATA Outstanding Manuscript Award twice, the ATA/Deloitte
Teaching Innovations Award, and the 2004 Distinguished Achievement in Accounting Education Award from the Michigan Association of CPAs. Ed has been recognized for his community service by the Greater Lansing Chapter of the Association of Government Accountants,
the City of East Lansing (Crystal Award), and the East Lansing Education Foundation. He
received a National Assistant Coach of the Year Award in 2003 from AFLAC and was named
an Assistant High School Baseball Coach of the Year in 2002 by the Michigan High School
Baseball Coaches Association.


About the Authors

John Robinson (PhD, University of Michigan, 1981) is the Patricia ’77 and Grant E. Sims ’77
Eminent Scholar Chair in Business. Prior to joining the faculty at Texas A&M, John was the
C. Aubrey Smith Professor of Accounting at the University of Texas at Austin, Texas, and he
taught at the University of Kansas where he was the Arthur Young Faculty Scholar. In
2009–2010 John served as the Academic Fellow in the Division of Corporation Finance at the

Securities and Exchange Commission. He has been the recipient of the Henry A. Bubb Award
for outstanding teaching, the Texas Blazer’s Faculty Excellence Award, and the MPA Council
Outstanding Professor Award. John also received the 2012 Outstanding Service Award from
the American Taxation Association (ATA). John served as the 2014–2015 president (elect) of
the ATA and is the ATA’s president for 2015–2016.  John conducts research in a broad variety
of topics involving financial accounting, mergers and acquisitions, and the influence of taxes
on financial structures and performance. His scholarly articles have appeared in The Accounting Review, The Journal of Accounting and Economics, Journal of Finance, National Tax
Journal, Journal of Law and Economics, Journal of the American Taxation Association, The
Journal of the American Bar Association, and The Journal of Taxation. John’s research was
honored with the 2003 and 2008 ATA Outstanding Manuscript Awards. In addition, John was
the editor of The Journal of the American Taxation Association from 2002–2005. Professor
Robinson received his J.D. (Cum Laude) from the University of Michigan in 1979, and he
earned a PhD in accounting from the University of Michigan in 1981. John teaches courses on
individual and corporate taxation and advanced accounting.
Connie Weaver (PhD, Arizona State University, 1997) is the KPMG Professor of Accounting
at Texas A&M University. She received a PhD from Arizona State University, an MPA from
the University of Texas at Arlington, and a BS (chemical engineering) from the University of
Texas at Austin. Prior to entering the PhD Program, Connie was a tax manager at Ernst &
Young in Dallas, Texas, where she became licensed to practice as a CPA. She teaches taxation
in the Professional Program in Accounting and the Executive MBA program at Texas A&M
University. She has also taught undergraduate and graduate students at the University of Wisconsin–Madison and the University of Texas at Austin. She is the recipient of several teaching
awards, including the 2006 American Taxation Association/Deloitte Teaching Innovations
award, the David and Denise Baggett Teaching award, and the college level Association of
Former Students Distinguished Achievement award recognizing innovation in teaching taxation. Connie’s current research interests include the effects of tax and financial incentives on
corporate decisions and reporting. She has published articles in journals such as The Accounting Review, Contemporary Accounting Research, Journal of the American Taxation Association, National Tax Journal, Accounting Horizons, Journal of Corporate Finance, and Tax
Notes. She serves on the editorial board of Contemporary Accounting Research and Issues in
Accounting Education and was the 1998 recipient of the American Taxation Association’s
Outstanding Dissertation award.
Ron Worsham (PhD, University of Florida, 1994) is an associate professor in the School of
Accountancy at Brigham Young University. He teaches taxation in the graduate, undergraduate, MBA, and Executive MBA programs at Brigham Young University. He has also taught as

a visiting professor at the University of Chicago. He received both BS and MAcc (tax emphasis) degrees from Brigham Young University before working as a tax consultant for Arthur
Young & Co. (now Ernst & Young) in Dallas, Texas. While in Texas, he became licensed to
practice as a CPA. After his professional work experience, Ron earned his PhD at the University of Florida. He has been honored for outstanding innovation in the classroom at Brigham
Young University. Ron has published academic research in the areas of taxpayer compliance
and professional tax judgment. He has also published legal research in a variety of areas. His
work has been published in journals such as Journal of the American Taxation Association,
The Journal of International Taxation, The Tax Executive, Tax Notes, The Journal of Accountancy, and Practical Tax Strategies.

Courtesy John Robinson

Courtesy Connie Weaver

Courtesy Ron Worsham

v


TEACHING THE CODE IN CONTEXT

The basic approach to teaching taxation hasn’t changed in decades. Today’s
student deserves a new approach. McGraw-Hill’s Taxation of Individuals
and Business Entities is a bold and innovative series that has been adopted
by over 300 schools across the country.
McGraw-Hill’s Taxation is designed to provide
a unique, innovative, and engaging learning experience for students studying taxation. The
breadth of the topical coverage, the storyline
approach to presenting the material, the emphasis on the tax and nontax consequences of
multiple parties involved in transactions, and
the integration of financial and tax accounting
topics make this book ideal for the modern tax

curriculum.
“A lot of thought and planning went into the structure and content of the text, and a great product
was achieved. One of the most unique and helpful features is the common storyline throughout
each chapter.”
– Raymond J. Shaffer,
Youngstown State University

“This is the best tax book on the market. It’s very
readable, student-friendly, and provides great
supplements.”
– Ann Esarco,
McHenry County College

Since the first manuscript was written in
2005, 437 professors have contributed 478
book reviews, in addition to 26 focus groups
and symposia. Throughout this preface, their
comments on the book’s organization, pedagogy, and unique features are a testament to
the market-driven nature of Taxation’s
development.

“The Spilker text, in many ways, is a more logical approach than any other tax textbook. The text makes
great use of the latest learning technologies through Connect and LearnSmart.”
– Ray Rodriguez, Southern Illinois University–Carbondale

vi


A MODERN APPROACH
FOR TODAY’S STUDENT

“This text provides a new approach to the teaching of the technical material. The style of the text material
is easier to read and understand. The examples and storyline are interesting and informative. The arrangement
makes more sense in the understanding of related topics.”
– Robert Bertucelli, Long Island University–Post

Spilker’s taxation series was built around the following five core precepts:

1
Storyline
Approach: Each chapter begins with a storyline that introduces a set of characters or
a business entity facing specific tax-related situations. Each chapter’s examples are related to
the storyline, providing students with opportunities to learn the code in context.
Integrated
Examples: In addition to provid2
ing examples in-context, we provide
“What if ” scenarios within many examples
to illustrate how variations in the facts
might or might not change the answers.

“Excellent text; love the story line approach and
integrated examples. It’s easy to read and understand explanations. The language of the text is very
clear and straightforward.”
– Sandra Owen, Indiana University–Bloomington

Conversational
Writing Style: The authors took special care to write McGraw-Hill’s Taxation in
3
a way that fosters a friendly dialogue between the content and each individual student. The
tone of the presentation is intentionally conversational—creating the impression of speaking
with the student, as opposed to lecturing to the student.

Superior
Organization of Related Topics:
4
“I believe it breaks down complex topics in a way
McGraw-Hill’s Taxation provides two althat’s easy to understand. Definitely easier than
ternative topic sequences. In the McGrawother tax textbooks that I’ve had experience with.”
Hill’s Taxation of Individuals and Business
– Jacob Gatlin, Athens State University
Entities volume, the individual topics generally follow the tax form sequence, with
an individual overview chapter and then chapters on income, deductions, investment-related
issues, and the tax liability computation. The topics then transition into business-related topics
that apply to individuals.  This volume then provides a group of specialty chapters dealing with
topics of particular interest to individuals (including students), including separate chapters on
home ownership, compensation, and retirement savings and deferred compensation. This volume
concludes with a chapter covering the taxation of business entities. Alternatively, in the
­Essentials of Federal Taxation volume, the topics follow a more traditional sequence, with
­topics streamlined (no specialty chapters) and presented in more of a life-cycle approach. 
Real-World
Focus: Students learn best when they see how concepts are applied in the real world.
5
For that reason, real-world examples and articles are included in “Taxes in the Real World”
boxes throughout the book. These vignettes demonstrate current issues in taxation and show
the relevance of tax issues in all areas of business.
vii


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73% of instructors who use
Connect require it; instructor
satisfaction increases by 28% when
Connect is required.

Analytics
Connect Insight®
Connect Insight is Connect’s new oneof-a-kind visual analytics dashboard that
provides at-a-glance information regarding
student performance, which is immediately
actionable. By presenting assignment,
assessment, and topical performance results
together with a time metric that is easily
visible for aggregate or individual results,
Connect Insight gives the user the ability to
take a just-in-time approach to teaching and
learning, which was never before available.
Connect Insight presents data that helps

instructors improve class performance in a
way that is efficient and effective.

Using Connect improves retention
rates by 19.8%, passing rates by
12.7%, and exam scores by 9.1%.


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SmartBook®
Proven to help students improve grades and
study more efficiently, SmartBook contains the
same content within the print book, but actively
tailors that content to the needs of the individual.
SmartBook’s adaptive technology provides precise,
personalized instruction on what the student
should do next, guiding the student to master
and remember key concepts, targeting gaps in
knowledge and offering customized feedback,
and driving the student toward comprehension

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ONLINE ASSIGNMENTS
Connect helps students learn more efficiently by providing feedback and practice
material when they need it, where they
need it. Connect grades homework automatically and gives immediate feedback
on any questions students may have
missed. The extensive assignable, gradable
end-of-chapter content includes a general
journal application that looks and feels
more like what you would find in a general
ledger software package. Also, select questions have been redesigned to test students’
knowledge more fully. They now include
tables for students to work through rather than requiring that all calculations be done offline.
End-of-chapter questions in Connect include:
∙Discussion Questions
∙Problems
∙Comprehensive Problems (Available in the Auto-graded Tax Forms!)
Auto-Graded Tax Forms
The auto-graded Tax Forms  in Connect provide a much-improved student experience when
­solving the tax-form based problems. The tax form simulation allows students to apply tax concepts by completing the actual tax forms online with automatic feedback and grading for both

students and instructors.

x


Guided Examples
The Guided Examples in Connect provide a narrated, animated, step-by-step walk-through of select
problems similar to those assigned. These short presentations can be turned on or off by instructors
and provide reinforcement when students need it most.

McGraw-Hill Customer Experience Group Contact Information
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TaxACT®

McGraw-Hill’s Taxation can be packaged with tax software from TaxACT, one of the
leading preparation software companies in the market today. The 2017 edition includes availability of both Individuals and Business Entities software, including the 1040 Forms and
TaxACT Preparer’s Business 3-Pack (with Forms 1065, 1120, and 1120S).
Roger’s CPA

McGraw-Hill Education has partnered with Roger CPA Review, a global leader
in CPA Exam preparation, to provide students a smooth transition from the accounting classroom to successful completion of the CPA Exam. While many aspiring accountants wait until they
have completed their academic studies to begin preparing for the CPA Exam, research shows that those who become familiar with exam content earlier in the process have a stronger chance of successfully passing the CPA
Exam. Accordingly, students using these McGraw-Hill materials will have access to sample CPA Exam MultipleChoice questions and Task-based Simulations from Roger CPA Review, with expert-written explanations and solutions. All questions are either directly from the AICPA or are modeled on AICPA questions that appear in the
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www.rogercpareview.com.

xi


A STORYLINE APPROACH THAT WILL
RESONATE WITH STUDENTS
Each chapter begins with a storyline that
introduces a set of characters facing
­specific tax-related situations. This revolutionary approach to teaching tax emphasizes real people facing real tax
dilemmas. Students learn to apply practical tax information to specific business
and personal situations. As their situations
evolve, the characters are brought further
to life.

Storyline Summary

© Image Source

C

ourtney has already determined her
taxable income. Now she’s working
on computing her tax liability. She

Taxpayers:

Courtney Wilson, age 40,
Courtney’s mother Dorothy “Gram” Weiss,
age 70

Family

description:

Courtney is divorced with a son, Deron,
age 10, and a daughter, Ellen, age 20.
Gram is currently residing with Courtney.

Location:

Kansas City, Missouri

Employment
status:

Courtney works as an architect for EWD.
Gram is retired.

Filing status:

Courtney is head of household. Gram is
single.

Current
situation:

Courtney and Gram have computed their
taxable income. Now they are trying to
determine their tax liability, tax refund
or additional taxes due, and whether they
owe any payment-related penalties.

knows she owes a significant amount of regular income tax on her employment and business activities. However, she’s not sure how to
compute the tax on the qualified dividends she received from General Electric. Courtney is worried

during the year to avoid underpayment penalties.

that she may be subject to the alternative minimum

She’s planning on filing her tax return and paying

tax this year because she’s heard that an increasing

her taxes on time.

number of taxpayers in her income range must pay

Gram’s tax situation is much more straight-

the tax. Finally, Courtney knows she owes some self-

forward. She needs to determine the regular income tax

employment taxes on her business income. Courtney

on her taxable income. Her income is so low she knows

would like to determine whether she is eligible to

she need not worry about the alternative minimum tax,

claim any tax credits such as the child tax credit for

and she believes she doesn’t owe any self-employment

her two children and education credits because she

tax. Gram didn’t prepay any taxes this year, so she is

paid for a portion of her daughter Ellen’s tuition at

concerned that she might be required to pay an under-

the University of Missouri–Kansas City this year.

payment penalty. She also expects to file her tax return

Courtney is hoping that she has paid enough in taxes

and pay her taxes by the looming due date.

“The text provides very useful tools that
students can read and understand, making
it easier to break the myth that ‘tax is
hard.’”

to be continued . . .

Examples
Examples are the cornerstone of
any textbook covering taxation.
For this reason, McGraw-Hill’s

Taxation authors took special care
to create clear and helpful examples that relate to the storyline
of  the chapter. Students learn to
refer to the facts presented in the
storyline and apply them to other
­scenarios—in this way, they build
a greater base of knowledge
through application. Many examples also include “What if?” scenarios that add more complexity
to the example or explore related
tax concepts.

– Daniel Hoops, Walsh College
“I absolutely love this textbook. This textbook makes my job of teaching so much
easier.”

8-1

– Chuck Pier, Angelo State University
2-4

CHAPTER 2

Tax Compliance, the IRS, and Tax Authorities

The statute of limitations for IRS assessment can be extended in certain circumstances.
For example, a six-year statute of limitations applies to IRS assessments if the taxpayer
omits items of gross income that exceed 25 percent of the gross income reported on the tax
return. For fraudulent returns, or if the taxpayer fails to file a tax return, the news is understandably worse. The statute of limitations remains open indefinitely in these cases.

spi11838_ch08_000-055.indd 1

“The case study approach is excellent as you follow the taxpayers
through the chapters.”
– Irwin Uhr, Hunter College
xii

1/13/17 8:44 PM

Example 2-1
Bill and Mercedes file their 2013 federal tax return on September 6, 2014, after receiving an automatic extension to file their return by October 15, 2014. In 2017, the IRS selects their 2013 tax return
for audit. When does the statute of limitations end for Bill and Mercedes’s 2013 tax return?
Answer: Assuming the six-year and “unlimited” statute of limitation rules do not apply, the statute
of limitations ends on September 6, 2017 (three years after the later of the actual filing date and the
original due date).
What if: When would the statute of limitations end for Bill and Mercedes for their 2013 tax return if the
couple filed the return on March 22, 2014 (before the original due date of April 15, 2014)?
Answer: In this scenario the statute of limitations would end on April 15, 2017, because the later of
the actual filing date and the original due date is April 15, 2014.

Taxpayers should prepare for the possibility of an audit by retaining all supporting documents (receipts, cancelled checks, etc.) for a tax return until the statute of limitations expires. After the statute of limitations expires, taxpayers can discard the majority of supporting
documents but should still keep a copy of the tax return itself, as well as any documents that
may have ongoing significance, such as those establishing the taxpayer’s basis or original
investment in existing assets like personal residences and long-term investments.
LO 2-2

IRS AUDIT SELECTION
Why me? This is a recurring question in life and definitely a common taxpayer question after
receiving an IRS audit notice. The answer, in general, is that a taxpayer’s return is selected
for audit because the IRS has data suggesting the taxpayer’s tax return has a high probability
of a significant understated tax liability. Budget constraints limit the IRS’s ability to audit a

majority or even a large minority of tax returns. Currently, fewer than 1 percent of all tax
returns are audited. Thus, the IRS must be strategic in selecting returns for audit in an effort
to promote the highest level of voluntary taxpayer compliance and increase tax revenues.
Specifically, how does the IRS select tax returns for audit? The IRS uses a number of
computer programs and outside data sources (newspapers, financial statement disclosures, informants, and other public and private sources) to identify tax returns that may
have an understated tax liability. Common computer initiatives include the DIF (Discriminant Function) system, the document perfection program, and the information
matching program. The most important of these initiatives is the DIF system. The DIF
system assigns a score to each tax return that represents the probability the tax liability on


THE PEDAGOGY YOUR STUDENTS NEED
TO PUT THE CODE IN CONTEXT

CHAPTER 1

TAXES IN THE REAL WORLD

An Introduction to Tax

1-3

Republicans vs. Democrats
CHAPTER 1

Tax Policy: Republicans versus Democrats

An Introduction to Tax

Democrats

Taxes in the Real World are short boxes used
throughout the book to demonstrate the real-world
Margaret
travels to Birmingham,
where she rents a hotel room and dines at several restauuse of tax concepts. Current
articles
on taxAlabama,
issues,
rants. The price she pays for her hotel room and meals includes an additional 2 percent city surcharge
the real-world applicationto fund
of roadway
chapter-specific
tax
construction in Birmingham.
Is this a tax?
Answer: Yes. The payment is required by a local government and does not directly relate to a specific
rules, and short vignettes on
popular
news
about
tax
benefit that Margaret receives.
are some of the issues covered in Taxes in the Real
World boxes.
Oliver Wendell Holmes said “taxes are the price
we pay to live in a civilized society.” Both Democrats and Republicans desire the same things: a
civilized society and a healthy economy. However, neither party can agree on what defines a
civilized society or which path best leads to a
healthy economy. The U.S. national debt is
$20 trillion dollars and growing, yet the only thing

we might agree on is that something has gone
wrong. Regardless of which party or candidate
you support, each party’s agenda will affect your
income and taxes in various ways.
To explore the divide, let’s examine excerpts
from each party’s National Platform from our most
recent presidential election (2016).

1-5

“At a time of massive income and wealth inequality, we believe the wealthiest Americans and largest corporations must pay their fair share of
taxes. Democrats will claw back tax breaks for
companies that ship jobs overseas, eliminate tax
breaks for big oil and gas companies, and crack
down on inversions and other methods companies use to dodge their tax responsibilities … We
will then use the revenue raised from fixing the
corporate tax code to reinvest in rebuilding
America and ensuring economic growth that will
lead to millions of good-paying jobs.”
“We will ensure those at the top contribute to
our country’s future by establishing a multimillionaire surtax to ensure millionaires and billionaires
pay their fair share. In addition, we will shut down
Republicans
the “private tax system” for those at the top, im“We areand
the party
a growing economy
mediately close egregious loopholes like those
Margaret’s parents, Bill and Mercedes, recently built a house
wereofassessed
$1,000that

by their
gives everyone a chance in life, an opportunity to
enjoyed by hedge fund managers, restore fair
county government to connect to the county sewer system.
Is
this
a
tax?
learn, work, and realize the prosperity freedom
taxation on multimillion dollar estates, and ensure
Answer: No. The assessment was mandatory and it wasmakes
paid possible.”
to a local government. However, millionaires
the
can no longer pay a lower rate than
“Government cannot create prosperity, their secretaries. At a time of near-record corpothird criterion was not met since the payment directly relates to a specific benefit (sewer service)
though government can limit or destroy it. Pros- rate profits, slow wage growth, and rising costs,
received by the payees. For the same reason, tolls, parkingperity
meter
and
annual licensing
fees we
areneed to offer tax relief to middle-class
is thefees,
product
of self-discipline,
enterprise,
saving and investment by individuals, but it is not
also not considered taxes.
families—not those at the top.”

an end in itself. Prosperity provides the means by
“We will offer tax relief to hard working, middlewhich citizens and their families can maintain class families for the cost squeeze they have
their independence from government, raise their faced for years from rising health care, childcare,
children by their own values, practice their faith,
1-3expenses.” https://www
education, andLO
other
and build communities of cooperation and mu- .democrats.org/party-platform#preamble
tual respect.”
“Republicans consider the establishment of Conclusion
Each party fundamentally believes the governa pro-growth tax code a moral imperative.
More than any other public policy, the way gov- ment should create/maintain cities and states that
form a civilized society, and that government
ernment raises revenue—how much, at what
should foster a healthy economy. However, they
rates, under what  circumstances, from whom,
and for whom—has the greatest impact on our choose very different paths to reach this objececonomy’s performance. It powerfully influ- tive. Democrats want to raise taxes on the
wealthy and createTHE
government
which
KEYprograms
FACTS
ences the level of economic growth and job
creation, which translates into the level of op- cost more money, while Republicans wish to
How to government
Calculate asize
Taxand
lower taxes and decrease
portunity for those who would otherwise be left
spending. Both •

motives
curbehind.”
Tax =are
Taxpure;
basehowever,
× Tax rate
“A strong economy is one key to debt reduc- rent and cumulative deficits indicate that current
• The tax base defines what
tion, but spending restraint is a necessary com- revenue is insufficient to meet government
actually
taxed will
andrequire
is
problems
ponent that must be vigorously pursued.” https:// spending. Solving isthese
research/informausuallyand
expressed
in
www.gop.com/platform/restoring-the-american- civil discourse, education
tion
in
order
to
find
realistic,
effective
solutions.
dream/
monetary terms.

Example 1-1

Example 1-2

“The Spilker text makes tax easy for students to understand. It integrates great real-world examples so
­students can see how topics will be applied in practice.
The integration of the tax form and exhibits of the tax
forms in the text are outstanding.”
HOW TO CALCULATE A TAX

its simplest
form,Tech
the amount
of tax equals the tax base multiplied by the tax rate:
– Kristen In
Bigbee,
Texas
University
Eq. 1-1

Tax = Tax Base × Tax Rate

THE KEY FACTS
What Qualifies
as a Tax?

The tax base defines what is actually taxed and is usually expressed in monetary
The Key Facts
terms, whereas the tax rate determines the level of taxes imposed on the tax base and is
The Key Facts pro- usually expressed as a percentage. For example, a sales tax rate of 6 percent on a purchase

of $30 yields a tax of $1.80 ($1.80 = $30 × .06).
vide quick synopses
Federal, state, and local jurisdictions use a large variety of tax bases to collect tax.
of the critical pieces Some common tax bases (and related taxes) include taxable income (federal and state
income taxes), purchases (sales tax), real estate values (real estate tax), and personal
of information pre- property values (personal property tax).
• The tax rate determines
portions of a tax base may be taxed at different rates. A single tax applied
the level of taxes imposed
sented throughout to anDifferent
summary, taxes
affect the
manybase
aspects
of personal, business, and political decisions.
entire base constitutes a flat tax. In the case ofIngraduated
taxes,
is divided
on the
andinformed
is
Developing a solid understanding of taxation should allow
youtaxtobase
make
into a series of monetary amounts, or brackets, and
eachin successive
bracket
is taxed
at comfort
a

each chapter.
usually
a likely
decisions
these areas. Thus,
Margaret
can take
that
her expressed
semester as
will
Tax Compliance, the IRS, and Tax Authorities
2-7
percentage.
different (gradually higher or gradually lower) percentage
prove useful rate.
to her personally. Who knows? Depending on
her interest in business,
investment, retirement
planning, for
and example—
the like, she may ultimately
a
• Different decide
portionstoof pursue
a
Calculating some taxes—income taxes for individuals
or corporations,
IRS Appeals/Litigation
career inProcess

taxation.
tax base may be taxed
Exhibits
can be quite complex. Advocates of flat taxes argue
that the
process should be simpler. But
IRS Exam
at different rates.
1a. Agree with proposed
1b. Disagree with
as we’ll seelearners,
throughout the text, most of the difficulty
in calculating proposed
a taxadjustment
rests in determinadjustment
Today’s students are visual
ing the tax base, not the tax rate. Indeed, there are only three basic tax rate structures (proTaxes Due
30-Day Letter
and McGraw-Hill’s Taxation
delivers
portional, progressive,
and regressive),Payand
each can be mastered without much
difficulty.

• The general purpose of
taxes is to fund government agencies.
• Unlike fines or penalties,
taxes are not meant to
punish or prevent illegal

behavior; however, “sin
taxes” are meant to discourage some behaviors.
• To qualify as a tax, three
criteria must be met. The
payment must be:
• required;
• imposed by a
government;
• and not tied directly to
the benefit received by
the taxpayer.

by making appropriate use of charts,
DIFFERENT WAYS TO MEASURE TAX RATES
diagrams, and tabular demonstrations
Before we discuss the alternative tax rate structures, let’s first define three different tax
of key material.
rates that will be useful in contrasting the different tax rate structures: the marginal,
spi11838_ch01_000-029.indd 3 3a. Agree with proposed
adjustment

2a. Request appeals

Appeals Conference

2b. No
taxpayer

3b. Disagree with proposed adjustment

90-Day Letter
or U.S. Court of
5. IRS denies
Refund with the IRS
average, and effective tax rates. CourtFederal
Claims
refund claim
4b. Pay tax
The marginal tax rate is the tax rate that applies to the next additional increment of
a taxpayer’s taxable income (or deductions). Specifically,
4a. Do not pay tax;
Petition Tax Court

Marginal Tax Rate =

“A good textbook that uses great
­examples throughout the chapters
to
Eq. 1-2
give a student an understanding of theΔTaxable Income (New Taxable Income − Old Taxable Income)
*Δ means change in.
tax theory and how it applies to the
“Spilker’s use of examples immediately following the
taxpayers.”
concept is a great way to reinforce the concepts.”
– Jennifer Wright,
– Karen Wisniewski, County College of Morris
Drexel University
x Court

IRS Exam: © Royalty-Free/Corbis, Supreme Court: © McGraw-Hill Education/Jill Braaten, photographer, File Claim: © Michael A. Keller/Corbis

spi11838_ch01_000-029.indd 5
CHAPTER 2

response
File Suit in U.S. District

Claims to interpret and rule differently on the same basic tax issue. Given a choice of
courts, the taxpayer should prefer the court most likely to rule favorably on his or her
particular issues. The courts also differ in other ways. For example, the U.S. District
Court is the only court that provides for a jury trial; the U.S. Tax Court is the only court
that allows tax cases to be heard before the taxpayer pays the disputed liability and the
only court with a small claims division (hearing claims involving disputed liabilities of
$50,000 or less); the U.S. Tax Court judges are tax experts, whereas the U.S. District
Court and U.S. Court of Federal Claims judges are generalists. The taxpayer should consider each of these factors in choosing a trial court. For example, if the taxpayer feels very
confident in her tax return position but does not have sufficient funds to pay the disputed
liability, she will prefer the U.S. Tax Court. If, instead, the taxpayer is litigating a tax return position that is low on technical merit but high on emotional appeal, a jury trial in
the local U.S. District Court may be the best option.
What happens after the taxpayer’s case is decided in a trial court? The process may
not be quite finished. After the trial court’s verdict, the losing party has the right to request one of the 13 U.S. Circuit Courts of Appeals to hear the case. Exhibit 2-3 depicts
the specific appellant courts for each lower-level court. Both the U.S. Tax Court and local
U.S. District Court cases are appealed to the specific U.S. Circuit Court of Appeals based
on the taxpayer’s residence.9 Cases litigated in Alabama, Florida, and Georgia, for example,

19/01/17 2:11 PM

xiii

Decisions rendered by the U.S. Tax Court Small Claims Division cannot be appealed by the taxpayer or the IRS.

9

File Claim for

EXHIBIT 2-2

Ta

spi11838_ch02_000-035.indd 7

01/11/17 9:25 PM


the appeals officer may consider the hazards of litigation. Accordingly, Bill and Mercedes
have a good likelihood of a favorable resolution at the appeals conference.
In this chapter we discussed several of the fundamentals of tax practice and procedure: taxpayer filing requirements, the statute of limitations, the IRS audit process, the
primary tax authorities, tax research, tax professional standards, and taxpayer and tax
practitioner penalties. For the tax accountant, these fundamentals form the basis for much
of her work. Likewise, tax research forms the basis of much of a tax professional’s compliance and planning services. Even for the accountant who doesn’t specialize in tax accounting, gaining a basic understanding of tax practice and procedure is important.
Assisting clients with the IRS audit process is a valued service that accountants provide,
and clients expect all accountants to understand basic tax procedure issues and how to
research basic tax issues.

PRACTICE MAKES PERFECT WITH A

Summary
Identify the filing requirements for income tax returns and the statute of limitations for
A unique feature of McGraw-Hill’s
assessment.

Taxation is the end-of-chapter sum• All corporations must file a tax return annually regardless of their taxable income. Estates
and trusts are required to file annual income tax returns if their gross income exceeds
mary organized around learning
$600. The filing requirements for individual taxpayers depend on the taxpayer’s filing
status, age, and gross income.
­objectives. Each objective has a
• Individual and C corporation tax returns (except for C corporations with a June 30 year-end)
are due on the fifteenth day of the fourth month following year-end. For C corporations
brief, bullet-point summary that
with a June 30 year-end, partnerships and S corporations, tax returns must be filed by the
fifteenth day of the third month following the entity’s fiscal year-end. Any taxpayer unable
covers the major topics and conto file a tax return by the original due date can request an extension to file.
• For both amended tax returns filed by a taxpayer and proposed tax assessments by the
cepts for that chapter, including
IRS,the
theIRS,
statute
of limitations
generally ends three years from the later of (1) the date the
Tax Compliance,
and
Tax Authorities
chapter
tax return was actually filed or (2) the tax return’s original due date.
Tax
Compliance,
­references to critical exhibits and
Outline the IRS audit process, how returns are selected, the different types of audits, and what
happens after the audit.
the IRS, and Tax

examples. All end-of-chapter mate• The IRS uses a number of computer programs and outside data sources to identify tax
Authorities
returns that may have
an understated tax liability. Common computer initiatives include the
rial
Statements on Standards for
Taxis tied to learning objectives.
information matching program (2-4)
DIF (Discriminant Function) system, the document perfection program, and the information

Summary

LO 2-1

2-30

CHAPTER 2

KEY TERMS

LO 2-2

2

30-day letter (2-6)
Services (SSTS) (2-23)
matching
program.Revenue Code of 1986 (2-11)
Internal
90-day letter (2-6)

• The three types of IRS audits consist of correspondence, office,statute
and field examinations.
of limitations (2-3)
interpretative
regulations
(2-16)
acquiescence (2-17)
• After the audit, the IRS will send the taxpayer a 30-day letter, which provides the taxpayer
substantial
authority (2-24)
legislative
regulations
action on decision (2-17)
the opportunity
to pay
the proposed(2-16)
assessment or request an
appeals conference.
If an agreement is not reached at appeals or the taxpayer does
pay the proposed
taxnottreaties
(2-14)
nonacquiescence
(2-17)
annotated tax service (2-18)
Learning Objectives
technical advice memorandum
(2-16)
office examination (2-6)
Circular 230 (2-24)

“You
can tell the authors of this textUpon completing this chapter, you should be able to:
temporary
regulations
(2-15)
primary
authorities
(2-9)
citator (2-21)
book are still in the classroom and
LO 2-1 private
Identify theletter
filing requirements
for income
tax returns and the statute topical
of limitationstax
for service (2-19)
rulings
(2-16)
civil penalties (2-26)
assessment.
­responsible for the day-to-day
U.S. Circuit Courts of Appeals (2-7)
procedural regulations (2-16)
correspondence examination (2-5)
LO 2-2 Outline the IRS audit process, how returns are selected, the different types of audits, and
U.S. Constitution (2-11) ­education of accounting students.
what happens after
the audit.
proposed

regulations
(2-15)
criminal
penalties (2-26)
01/11/17 2:51 PM
spi11838_ch02_000-035.indd 28
U.S. Court of Federal Claims
(2-6)
LO 2-3 question
Evaluate the relative
weights
of the various tax law sources.
of fact
(2-19)
determination letters (2-16)
­Examples
are representative of the
U.S.
District
Court
(2-6)
LO
2-4
Describe
the
legislative
process
as
it
pertains

to
taxation.
question
of
law
(2-19)
DIF (Discriminant Function)
end-of-chapter problems, and the
U.S.when
Supreme
Court (2-8)
system (2-4)
LO 2-5 regulations
Perform the basic steps
in tax research and evaluate various tax law sources
faced
(2-15)
with ambiguous statutes.
end-of-chapter summary is an excellent
U.S. Tax Court (2-6)
document perfection program (2-4)
revenue procedures (2-16)
LO 2-6 Describe tax professional responsibilities in providing tax advice.
study tool.”
writ of certiorari (2-8)
field examination (2-6)
revenue rulings (2-16)
LO 2-7 Identify taxpayer and tax professional penalties.
final regulations (2-15)
secondary authorities (2-9)

– Debra Petrizzo, Franklin University
Golsen rule (2-15)
stare decisis (2-15)

DISCUSSION QUESTIONS
Discussion Questions are available in Connect®.

1. Name three factors that determine whether a taxpayer is required to file a tax
return.
2. Benita is concerned that she will not be able to complete her tax return by April 15.
LO 2-1
Can she request an extension to file her return? By what date must she do so?
Assuming she requests an extension, what is the latest date that she could file
her return this year without penalty?
3. Agua Linda Inc. is a calendar-year corporation. What is the original due date for
LO 2-1
the corporate tax return? What happens if the original due date falls on a
Saturday?
4. Approximately what percentage of tax returns does the IRS audit? What are the
LO 2-2
implications of this number for the IRS’s strategy in selecting returns for audit?
5. Explain
the difference
between the
system and the
National
LO 2-2 is a very
“This
readable
text. Students

willDIF
understand
it on
theirResearch
own, Program.
How do they relate to each other?
generally, freeing more class time for application, practice, and student
6. Describe the differences between the three types of audits in terms of their scope
LO 2-2
questions.” and taxpayer type.
7. Simon just received a 30-day letter from the IRS indicating a proposed assessment.
LO 2-2
– Valrie
Chambers,
Does he have to pay the additional tax? What are his
options?
Texas
A&M
University–Corpus
Christi
8.
Compare
and
contrast
the
three
trial-level
courts.
LO 2-2
9. Compare and contrast the three types of tax law sources and give examples of

LO 2-3
each.
10. The U.S. Constitution is the highest tax authority but provides very little in the
LO 2-3
way of tax laws. What are the next highest tax authorities beneath the U.S.
Constitution?
11. Jackie has just opened her copy of the Code for the first time. She looks at the
LO 2-3
xiv
table of contents and wonders why it is organized the way it is. She questions
whether it makes sense to try and understand the Code’s organization. What are
LO 2-1

spi11838_ch02_000-035.indd 1

01/11/17 2:50 PM

Discussion
Questions
Discussion questions,
now available in Connect, are provided for
each of the major concepts in each chapter,
providing students
with an opportunity
to review key parts of
the chapter and answer
evocative questions
about what they have
learned.

b) As a salesperson, Alyssa incurred $2,000 in travel expenses related to her
employment that were not reimbursed by her employer.
c) The Johnsons own a piece of raw land held as an investment. They paid $500 of
real property taxes on the property and they incurred $200 of expenses in travel
37.costs
Levitoissee
recommending
a tax
position
to his client.
What
standard must he
LO 2-6
the property and
to return
evaluate
other similar
potential
investment
meet to satisfy his professional standards? What is the source of this professional
properties.
standard?
d) The Johnsons own a rental home. They incurred $8,500 of expenses associated
38.with
What
Circular 230?
LO 2-6
theisproperty.
39.

What
are the home
basic differences
between
civil the
andOffice
criminal
tax store
penalties?
LO 2-7
e) The
Johnsons’
was only five
miles from
Depot
where
inof
January
andcommon
February.civil
Thepenalties
ST store imposed
was 60 miles
from their
40.Alyssa
What worked
are some
the most
on taxpayers?
LO 2-7

home,
so
the
Johnsons
decided
to
move
to
make
the
commute
easier
for
Alyssa.
41. What are the taxpayer’s standards to avoid the substantial understatement
of tax
LO 2-7
The
Johnsons’ new home was only 10 miles from the ST store. However, their
penalty?
new home was 50 miles from their former residence. The Johnsons paid a mov42. What are the tax practitioner’s standards to avoid a penalty for recommending a tax
LO 2-7
ing company $2,002 to move their possessions to the new location. They also
return position?
drove the 50 miles to their new residence. They stopped along the way for
lunch and spent $60 eating at Denny’s. None of the moving expenses were
2-34 CHAPTER 2
Tax Compliance, reimbursed
the IRS, and Tax
byAuthorities

ST.
PROBLEMS
f) Jeremy paid $4,500 for health insurance coverage for himself (not through an
66. Georgette
has identified
a 1983
court
that
to answer
LO 2-5
® plans
exchange).
Alyssa
covered
bycase
health
provided
by her her
employer, but
Select
problems
are was
available
in Connect
. appears
research question.
must
she plan
do tountil
determine

if the case still represents
Jeremy is not What
eligible
for the
next year.
43.
Ahmed
does
not have
enough cash ontaxes
hand($1,250
to pay his
taxes. He
excited to hear
LO 2-1 “current”
law?
g) Jeremy
paid
$2,500
in self-employment
represents
thewas
employer
thatdetermined
heofcan
to
file his depends
tax return.
Does
solve his problem?

67. Sandyportion
has
thatan
herextension
research
question
upon
thethis
interpretation
LO 2-5
therequest
self-employment
taxes).
What are
the
ramifications
ifinsurance.”
he doesn’t pay
histype
tax of
liability
by April
15?
of the
phrase
“not
compensated
by
What
research

question
h) Jeremy paid $5,000 in alimony and $3,000 in child support from his prior
44.marriage.
Molto Stancha Corporation had zero earnings this fiscal year; in fact, it lost money.
LO 2-1 is this?
Must
the
corporation
file
a
tax
return?
68. J. C.i) has
beenpaid
a professional
gambler
many
years.night
He loves
thisatline
of work
and
LO 2-5
Alyssa
$3,100 of tuition
andforfees
to attend
classes
a local
university.

theJohnsons
incomeofwould
isMonique
tax-free.
45.The
The
estate
Chablis
$450
of income
this year.
Is the rather
estate
LO 2-1 believes
like to
deductearned
as much
of this
expenditure
as possible
research
required
file
income
tax return?
claim to
a credit.
a) Usethan
an
available

tax an
research
service
to determine whether J. C.’s thinking is
correct.
Is the answer
to this
question
found
in thecharity.
Internal
Code? Ifjob. He had
46.
Jamarcus,
a full-time
student,
$2,500
this yearRevenue
from a summer
LO 2-1
j) The
Johnsons
donated
$2,000
to earned
their
favorite
not, what
typeincome
of authority

answers
this question?
no other
this year
and will
have zero federal income tax liability this year.
70. Shauna Coleman is single. She is employed as an architectural designer for StreamHis
employer
withheld $300
of
federal
income
tax from his summer pay. Is
b)
Write
a
memo
communicating
the
results
of
your
research.
line Design (SD). Shauna wanted to determine her taxable income for this year. She
tax forms
Jamarcus
file
a tax return?
Should
Jamarcus

a tax
return?
69. Katie
recently
wonrequired
a ceramic
dalmatian
valued
at $800
onhow
a television
game
LO 2-5
correctly
calculated
her to
AGI.
However,
she wasn’t
sure
to file
compute
the
rest of
47.
Shane
has
never
filed
a tax

return
despitesince
earning
excessive
sums
of money
LO 2-1 show. She
questions
whether
this
prize
taxable
it was
awith
“gift”
she won
her taxable
income.
She
provided
theisfollowing
information
hopes
that
you as a
research
gambler.
When
does
the

statute
of
limitations
expire
for
the
years
in
which
Shane
on the
show.
could use it to determine her taxable income.
hasavailable
not paid
filedtax
a tax
return?
a) Use
research
serviceexpenses
to answer
question.
a) an
Shauna
$4,680
for medical
forKatie’s
care from
a broken ankle. Also,

48. Shauna’s
Latoya
her tax
returndrove
on February
10
year.aresearch.
When
statute
LO 2-1 b) Write
boyfriend,
Blake,
Shauna
(in this
her
car)
total ofwill
115the
miles
to theof limitaa letterfiled
to
Katie
communicating
the results
of your
tions expire
forsothis
tax return?
doctor’s
office

receive
care for
ankle.He was upset
70. Pierre recently
received
ashe
taxcould
penalty
for failing
to her
file broken
a tax return.
LO 2-5
b) Shauna
paid
a
total
of
$3,400
in
health
insurance
premiums
during
the
year
49.
Using
the
facts

from
the
previous
problem,
how
would
your
answer
change
LO 2-1 to receive
the penalty, but he was comforted by the thought that he will get a tax (notif
through
an exchange).
SDincome
did notby
reimburse
any How
of thiswould
expense.
Latoya
understated
her
40 percent?
yourBesides
answerthe
change if
research
deduction
for paying
the penalty.

Latoya
intentionally
failed
to report
as taxableif income
cash payments she
a) Use an
available
tax research
service
to determine
Pierre isany
correct.
received from her clients?
b) Write a memo communicating the results of your research.
50. Paula could not reach an agreement with the IRS at her appeals conference and has
LO 2-2
71. Paris was
to provide
a contribution
to her to
friend
Nicole’s
campaign
LO 2-5
justhappy
received
a 90-day
letter. If she wants
litigate

the issue
but doesfor
not have
mayor, sufficient
especiallycash
aftertoshe
that charitable
contributions
paylearned
the proposed
deficiency,
what is herare
besttax
court choice?
research
deductible.
51. In choosing a trial-level court, how should a court’s previous rulings influence the
LO 2-2
a) Use an
available
service
to determine
whether
Paris can
this choice of a trialchoice?
Howtax
should
circuit
court rulings
influence

thededuct
taxpayer’s
1/13/17
spi11838_ch06_000-055.indd 52
contribution.
level court?
b) Write
a memo
communicating
results
of your
research.
52. Sophia
recently
won a taxthe
case
litigated
in the
7th Circuit. She recently heard
LO 2-2
72. Matt and
Lori recently
were
divorced.
grief
stricken,Should
Matt was
LO 2-5
that the
Supreme

Court
deniedAlthough
the writ of
certiorari.
sheatbeleast
happy or not,
partiallyand why?
comforted by his monthly receipt of $10,000 alimony. He was particularly
research
excited to learn from his friend, Denzel, that the alimony was not taxable. Use an
53. Campbell’s tax return was audited because she failed to report interest she earned
LO 2-2
available tax service to determine if Denzel is correct. Would your answer change
on her tax return. What IRS audit selection method identified her tax return?
if Matt and Lori continued to live together?
54. Yong’s tax return was audited because he calculated his tax liability incorrectly.
LO 2-2
73. Shaun is a huge college football fan. In the past, he has always bought football
LO 2-5
What IRS audit procedure identified his tax return for audit?
tickets on the street from ticket scalpers. This year, he decided to join the univer55.ticket
Randy
deducted
a high
level of
itemized
deductionstotwo
ago relative to his
research LO 2-2 sity’s
program,

which
requires
a $2,000
contribution
the years
university
incometo
level.
He recently
an then
IRS notice
requesting
documentation
for
for the “right”
purchase
tickets. received
Shaun will
pay $400
per season
ticket.
his itemizedthat
deductions.
audit
likely
his tax return
Shaun understands
the price What
paid for
theprocedure

season tickets
is identified
not tax deductible
for audit?
as a charitable contribution. However, contributions to a university are typically
tax deductible.
a) Use an available tax service to determine how much, if any, of Shaun’s $2,000
contribution for the right to purchase tickets is tax deductible.
b) Write a letter to Shaun communicating the results of your research.
LO 2-5
74. Latrell recently used his Delta Skymiles to purchase a free round-trip ticket to
Milan, Italy (value $1,200). The frequent flyer miles used to purchase the ticket
research
were generated from Latrell’s business travel as a CPA. Latrell’s employer paid for
spi11838_ch02_000-035.indd 32
his business trips, and he was not taxed on the travel reimbursement.
4-40 CHAPTER 4
Individual Income Tax Overview, Exemptions, and Filing Status
a)
Use an available tax research service to determine how much income, if any,
Latrell will have to recognize as a result of purchasing an airline ticket with
a separate tax return. In year 4, the couple divorced. Both Jasper and Crewella filed sinSkymiles
earned from business travel.
gle tax returns in year 4. In year 5, the IRS audited the couple’s joint year 2 tax return
b) Write
memo
communicating
results
of The
yourIRS

research.
anda each
spouse’s
separate yearthe
3 tax
returns.
determined that the year 2 joint
2-32

CHAPTER 2

Tax Compliance, the IRS, and Tax Authorities

WIDE VARIETY OF ASSIGNMENT MATERIAL
Problems Problems are designed
to test the comprehension of more
complex topics. Each problem at the
end of the chapter is tied to one of that
chapter’s learning objectives, with
multiple problems for critical topics.

Tax Forms Problems Tax forms
problems are a set of requirements
included in the end-of-chapter material
of the 2018 edition. These problems
require students to complete a tax form
(or part of a tax form), providing students with valuable experience and practice with filling out these
forms. These requirements—and their relevant forms—are also included in Connect. Each tax form
problem includes an icon to differentiate it from regular problems.

5:06 PM

Research Problems Research
problems are special problems
throughout the end-of-chapter
assignment material. These
require students to do both basic
and more complex research on topics outside of the scope of the book. Each research problem includes
an icon to differentiate it from regular problems.
“The textbook is comprehensive, uses an integrated approach to taxation, contains clear illustrations
and examples in each chapter, and has a wealth of end-of-chapter assignment material.”

01/11/17 2:51 PM

– James P. Trebby, Marquette University

return and Crewella’s separate
year 3 tax
understatedthe
Crewella’s
self-employCHAPTER
2 return
Tax Compliance,
IRS, and Tax
Authorities
2-33
ment income, causing the joint return year 2 tax liability to be understated by $4,000
and Crewella’s
year 3 separate
return

tax liability
be understated
by
The IRS
Jackie has a corporate client
that has recently
received
a 30-day
notice to
from
the IRS
LO$6,000.
2-2
also assessed
interest on
both of these
tax returns. Try as it might, the IRS
with a $100,000 tax assessment.
Herpenalties
client is and
considering
requesting
an appeals
planning
hasassessment.
not been able
to locate
Crewella,
but theyadvise
have been

able to find Jasper.
conference to contest the
What
factors
should Jackie
her client
a) What
tax can the IRS require Jasper to pay for the Dahvill’s year 2
to consider before requesting
anamount
appealsof
conference?
joint
The IRS recently completed
anreturn?
audit ofExplain.
Shea’s tax return and assessed $15,000 adLO 2-2
b) What
amountconference
of tax can the
paycase
for Crewella’s
year 3
ditional tax. Shea requested
an appeals
butIRS
was require
unable Jasper
to settletothe
planning

separate tax return?
at the conference. She is contemplating
whichExplain.
trial court to choose to hear her case.
Provide aLOrecommendation
based
on the
following
facts: son named Marty. Marty is Janice’s
51. Janice
Traylor
is single.
She alternative
has an 18-year-old
4-3
onlyCircuit,
child. Marty
has
lived
with has
Janice
his entire
However,
a) Shea resides in the 2nd
and the
2nd
Circuit
recently
ruledlife.
against

the Marty recently
research
joined the Marines and was sent on a special assignment to Australia. During the
position
Shea is litigating.
Martyhas
spent
nine months
Australia.
Marty was extremely homesick
b) The Federal Circuit current
Court ofyear,
Appeals
recently
ruled ininfavor
of Shea’s
while in Australia, since he had never lived away from home. However, Marty knew
position.
this assignment
was onlyof
temporary,
couldn’t
wait to come home and find his
c) The issue being litigated
involves a question
fact. Sheaand
hashe
a very
appealing
just the

way
it. Janice
always filed as head of household, and Marty
story to tell but littleroom
favorable
case
lawhetoleft
support
her has
position.
has always been considered a qualifying child (and he continues to meet all the tests
d) The issue being litigated is highly technical, and Shea believes strongly in her
with the possible exception of the residence test due to his stay in Australia). Howinterpretation of the law.
ever, this year Janice is unsure whether she qualifies as head of household due to
e) Shea is a local elected
official
and wouldabsence
prefer toduring
minimize
any Janice
local publicity
Marty’s
nine-month
the year.
has come to you for advice on
regarding the case. whether she qualifies for head of household filing status. What do you tell her?
Juanita, aLOTexas
resident
(5th Jones
Circuit),

is researching
a tax
andtime
finds
a elected toLOfile
2-3
52. Doug
submitted
his 2017
taxquestion
return on
and
a joint tax
4-3
5th Circuit case ruling return
that is favorable
and aDarlene.
9th Circuit
caseand
thatDarlene
is unfavorable.
with his wife,
Doug
did not request an extension for
Whichresearch
circuit case has their
more2017
“authoritative
weight”
How

would
tax return.
Doug and
and why?
Darlene
owed
andyour
paid the IRS $124,000 for
answer change if Juanita
were
a Kentucky
(6thlater,
Circuit)?
their
2017
tax year.resident
Two years
Doug amended his return and claimed marFaith, a resident of Florida
a circuithis
court
case
that isDoug sought
LO 2-3 a refund
ried (11th
filingCircuit)
separaterecently
status. found
By changing
filing
status,

favorable to her research
question.
Which
two
circuits
would
she prefer
to have
for an overpayment for the tax year 2017
(he paid
more tax in the original joint
issued the opinion? return than he owed on a separate return). Is Doug allowed to change his filing
Robert has found a “favorable”
onand
point
for hisa tax
If the
LO 2-3 return?
status forauthority
the 2017directly
tax year
receive
taxquestion.
refund with
his amended
authority is a court case, which court would he prefer to have issued the opinion?
Which court would he least prefer to have issued the opinion?
PROBLEMS
Jamareo has foundCOMPREHENSIVE
a “favorable” authority directly

on point for his tax question. If
LO 2-3
the authority is an administrative authority, which specific type
of authority would
®
Select
problems
are
available
in Connect
.
he prefer to answer his question? Which administrative
authority
would he least
prefer to answer his53.
question?
Marc and Michelle are married and earned salaries this year of $64,000 and
For each
the following
citations,
identify the
of authority
(statutory,
adminLO 2-3 of $350
$12,000,
respectively.
In type
addition
to their salaries,
they

received interest
tax of
forms
istrative, or judicial) and
explain
the citation.
from
municipal
bonds and $500 from corporate bonds. Marc and Michelle also paid
a) Reg. Sec. 1.111-1(b)$2,500 of qualifying moving expenses, and Marc paid alimony to a prior spouse in
the amount of $1,500. Marc and Michelle have a 10-year-old son, Matthew, who
b) IRC Sec. 469(c)(7)(B)(i)
lived with them throughout the entire year. Thus, Marc and Michelle are allowed to
c) Rev. Rul. 82-204, 1982-2 C.B. 192
claim a $1,000 child tax credit for Matthew. Marc and Michelle paid $6,000 of exd) Amdahl Corp., 108 TC
507 (1997)
penditures
that qualify as itemized deductions and they had a total of $5,500 in fede) PLR 9727004
eral income taxes withheld from their paychecks during the course of the year.
f) Hills v. Comm., 50 AFTR2d
(11th
Cir., 1982)
a) What 82-6070
is Marc and
Michelle’s
gross income?
For each of the following
citations,
identify
type of adjusted

authoritygross
(statutory,
adminLO 2-3
b) What
is Marc
and the
Michelle’s
income?
istrative, or judicial) and
explain
the
citation.
c) What is the total amount of Marc and Michelle’s deductions from AGI?
a) IRC Sec. 280A(c)(5)d) What is Marc and Michelle’s taxable income?
b) Rev. Proc. 2004-34, e)
2004-1
911and Michelle’s taxes payable or refund due for the year? (Use the
WhatC.B.
is Marc
c) Lakewood Associates, RIA
TC schedules.)
Memo 95-3566
tax rate
d) TAM 200427004 f) Complete the first two pages of Marc and Michelle’s Form 1040 (use 2016 forms
e) U.S. v. Muncy, 2008-2 if
USTC
50,449
(E.D., AR, 2008)
2017par.
forms

are unavailable).
Justine would like to clarify her understanding of a code section recently enacted by
LO 2-4
Congress. What tax law sources are available to assist Justine?

56.
Planning Problems Planning problems
are another unique set of problems
57.
included in the end-of-chapter
assignment material. These require
students to test their tax planning skills
after covering the chapter topics. Each planning problem includes an icon to differentiate it from
regular problems.
spi11838_ch02_000-035.indd 34

01/11/17 2:51 PM

Comprehensive and Tax Return Problems
Comprehensive and tax return problems address
58.
multiple concepts in a single problem. Comprehensive problems are ideal for cumulative topics; for
59.
this reason, they are located at the end of all chapters.
In the end-of-book Appendix C, we include tax
return problems that cover multiple chapters. Additional
tax return problems are also available in
60.
the Connect Library. These problems
61.

range from simple to complex and
cover individual taxation, corporate
62.
taxation, partnership taxation, and
S corporation taxation.
63.

64.

xv


Four Volumes to Fit

McGraw-Hill’s Taxation of Individuals is organized to emphasize topics that are most important to undergraduates taking their
first tax course. The first three chapters provide an introduction
to taxation and then carefully guide students through tax research and tax planning. Part II discusses the fundamental elements of individual income tax, starting with the tax formula
in Chapter 4 and then proceeding to more discussion on income,
deductions, investments, and computing tax liabilities in
­Chapters 5–8. Part III then discusses tax issues associated with
business-related activities. Specifically, this part addresses business income and deductions, accounting methods, and tax consequences associated with purchasing assets and property dispositions (sales, trades, or other dispositions). Part IV is unique
among tax textbooks; this section combines related tax issues for
compensation, retirement savings, and home ownership.
Part I: Introduction to Taxation
  1. An Introduction to Tax
  2. Tax Compliance, the IRS, and Tax Authorities
  3. Tax Planning Strategies and Related Limitations
Part II: Basic Individual Taxation
  4. Individual Income Tax Overview, Exemptions and Filing
Status

  5. Gross Income and Exclusions
  6. Individual Deductions
  7. Investments
  8. Individual Income Tax Computation and Tax Credits
Part III: Business-Related Transactions
  9. Business Income, Deductions, and Accounting Methods
10. Property Acquisition and Cost Recovery
11. Property Dispositions
Part IV: Specialized Topics
12. Compensation
13. Retirement Savings and Deferred Compensation
14. Tax Consequences of Home Ownership

xvi

McGraw-Hill’s Taxation of Business Entities begins with the
process for determining gross income and deductions for
­businesses, and the tax consequences associated with purchasing
assets and property dispositions (sales, trades, or other dispositions). Part II provides a comprehensive overview of entities and
the formation, reorganization, and liquidation of corporations.
Unique to this series is a complete chapter on accounting for income taxes, which provides a primer on the basics of calculating
the income tax provision. Included in the narrative is a discussion of temporary and permanent differences and their impact on
a company’s book “effective tax rate.” Part III provides a detailed discussion of partnerships and S corporations. The last
part of the book covers state and local taxation, multinational
taxation, and transfer taxes and wealth planning.
Part I: Business-Related Transactions
  1. Business Income, Deductions, and Accounting Methods
  2. Property Acquisition and Cost Recovery
  3. Property Dispositions
Part II: Entity Overview and Taxation of C Corporations

  4. Entities Overview
  5. Corporate Operations
  6. Accounting for Income Taxes
  7. Corporate Taxation: Nonliquidating Distributions
  8. Corporate Formation, Reorganization, and Liquidation
Part III: Taxation of Flow-Through Entities
  9. Forming and Operating Partnerships
10. Dispositions of Partnership Interests and Partnership
Distributions
11. S Corporations
Part IV: Multijurisdictional Taxation and Transfer Taxes
12. State and Local Taxes
13. The U.S. Taxation of Multinational Transactions
14. Transfer Taxes and Wealth Planning


Four Course Approaches

McGraw-Hill’s Taxation of Individuals and Business Entities covers all chapters included in the
two split volumes in one convenient volume.
See Table of Contents.

McGraw-Hill’s Essentials of Federal Taxation is designed for a
one-semester course, covering the basics of taxation of individuals and business entities. To facilitate a one-semester course,
McGraw-Hill’s Essentials of Federal Taxation folds the key topics from the investments, compensation, retirement savings, and
home ownership chapters in Taxation of Individuals into three
individual taxation chapters that discuss gross income and
­exclusions, for AGI deductions, and from AGI deductions,
­respectively. The essentials volume also includes a two-chapter
C corporation sequence that uses a life-cycle approach covering

corporate formations and then corporate operations in the first
chapter and nonliquidating and liquidating corporate distributions in the second chapter. This volume is perfect for those
teaching a one-semester course and for those who struggle to get
through the 25-chapter comprehensive volume.
Part I: Introduction to Taxation
  1. An Introduction to Tax
  2. Tax Compliance, the IRS, and Tax Authorities
  3. Tax Planning Strategies and Related Limitations
Part II: Individual Taxation
  4. Individual Income Tax Overview, Exemptions, and Filing
Status
  5. Gross Income and Exclusions
  6. Individual For AGI Deductions
  7. Individual From AGI Deductions
  8. Individual Income Tax Computation and Tax Credits
Part III: Business-Related Transactions
  9. Business Income, Deductions, and Accounting Methods
10. Property Acquisition and Cost Recovery
11. Property Dispositions
Part IV: Entity Overview and Taxation of C Corporations
12. Entities Overview
13. Corporate Formations and Operations
14. Corporate Nonliquidating and Liquidating Distributions
Part V: Taxation of Flow-Through Entities
15. Forming and Operating Partnerships
16. 
D ispositions of Partnership Interests and Partnership
Distributions
17. S Corporations
xvii

SUPPLEMENTS FOR INSTRUCTORS
Assurance of Learning Ready
Many educational institutions today are focused
on the notion of assurance of learning, an important element of many accreditation standards. McGraw-Hill’s Taxation is designed
specifically to support your assurance of learning initiatives with a simple, yet powerful,
solution.
Each chapter in the book begins with a list
of numbered learning objectives, which appear
throughout the chapter as well as in the end-ofchapter assignments. Every test bank question
for McGraw-Hill’s Taxation maps to a specific
chapter learning objective in the textbook. Each
test bank question also identifies topic area,
level of difficulty, Bloom’s Taxonomy level,
and AICPA and AACSB skill area. 
AACSB Statement
McGraw-Hill Education is a proud corporate
member of AACSB International. Understanding the importance and value of AACSB accreditation, McGraw-Hill’s Taxation recognizes
the curricula guidelines detailed in the AACSB
standards for business accreditation by connecting selected questions in the text and the test
bank to the general knowledge and skill guidelines in the revised AACSB standards.

The statements contained in McGrawHill’s Taxation are provided only as a guide
for the users of this textbook. The AACSB
leaves content coverage and assessment
within the purview of individual schools, the
mission of the school, and the faculty. While
McGraw-Hill’s Taxation and the teaching
package make no claim of any specific

AACSB qualification or evaluation, we have,
within the text and test bank, labeled selected
questions according to the eight general
knowledge and skill areas.
TestGen 
TestGen is a complete, state-of-the-art test generator and editing application software that allows instructors to quickly and easily select test
items from McGraw Hill’s TestGen testbank
content and to organize, edit, and customize the
questions and answers to rapidly generate paper tests. Questions can include stylized text,
symbols, graphics, and equations that are inserted directly into questions using built-in
mathematical templates. With both quick-andsimple test creation and flexible and robust editing tools, TestGen is a test generator system
for today’s educators.

A HEARTFELT THANKS TO THE MANY COLLEAGUES WHO SHAPED THIS BOOK

The version of the book you are reading would not be the same book without the valuable suggestions, keen insights,
and constructive criticisms of the list of reviewers below. Each professor listed here contributed in substantive ways
to the organization of chapters, coverage of topics, and the use of pedagogy. We are grateful to them for taking the
time to read chapters or attend reviewer conferences, focus groups, and symposia in support of the development for
the book:
Previous Edition Reviewers
Donna Abelli, Mount Ida College
Joseph Assalone, Rowan College at Gloucester County
Valeriya Avdeev, William Paterson University
Robyn Barrett, St. Louis Community College
Kevin Baugess, ICDC College
Christopher Becker, Coastal Carolina University
Jeanne Bedell, Keiser University
Marcia Behrens, Nichols College
Michael Belleman, St. Clair County Community College

David Berman, Community College of Philadelphia
Tim Biggart, Berry College 
xviii

Cynthia Bird, Tidewater Community College
Lisa Blum, University of Louisville
Rick Blumenfeld, Sierra College
Cindy Bortman Boggess, Babson College
Cathalene Bowler, University of Northern Iowa
Justin Breidenbach, Ohio Wesleyan University
Suzon Bridges, Houston Community College
Stephen Bukowy, UNC Pembroke
Esther Bunn, Stephen F. Austin State University
Holly Caldwell, Bridgewater College
James Campbell, Thomas College
Alisa Carini, UCSD Extension


Ronald Carter, Patrick Henry Community College
Cynthia Caruso, Endicott College
Paul Caselton, University of Illinois Springfield
Christine Cheng, Louisiana State University
Amy Chataginer, Mississippi Gulf Coast Community College
Machiavelli Chao, University of California, Irvine
Max Chao, University of California, Irvine
Lisa Church, Rhode Island College
Marilyn Ciolino, Delgado Community College
Wayne Clark, Southwest Baptist University
Ann Cohen, University at Buffalo, SUNY
Sharon Cox, University of Illinois–Urbana-Champaign

Terry Crain, University of Oklahoma–Norman
Roger Crane, Indiana University East
Brad Cripe, Northern Illinois University
Richard Cummings, University of Wisconsin–Whitewater
Joshua Cutler, University of Houston
William Dams, Lenoir Community College
Nichole Dauenhauer, Lakeland Community College
Susan Snow Davis, Green River College
Jim Desimpelare, University of Michigan–Ann Arbor
Julie Dilling, Moraine Park Technical College
Steve Dombrock, Carroll University
John Dorocak, California State University–San Berdinado
Amy Dunbar, University of Connecticut–Storrs
John Eagan, Morehouse College
Reed Easton, Seton Hall University
Elizabeth Ekmekjian, William Paterson University
Ann Esarco, Columbia College Columbia
Frank Faber, St. Joseph’s College
Michael Fagan, Raritan Valley Community College
Frank Farina, Catawba College
Andrew Finley, Claremont McKenna
Tim Fogarty, Case Western Reserve University
Mimi Ford, Middle Georgia State University
Wilhelmina Ford, Middle Georgia State University
George Frankel, SFSU
Lawrence Friedken, Penn State University
Stephen Gara, Drake University 
Robert Gary, University of New Mexico
Greg Geisler, University of Missouri–St. Louis
Earl Godfrey, Gardner Webb University

Thomas Godwin, Purdue University
David Golub, Northeastern University 
Marina Grau, Houston Community College
Brian Greenstein, University of Delaware
Patrick Griffin, Lewis University
Lillian Grose, University of Holy Cross
Rosie Hagen, Virginia Western Community College
Marcye Hampton, University of Central Florida
Cass Hausserman, Portland State University 
Rebecca Helms, Ivy Tech Community College
Melanie Hicks, Liberty University
Mary Ann Hofmann, Appalachian State University
Robert Joseph Holdren, Muskingum University
Bambi Hora, University of Central Oklahoma
Carol Hughes, Asheville Buncombe Technical Community
College
Helen Hurwitz, Saint Louis University 
Rik Ichiho, Dixie State University

Kerry Inger, Auburn University 
Paul Johnson, MGCCC–JD Campus
Athena Jones, University of Maryland University College
Andrew Junikiewicz, Temple University 
Susan Jurney, University of Arkansas Fayetteville
Sandra Kemper, Regis University
Jon Kerr, Baruch College–CUNY
Lara Kessler, Grand Valley State University 
Janice Klimek, University of Central Missouri
Pamela Knight, Columbus Technical College
Satoshi Kojima, East Los Angeles College

Dawn Konicek, Idaho State University
Jack Lachman, Brooklyn College
Brandon Lanciloti, Freed-Hardeman University
Stacie Laplante, University of Wisconsin–Madison
Suzanne Laudadio, Durham Tech
Stephanie Lewis, Ohio State University–Columbus
Troy Lewis, Brigham Young University
Teresa Lightner, University of North Texas
Robert Lin, California State University–East Bay
Chris Loiselle, Cornerstone University 
Bruce Lubich, Penn State–Harrisburg
Michael Malmfeldt, Shenandoah University
Kate Mantzke, Northern Illinois University
Robert Martin, Kennesaw State University
Anthony Masino, East Tennessee State University
Paul Mason, Baylor University 
Lisa McKinney, University of Alabama at Birmingham
Lois McWhorter, Somerset Community College
Allison McLeod, University of North Texas
Janet Meade, University of Houston
Michele Meckfessel, University of Missouri–St. Louis
Frank Messina, University of Alabama at Birmingham
R Miedaner, Lee University 
Ken Milani, University of Notre Dame
Karen Morris, Northeast Iowa Community College
Stephanie Morris, Mercer University 
Michelle Moshier, University at Albany
Leslie Mostow, University of Maryland, College Park
James Motter, IUPUI Indianapolis 
Jackie Myers, Sinclair Community College

Michael Nee, Cape Cod Community College
Liz Ott, Casper College
Edwin Pagan, Passaic County Community College
Jeff Paterson, Florida State University
Ronald Pearson, Bay College
Martina Peng, Franklin University
James Pierson, Franklin University
Sonja Pippin, University of Nevada–Reno
Anthony Pochesci, Rutgers University
Joshua Racca, University of Alabama
Francisco Rangel, Riverside City College
Pauline Ash Ray, Thomas University 
Luke Richardson, University of South Florida
Rodney Ridenour, Montana State University Northern
John Robertson, Arkansas State University
Susan Robinson, Georgia Southwestern State University
Morgan Rockett, Moberly Area Community College
Miles Romney, Michigan State University 
Ananth Seetharaman, Saint Louis University 
xix


Alisa Shapiro, Raritan Valley Community College
Deanna Sharpe, University of Missouri
Wayne Shaw, Southern Methodist University
Sonia Singh, University of Florida
Lucia Smeal, Georgia State University
Pamela Smith, University of Texas at San Antonio
Adam Spoolstra, Johnson County Community College
Jason Stanfield, Ball State University

Joe Standridge, Sonoma State
George Starbuck, McMurry University
James Stekelberg, University of Arizona
Terrie Stolte, Columbus State Community College
Kenton Swift, University of Montana
Erin Towery, The University of Georgia

Ronald Unger, Temple University
Natasha Ware, Southeastern University
Luke Watson, University of Florida
Sarah Webber, University of Dayton
Cassandra Weitzenkamp, Peru State College
Marvin Williams, University of Houston—Downtown
Chris Woehrle, American College
Jennifer Wright, Drexel University 
Massood Yahya-Zadeh, George Mason University
James Yang, Montclair State University
Scott Yetmar, Cleveland State University
Charlie Yuan, Elizabeth City State University
Xiaoli Yuan, Elizabeth City State University
Mingjun Zhou, DePaul University

Acknowledgments
We would like to thank the many talented people who made valuable contributions to the creation of this ninth edition.
William A. Padley of Madison Area Technical College, Deanna Sharpe of the University of Missouri–Columbia, and
Troy Lewis of Brigham Young University checked the page proofs and solutions manual for accuracy; we greatly appreciate the hours they spent checking tax forms and double-checking our calculations throughout the book. Teressa F
­ arough,
Troy Lewis of Brigham Young University, and Deanna Sharpe of the University of Missouri–Columbia accuracy-checked
the test bank. Thank you to Troy Lewis, Michele Meckfessel of University of Missouri at St. Louis, and Shannon Bookout of Columbus State Community College for your contributions to the Smartbook revision for this edition. Special
thanks to Troy Lewis of Brigham Young University for his sharp eye and valuable feedback throughout the revision

process. Thanks as well to Colton Gigot from Agate Publishing for managing the supplement process. Finally, William
A. Padley of Madison Area Technical College, Deanna Sharpe of the University of Missouri–Columbia, and Vivian
Paige of Old Dominion University greatly contributed to the accuracy of McGraw-Hill’s Connect for the 2018 edition.
We also appreciate the expert attention given to this project by the staff at McGraw-Hill Education, especially Tim
Vertovec, Managing Director; Kathleen Klehr, Executive Brand Manager; Danielle Andries, Product Developer; Erin
Quinones, Product Developer; Lori Koetters, Brian Nacik, and Jill Eccher, Content Project Managers; Matt Backhaus,
Designer; Natalie King, Marketing Director; Cheryl Osgood, Marketing Manager; and Sue Culbertson, Senior Buyer.

xx


Changes in Taxation of Individuals
and Business Entities, 2018 Edition
For the 2018 edition of McGraw-Hill’s Taxation of Individuals and Business Entities, many changes
were made in response to feedback from reviewers and focus group participants:
∙All tax forms have been updated for the latest
­available tax form as of January 2017. In addition,
chapter content throughout the text has been
­updated to reflect tax law changes through
­January 2017.
Other notable changes in the 2018 edition include:
Chapter 1
∙Updated tax rates for 2017.
∙Updated Social Security Wage base for 2017.
∙Updated Unified Tax Credit for 2017.
∙Updated Taxes in the Real World: Republicans vs.
Democrats.
∙Updated Taxes in the Real World: Affordable Care
Act amount for 2017.
∙Updated Taxes in the Real World: National Debt for

current debt limit.
∙Updated Exhibit 1-4 for 2015 Federal revenues by
source from Treasury.
∙Updated Exhibit 1-5 for 2015 State revenues by
source from U.S. Census.
Chapter 2
∙Updated gross income thresholds by filing status
for 2017.
∙Revised discussion of primary authorities and IRS
Publications and tax forms.
∙Updated penalty amounts for failure to file a tax return and willful understatement of tax.
Chapter 3
∙Updated tax rates for 2017.
∙Updated Exhibit 3-3 for new tax rates.
Chapter 4
∙Updated personal exemption amounts for 2017.
∙Updated standard deduction amounts for 2017.
∙Updated tax rates for 2017.
∙Updated tax forms from 2015 to 2016 forms.
∙Clarified discussion of who is a qualifying person
for head of household filing status for divorced
­parents by editing footnote to Exhibit 4-9 and
­Appendix B.

Chapter 5
∙Updated for 2017 amounts for Flexible Spending
­Account contributions.
∙Added discussion of new exclusion for awards and prize
money for Team USA Olympic and Paralympic athletes.
∙Revised discussion of foreign-earned income exclusion

and updated for 2017 exclusion amounts.
∙Updated for annual gift tax exclusion and unified tax
credit for 2017.
∙Updated U.S. Series EE Bond interest income exclusion
for 2017.
∙Updated tax forms from 2015 to 2016 forms.
Chapter 6
∙Updated mileage rate for 2017 moving expense
deduction.
∙Updated phase-out for interest on qualified education
loan for 2017.
∙Updated pending expiration date for qualified education expense deduction.
∙Updated mileage rate for medical expense itemized
deduction for 2017.
∙Updated standard business mileage rate for 2017.
∙Updated thresholds for the itemized deduction and
personal exemption phase-outs for 2017.
∙Updated standard deduction and personal exemption
amounts for 2017.
∙Updated tax forms from 2015 to 2016 forms.
Chapter 7
∙Updated tax rates for 2017.
∙Updated tax forms from 2015 to 2016 forms.
Chapter 8
∙Updated tax rate schedules for 2017.
∙Updated AMT discussion for medical expense
adjustment.
∙Updated AMT exemption and AMT tax rate schedule
for 2017.
∙Revised Self-Employment Tax discussion.

∙Updated Social Security Tax wage base and Self-­
Employment Tax base for 2017.
∙Updated Lifetime Learning Credit phase-out for 2017.
∙Updated Earned Income Credit amounts for 2017.
∙Updated tax forms from 2015 to 2016 forms.
xxi


Chapter 9
∙Updated standard business mileage rate for 2017.
∙Updated tax forms from 2015 to 2016.
Chapter 10
∙Updated tax rates for 2017.
∙Updated tax forms from 2015 to 2016 forms.
∙Updated §179 amounts for inflation adjustments.
∙Updated examples and end of chapter problems for
2017 §179 amounts.
∙Clarified luxury car (§280F) depreciation limit
calculation.
Chapter 11
∙Updated tax rates for 2017.
∙Updated tax forms from 2015 to 2016 forms.
∙Clarified related-party holding period rules.
∙Clarified like-kind exchange debt offset rules.
Chapter 12
∙Updated qualified transportation fringe amounts
for 2017.
∙Updated tax forms from 2015 to 2016.
∙Updated Exhibits 12-2 through 12-4 and 12-8 for
2016 proxy statements.

∙Updated Taxes in the Real World for 2016 proxy
statement information.
Chapter 13
∙Increased salary for Dave Allan in storyline.
∙Updated inflation adjusted limits for defined benefit
plans, defined contribution plans, and individually
managed plans.
∙Updated Exhibit 13-6 to reflect most recent proxy
statement for Coca-Cola Company.
∙Updated AGI phase-out thresholds for deductible
contributions to traditional IRAs and contributions to
Roth IRAs.
∙Updated Saver’s credit information.
∙Clarified language in Discussion Question 33.
∙Clarified language in Problem 50 part e.
Chapter 14
∙Clarified that the terms “dwelling unit” and “home”
are used interchangebly.
∙Updated discussion of government’s list of expenditures from 2015–2024 to 2016–2025.
∙Updated URL in footnote 4.
∙Inserted new footnote 7 indicating that the IRS
­recently ruled that a couple’s need to move because
of a birth of a second child was an unforeseen
­circumstance (LTR 201628002).
xxii

∙In the discussion about combined limit for qualifying
debt, the use of average method and chronological
method of determining deductible interest expense
has been changed to the “simple” and “exact” methods of determining deductible interest expense, respectively. This is consistent with the terminology

provided in the regulations.
∙Updated Taxes in the Real World (“Double Take on
Home-Related Interest Deductions”) to reflect the
fact that the IRS has now acquiesced to the Voss 12th
Circuit case. Consequently, the finding in Voss should
apply to taxpayers anywhere in the country.
∙Updated Example 14-14 dealing with the IRS method
versus Tax Court method of allocating rent expense
to reflect non-leap year in 2017.
∙Clarified discussion of losses from nonresidential
rental property.
∙Updated tax forms from 2015 to 2016.
∙Clarified that taxpayer’s personal use of an office
­disqualifies the taxpayer from claiming a home
­office deduction in Example 14-17.
∙Updated settlement statement in Appendix A.
∙Clarified language in Discussion Question 2.
Chapter 15
∙In Exhibit 15-3, changed “Nontaxable” to “Tax deferred” when discussing the tax consequences of contributing appreciated property to the various entities.
∙Updated URL in Taxes in the Real World titled
­Comparing Entities Selected.
∙Shortened the fact pattern in problem 73. The relevant
facts have not changed.
Chapter 16
∙Updated the discussion on stock option compensation.
∙Revised Taxes in the Real World for Facebook stock
options.
∙Updated the compliance section for new year-end filing.
Chapter 17
∙Updated the Taxes in the Real World saga of

Weatherford.
∙Updated the material to incorporate the new FASB
rules on disclosures of deferred tax assets and
liabilities.
∙Updated the Microsoft uncertain tax benefit footnote
disclosure.
∙Updated the FASB’s projects involving accounting
for income taxes.
Chapter 18
∙Edited key facts summary of earnings and profits
(E&P) calculation.
∙Edited discussion of effect of distributions on E&P.


∙Streamlined and edited discussion of effect of
­noncash property distributions and the effect of
these distributions on taxable income and E&P.
∙Clarified examples of effect of distributions on
E&P.
Chapter 19
∙Clarified facts in Example 19-25.
∙Clarified facts in Comprehensive Problems 19-58
and 19-59.
Chapter 20
∙Added new Taxes in the Real World box in passive
losses discussion.
∙Clarified the definition of material participant for
passive loss purposes.
∙Clarified new partnership tax return due date.
∙Clarified the connection between 704(b) capital

­accounts and partnership agreements.
Chapter 21
∙Clarified the explanation of disproportionate distributions to be more consistent with the §751(b) proposed
regulations.
∙Clarified the problem illustrating disproportionate
distributions to be more consistent with the §751(b)
proposed regulations.
∙Clarified the explanation of special basis adjustments
applicable to distributions.

Chapter 22
∙Revised discussion of the family member rules for purposes of the S corporation qualification requirements.
∙Revised discussion of the excess passive investment
income rules.
∙Updated Social Security Tax wage base for 2017.
∙Updated tax forms from 2015 to 2016 forms.
Chapter 23
∙Updated Exhibit 23-4.
∙Updated Taxes in the Real World for sourcing receipts.
∙Updated Taxes in the Real World for apportionment.
Chapter 24
∙Updated the discussion on the OECD base erosion
and profit-shifting project.
∙Updated the proposals for international tax reform.
∙Updated the discussion on inversions.
Chapter 25
∙Clarified computation for unified credit.
∙Updated exemption equivalent for inflation adjustment made for 2016.
∙Revised terminology used for unified credit, which is
now referred to as the “applicable credit.”

∙Updated tax forms for 2016.
∙Revised discount factors for changes in the regulations.
∙Revised ethics problem to focus on what constitutes
an intent to make a gift.

As We Go to Press
The 2018 Edition is current through February 21, 2017. You can visit the
Connect Library for updates that occur after this date.

xxiii


Table of Contents
1An Introduction to Tax
Who Cares about Taxes and Why?  1-2
What Qualifies as a Tax?  1-4
How to Calculate a Tax  1-5
Different Ways to Measure Tax Rates  1-5
Tax Rate Structures  1-9
Proportional Tax Rate Structure  1-9
Progressive Tax Rate Structure  1-9
Regressive Tax Rate Structure  1-10
Types of Taxes  1-11
Federal Taxes  1-11
Income Tax  1-12
Employment and Unemployment Taxes  1-12
Excise Taxes  1-13
Transfer Taxes  1-13
State and Local Taxes  1-14
Income Taxes  1-14

Sales and Use Taxes  1-14
Property Taxes  1-15
Excise Taxes  1-15
Implicit Taxes  1-16
Evaluating Alternative Tax Systems  1-17
Sufficiency 1-18
Static versus Dynamic Forecasting  1-18
Income versus Substitution Effects  1-19
Equity 1-20
Horizontal versus Vertical Equity  1-21
Certainty 1-22
Convenience 1-22
Economy 1-22
Evaluating Tax Systems—The Trade-Off  1-23
Conclusion 1-23

2Tax Compliance, the IRS, and Tax
Authorities

Taxpayer Filing Requirements  2-2
Tax Return Due Date and Extensions  2-3
Statute of Limitations  2-3
IRS Audit Selection  2-4
Types of Audits  2-5
After the Audit  2-6
xxiv

Tax Law Sources  2-9
Legislative Sources: Congress and the
Constitution 2-11

Internal Revenue Code  2-11
The Legislative Process for Tax Laws  2-12
Basic Organization of the Code  2-13
Tax Treaties  2-14
Judicial Sources: The Courts  2-14
Administrative Sources: The U.S. Treasury  2-15
Regulations, Revenue Rulings, and Revenue
Procedures 2-15
Letter Rulings  2-16
Tax Research  2-17
Step 1: Understand Facts  2-17
Step 2: Identify Issues  2-17
Step 3: Locate Relevant Authorities  2-18
Step 4: Analyze Tax Authorities  2-19
Step 5: Document and Communicate the
Results 2-21
Facts 2-21
Issues 2-21
Authorities 2-22
Conclusion 2-22
Analysis 2-22
Client Letters  2-22
Research Question and Limitations  2-22
Facts 2-22
Analysis 2-22
Closing 2-22
Tax Professional Responsibilities  2-23
Taxpayer and Tax Practitioner Penalties  2-26
Conclusion 2-28

3Tax Planning Strategies and Related
Limitations

Basic Tax Planning Overview  3-2
Timing Strategies  3-2
Present Value of Money  3-3
The Timing Strategy When Tax Rates Are
Constant 3-4
The Timing Strategy When Tax Rates
Change 3-7
Limitations to Timing Strategies  3-10