pearson’s federal taxation2019 · 2019. 2. 20. · n. allen ford university of kansas david s....

PEARSON’S FEDERAL TAXATION

2019INDIVIDUALS

EDITORS

TIMOTHY J. RUPERTNortheastern University

KENNETH E. ANDERSONUniversity of Tennessee

CONTRIBUTING AUTHORS

THOMAS R. POPEUniversity of Kentucky

D. DALE BANDYUniversity of Central Florida (Emeritus)

N. ALLEN FORDUniversity of Kansas

DAVID S. HULSEUniversity of Kentucky

LEANN LUNAUniversity of Tennessee

CHARLENE HENDERSONLouisiana State University

JARED MOOREOregon State University

WILLIAM D. BRINKMiami University

SUSAN L. PORTERUniversity of Virginia

MICHAEL S. SCHADEWALDUniversity of Florida

330 Hudson Street, New York, NY 10013

A01_POPE9670_32_SE_FM.indd 1 6/12/18 11:33 PM

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www.pearsonhighered.comISBN-10: 0-13-473967-1

ISBN-13: 978-0-13-473967-0


CONTENTS

PREFACE xiv

C H A P T E R 1c AN INTRODUCTION TO TAXATION 1-1

History of Taxation in the United States 1-2Early Periods 1-2Revenue Acts from 1913 to the Present 1-3Revenue Sources 1-3

Types of Tax Rate Structures 1-4The Structure of Individual Income Tax Rates 1-4The Structure of Corporate Tax Rates 1-5Marginal, Average, and Effective Tax Rates for

Taxpayers 1-5Determination of Taxable Income and

Tax Due 1-6

Other Types of Taxes 1-7State and Local Income and Franchise Taxes 1-7Wealth Transfer Taxes 1-7Other Types of Taxes 1-11

Criteria for a Tax Structure 1-12Equity 1-12Certainty 1-13Convenience 1-13Economy 1-13Simplicity 1-14Objectives of the Federal Income Tax Law 1-14

Entities in the Federal Income Tax System 1-16Taxpaying Entities 1-17Flow-Through Entities 1-20Other Entities 1-23

Tax Law Sources 1-24

Enactment of a Tax Law 1-24Steps in the Legislative Process 1-24

Administration of the Tax Law and Tax Practice Issues 1-26Organization of the Internal Revenue

Service 1-26Enforcement Procedures 1-27Selection of Returns for Audit 1-27Statute of Limitations 1-28Interest 1-28Penalties 1-28Administrative Appeal Procedures 1-29

Components of a Tax Practice 1-29Tax Compliance and Procedure 1-29Tax Research 1-30Tax Planning and Consulting 1-30Financial Planning 1-31

Computer Applications in Tax Practice 1-31Tax Return Preparation 1-31Tax Planning Applications 1-31Tax Research Applications 1-31

Problem Materials 1-32Discussion Questions 1-32Problems 1-34Tax Strategy Problem 1-36Case Study Problem 1-36Tax Research Problem 1-36

C H A P T E R 2c DETERMINATION OF TAX 2-1

Formula for Individual Income Tax 2-2Basic Formula 2-2Definitions 2-3Tax Formula Illustrated 2-6

Deductions from Adjusted Gross Income 2-7Itemized Deductions 2-7Standard Deduction 2-10Dependency Requirements 2-12Child Credit 2-18

Determining the Amount of Tax 2-19Filing Status 2-20Joint Return 2-20Surviving Spouse 2-21Head of Household 2-22Single Taxpayer 2-22Married Filing Separately 2-22Abandoned Spouse 2-23Children with Unearned Income 2-24Additional Medicare Tax and Net Investment

Income Tax 2-27

Business Income and Business Entities 2-27

Treatment of Capital Gains and Losses 2-30Definition of Capital Assets 2-30Tax Treatment of Gains and Losses 2-30

Tax Planning Considerations 2-30Shifting Income Between Family

Members 2-30Splitting Income 2-31Maximizing Itemized Deductions 2-31Filing Joint or Separate Returns 2-32

Compliance and Procedural Considerations 2-33Who Must File 2-33Due Dates and Extensions 2-34Use of Forms 1040, 1040EZ, and 1040A 2-35System for Reporting Income 2-35

Problem Materials 2-36Discussion Questions 2-36Issue Identification Questions 2-37Problems 2-37Tax Strategy Problems 2-42Tax Form/Return Preparation Problems 2-42Case Study Problems 2-43Tax Research Problems 2-43

iii


iv Individuals ▶ Contents

C H A P T E R 3c GROSS INCOME: INCLUSIONS 3-1

Economic, Accounting, and Tax Concepts of Income 3-2Economic Concept 3-2Accounting Concept 3-2Tax Concept of Income 3-3

To Whom Is Income Taxable? 3-6Assignment of Income 3-6Allocating Income Between Married People 3-6Income of Minor Children 3-8

When Is Income Taxable? 3-8Cash Method 3-8Accrual Method 3-11Hybrid Method 3-12

Items of Gross Income: Sec. 61(a) 3-13Compensation 3-13Business Income 3-13Gains from Dealings in Property 3-13Interest 3-13Rents and Royalties 3-15Dividends 3-16Alimony and Separate Maintenance Payments 3-19Pensions and Annuities 3-20Income from Life Insurance and Endowment

Contracts 3-22Income from Discharge of Indebtedness 3-23Income Passed Through to Taxpayer 3-23Other Items of Gross Income 3-23Prizes, Awards, Gambling Winnings, and Treasure

Finds 3-24Illegal Income 3-24Unemployment Compensation 3-24Social Security Benefits 3-24Insurance Proceeds and Court Awards 3-26Recovery of Previously Deducted Amounts 3-26Claim of Right 3-27

Tax Planning Considerations 3-27Shifting Income 3-27Divorce Settlements 3-28Prepaid Income 3-28Taxable, Tax-Exempt, or Tax-Deferred Bonds 3-29Reporting Savings Bond Interest 3-29Deferred Compensation Arrangements 3-30

Compliance and Procedural Considerations 3-30

Problem Materials 3-31Discussion Questions 3-31Issue Identification Questions 3-34Problems 3-35Comprehensive Problems 3-38Tax Strategy Problems 3-38Tax Form/Return Preparation Problem 3-39Case Study Problems 3-39Tax Research Problem 3-40

C H A P T E R 4c GROSS INCOME: EXCLUSIONS 4-1

Items That Are Not Income 4-2Unrealized Income 4-2Self-Help Income 4-3

Rental Value of Personal-Use Property 4-3Selling Price of Property 4-3

Major Statutory Exclusions 4-4Gifts and Inheritances 4-4Life Insurance Proceeds 4-5Awards for Meritorious Achievement 4-7Scholarships and Fellowships 4-7Distributions from Qualified Tuition Programs 4-7Payments for Injury and Sickness 4-8Employee Fringe Benefits 4-10Foreign-Earned Income Exclusion 4-19Income from the Discharge of a Debt 4-20Exclusion for Gain from Small Business

Stock 4-22Other Exclusions 4-22

Tax Planning Considerations 4-23Employee Fringe Benefits 4-23Self-Help Income and Use of Personally Owned

Property 4-24

Compliance and Procedural Considerations 4-24

Problem Materials 4-25Discussion Questions 4-25Issue Identification Questions 4-26Problems 4-26Comprehensive Problem 4-30Tax Strategy Problems 4-30Tax Form/Return Preparation Problems 4-31Case Study Problems 4-31Tax Research Problems 4-32

C H A P T E R 5c PROPERTY TRANSACTIONS: CAPITAL GAINS AND

LOSSES 5-1

Determination of Gain or Loss 5-3Realized Gain or Loss 5-3Recognized Gain or Loss 5-5

Basis Considerations 5-5Cost of Acquired Property 5-5Property Received as a Gift: Gifts After 1921 5-7Property Received from a Decedent 5-8Property Converted from Personal Use to Business

Use 5-10Allocation of Basis 5-11

Definition of a Capital Asset 5-13Influence of the Courts 5-14Other IRC Provisions Relevant to Capital Gains and

Losses 5-14

Tax Treatment for Capital Gains and Losses of Noncorpo-rate Taxpayers 5-16Capital Gains 5-16Adjusted Net Capital Gains (ANCG) 5-18Capital Losses 5-19

Tax Treatment of Capital Gains and Losses: Corporate Taxpayers 5-22

Sale or Exchange 5-22Worthless Securities 5-23Retirement of Debt Instruments 5-23Options 5-26Patents 5-27


Contents ◀ Individuals v

Franchises, Trademarks, and Trade Names 5-27Lease Cancellation Payments 5-28

Holding Period 5-29Property Received as a Gift 5-29Property Received from a Decedent 5-29Nontaxable Exchanges 5-30Receipt of Nontaxable Stock Dividends and Stock

Rights 5-30Justification for Preferential Treatment of Net Capital

Gains 5-30Mobility of Capital 5-31Mitigation of the Effects of Inflation and the Progressive

Tax System 5-31Lowers the Cost of Capital 5-31

Tax Planning Considerations 5-32Selection of Property to Transfer by Gift 5-32Selection of Property to Transfer at Time

of Death 5-33

Compliance and Procedural Considerations 5-33Documentation of Basis 5-33Reporting of Capital Gains and Losses on Schedule

D 5-34

Problem Materials 5-41Discussion Questions 5-41Issue Identification Questions 5-42Problems 5-42Comprehensive Problem 5-47Tax Strategy Problems 5-47Tax Form/Return Preparation Problems 5-48Case Study Problems 5-49Tax Research Problems 5-49

C H A P T E R 6c DEDUCTIONS AND LOSSES 6-1

Classifying Deductions as For Versus From Adjusted Gross Income (AGI) 6-3

Criteria for Deducting Business and Investment Expenses 6-4Business or Investment Activity 6-5Ordinary Expense 6-7Necessary Expense 6-7Reasonable Expense 6-8Expenses and Losses Incurred Directly by the

Taxpayer 6-8

General Restrictions on the Deductibility of Expenses 6-9Capitalization Versus Expense Deduction 6-10Expenses Related to Exempt Income 6-11Expenditures Contrary to Public Policy 6-12Other Expenditures Specifically Disallowed 6-14

Proper Substantiation Requirement 6-17

When an Expense Is Deductible 6-18Cash Method 6-18Accrual Method 6-20

Special Disallowance Rules 6-23Wash Sales 6-23Transactions Between Related Parties 6-26Hobby Activities 6-29Vacation Home 6-30Expenses of an Office in the Home 6-34

Tax Planning Considerations 6-35Hobby Losses 6-35Unreasonable Compensation 6-36Timing of Deductions 6-36

Compliance and Procedural Considerations 6-37Proper Classification of Deductions 6-37Proper Substantiation 6-37Business Versus Hobby 6-37

Problem Materials 6-38Discussion Questions 6-38Issue Identification Questions 6-39Problems 6-40Comprehensive Problems 6-45Tax Strategy Problems 6-46Tax Form/Return Preparation Problems 6-46Case Study Problem 6-49Tax Research Problems 6-49

C H A P T E R 7c ITEMIZED DEDUCTIONS 7-1

Medical Expenses 7-2Qualified Individuals 7-2Qualified Medical Expenses 7-3Amount and Timing of Deduction 7-6

Taxes 7-9Definition of a Tax 7-9Deductible Taxes 7-9Limits on Itemized Deductions for State and Local Taxes 7-9State and Local Income Taxes 7-10State and Local Sales Taxes 7-10Personal Property Taxes 7-10Real Estate Taxes 7-11Self-Employment Tax 7-12Nondeductible Taxes 7-12

Interest 7-12Definition of Interest 7-13Classification of Interest Expense 7-13Timing of the Interest Deduction 7-19

Charitable Contributions 7-21Qualifying Organization 7-21Type of Property Contributed 7-22Deduction Limitations 7-25Application of Carryovers 7-26Special Rules for Charitable Contributions Made by

Corporations 7-27Summary of Charitable Contributions Deduction

Limitations 7-27

Casualty and Theft Losses 7-28

Tax Planning Considerations 7-29Medical Expense Deduction 7-29Interest Expense Deduction 7-30Deduction for Charitable Contributions 7-31

Compliance and Procedural Considerations 7-32Medical Expenses 7-32Charitable Contributions 7-32Taxes 7-34

Problem Materials 7-36Discussion Questions 7-36Issue Identification Questions 7-37


vi Individuals ▶ Contents

Problems 7-38Comprehensive Problem 7-41Tax Strategy Problems 7-42Tax Form/Return Preparation Problems 7-42Case Study Problems 7-44Tax Research Problems 7-45

C H A P T E R 8c LOSSES AND BAD DEBTS 8-1

Transactions That May Result in Losses 8-2Sale or Exchange of Property 8-2Expropriated, Seized, Confiscated, or Condemned

Property 8-3Abandoned Property 8-3Worthless Securities 8-3Demolition of Property 8-4

Classifying the Loss on the Taxpayer’s Tax Return 8-4Ordinary Versus Capital Loss 8-5Disallowance Possibilities 8-6

Passive Losses 8-7Computation of Passive Losses and Credits 8-7Carryovers 8-8Definition of a Passive Activity 8-10Taxpayers Subject to Passive Loss Rules 8-12Real Estate Businesses 8-14Other Rental Real Estate Activities 8-15

Casualty and Theft Losses 8-17Casualty Defined 8-17Theft Defined 8-19Deductible Amount of Casualty Loss 8-19Limitations on Personal-Use Property 8-20Netting Casualty Gains and Losses on Personal-Use

Property 8-21Casualty Gains and Losses Attributable to Business and

Investment Property 8-22Timing of Casualty Loss Deduction 8-22

Bad Debts 8-24Bona Fide Debtor-Creditor Relationship 8-24Taxpayer’s Basis in the Debt 8-25Debt Must Be Worthless 8-26Nonbusiness Bad Debts 8-26Business Bad Debts 8-28Deposits in Insolvent Financial Institutions 8-28

Net Operating Losses 8-29Computing the Net Operating Loss for Individuals 8-29Carryover Periods 8-32

Excess Business Losses 8-33

Tax Planning Considerations 8-33Bad Debts 8-33Casualties 8-34

Compliance and Procedural Considerations 8-34Casualty Losses 8-34Worthless Securities 8-34

Problem Materials 8-35Discussion Questions 8-35Issue Identification Questions 8-37Problems 8-37Tax Strategy Problems 8-41Tax Form/Return Preparation Problems 8-42

Case Study Problems 8-44Tax Research Problem 8-44

C H A P T E R 9 .c BUSINESS AND EMPLOYEE EXPENSES AND DEFERRED

COMPENSATION 9-1

Part I: Employee and Self-Employed Expenses 9-2

Classification and Limitations of Employee Expenses 9-2Nature of the Employment Relationship 9-3Limitations on Unreimbursed Employee Expenses 9-4

Travel Expenses 9-5Deductibility of Travel Expenses 9-5Definition of Travel Expenses 9-6General Qualification Requirements 9-6Business Versus Pleasure 9-8Foreign Travel 9-9Additional Limitations on Travel Expenses 9-9

Transportation Expenses 9-10Definition and Classification 9-10Treatment of Automobile Expenses 9-11Reimbursement of Automobile Expenses 9-13

Entertainment Expenses 9-1350% Disallowance for Meal and Entertainment

Expenses 9-14Classification of Expenses 9-14Business Meals 9-15Entertainment Facilities and Club Dues 9-16Business Gifts 9-16Limitations on Entertainment Tickets 9-17

Reimbursed Employee Business Expenses 9-17

Moving Expenses 9-20Expense Classification 9-21Definition of Moving Expenses 9-21Treatment of Employer Reimbursements 9-22

Education Expenses 9-22Classification of Education Expenses 9-23General Requirements for a Deduction 9-24

Office in Home Expenses 9-25General Requirements for a Deduction 9-25Deductions and Limitations 9-26

Part II: Deferred Compensation 9-28Qualified Pension and Profit-Sharing Plans 9-29Qualification Requirements for a Qualified Plan 9-30Tax Treatment to Employees and Employers 9-31Nonqualified Plans 9-33Employee Stock Options 9-35Plans for Self-Employed Individuals 9-37Simplified Employee Pensions (SEP IRAs) 9-39Simple Retirement Plans 9-39Individual Retirement Accounts (IRAs) 9-39Traditional IRA 9-40Roth IRA 9-41Coverdell Education Savings Account 9-44Health Savings Accounts 9-45

Tax Planning Considerations 9-45Moving Expenses 9-45Providing Nontaxable Compensation to

Employees 9-46Rollovers to Roth IRA 9-46


Contents ◀ Individuals vii

Compliance and Procedural Considerations 9-47Substantiating Travel and Entertainment Expenses 9-47Reporting Employee Business Expenses 9-47Reporting Office in Home Expenses 9-48Qualification of Pension and Profit-Sharing Plans 9-48

Problem Materials 9-51Discussion Questions 9-51Issue Identification Questions 9-53Problems 9-54Comprehensive Problem 9-61Tax Strategy Problem 9-62Tax Form/Return Preparation Problems 9-62Case Study Problems 9-63Tax Research Problem 9-64

C H A P T E R 1 0c DEPRECIATION, COST RECOVERY, AMORTIZATION, AND

DEPLETION 10-1

Depreciation and Cost Recovery 10-2General Considerations 10-2Depreciation Methods 10-4Calculation of Depreciation 10-5MACRS Restrictions 10-12

Amortization 10-17Sec. 197 Intangibles 10-17Research and Experimental Expenditures 10-19Computer Software 10-20

Depletion, Intangible Drilling and Development Costs 10-21Depletion Methods 10-22Treatment of Intangible Drilling and Development

Costs 10-23

Tax Planning Considerations 10-24Alternative Depreciation System Under

MACRS 10-24Use of Units of Production Depreciation 10-24Structuring a Business Combination 10-24

Compliance and Procedural Considerations 10-25Reporting Cost Recovery, Depreciation, Depletion, and

Amortization Deductions 10-25

Problem Materials 10-28Discussion Questions 10-28Issue Identification Questions 10-30Problems 10-30Comprehensive Problem 10-35Tax Strategy Problem 10-36Tax Form/Return Preparation Problems 10-36Case Study Problems 10-37Tax Research Problem 10-37

C H A P T E R 1 1c ACCOUNTING PERIODS AND METHODS 11-1

Accounting Periods 11-2Required Payments and Fiscal Years 11-3Changes in the Accounting Period 11-4Returns for Periods of Less than 12 Months 11-5

Overall Accounting Methods 11-7Cash Receipts and Disbursements Method 11-7Accrual Method 11-9Hybrid Method 11-10

Inventories 11-11Determination of Inventory Cost 11-11

Special Accounting Methods 11-15Long-Term Contracts 11-15Installment Sales Method 11-17Deferred Payment Sales 11-21

Imputed Interest 11-22Imputed Interest Computation 11-23Accrual of Interest 11-23Gift, Shareholder, and Other Loans 11-24

Change in Accounting Methods 11-25Amount of Change 11-26Reporting the Amount of the Change 11-27Obtaining IRS Consent 11-27

Tax Planning Considerations 11-28Accounting Periods 11-28Accounting Methods 11-28Installment Sales 11-28

Compliance and Procedural Considerations 11-28Reporting Installment Sales on Form 6252 11-28Procedures for Changing to LIFO 11-30

Problem Materials 11-30Discussion Questions 11-30Issue Identification Questions 11-31Problems 11-32Comprehensive Problem 11-34Tax Strategy Problems 11-35Tax Form/Return Preparation Problem 11-35Case Study Problems 11-35Tax Research Problems 11-36

C H A P T E R 1 2c PROPERTY TRANSACTIONS: NONTAXABLE

EXCHANGES 12-1

Like-Kind Exchanges 12-2Like-Kind Property Defined 12-2A Direct Exchange Must Occur 12-4Three-Party Exchanges 12-4Receipt of Boot 12-5Basis of Property Received 12-6Exchanges Between Related Parties 12-7Transfer of Non–Like-Kind Property 12-8Holding Period for Property Received 12-8

Involuntary Conversions 12-9Involuntary Conversion Defined 12-10Tax Treatment of Gain Due to Involuntary Conversion

into Boot 12-10Replacement Property 12-12Obtaining Replacement Property 12-13Time Requirements for Replacement 12-14

Sale of Principal Residence 12-15Principal Residence Defined 12-16Sale of More than One Principal Residence Within a

Two-Year Period 12-17Nonqualified Use After 2008 12-19Involuntary Conversion of a Principal Residence 12-20

Tax Planning Considerations 12-20Avoiding the Like-Kind Exchange Provisions 12-20Sale of a Principal Residence 12-21


viii Individuals ▶ Contents

Compliance and Procedural Considerations 12-22Reporting of Involuntary Conversions 12-22Reporting of Sale or Exchange of a Principal

Residence 12-23

Problem Materials 12-23Discussion Questions 12-23Issue Identification Questions 12-24Problems 12-25Comprehensive Problem 12-29Tax Strategy Problem 12-29Tax Form/Return Preparation Problems 12-30Case Study Problem 12-31Tax Research Problems 12-31

C H A P T E R 1 3c PROPERTY TRANSACTIONS: SECTION 1231 AND

RECAPTURE 13-1History of Sec. 1231 13-2

Overview of Basic Tax Treatment for Sec. 1231 13-3Net Gains 13-3Net Losses 13-3Tax Rate for Net Sec. 1231 Gain 13-4

Section 1231 Property 13-5Section 1231 Property Defined 13-5Real or Depreciable Property Used in Trade or

Business 13-5Involuntary Conversions 13-6Condemnations 13-6Other Involuntary Conversions 13-7

Procedure for Sec. 1231 Treatment 13-7

Recapture Provisions of Sec. 1245 13-8Purpose of Sec. 1245 13-9

Recapture Provisions of Sec. 1250 13-10Purpose of Sec. 1250 13-11Section 1250 Property Defined 13-11Unrecaptured Section 1250 Gain 13-12Taxation of Gains on Sale or Exchange of Depreciable

Real Property 13-12Low-Income Housing 13-15

Additional Recapture for Corporations 13-16Summary of Secs. 1231, 1245, and 1250 Gains 13-17

Recapture Provisions—Other Applications 13-18Gifts of Property Subject to Recapture 13-18Transfer of Property Subject to Recapture at

Death 13-18Charitable Contributions 13-18Like-Kind Exchanges 13-19Involuntary Conversions 13-19Installment Sales 13-19Section 179 Expensing Election 13-20Conservation and Land Clearing Expenditures 13-20Intangible Drilling Costs and Depletion 13-21Gain on Sale of Depreciable Property Between Related

Parties 13-22

Tax Planning Considerations 13-23Avoiding the Recapture Provisions 13-23

Compliance and Procedural Considerations 13-24Reporting Sec. 1231 Gains and Losses on Form

4797 13-24

Reporting Gains Recaptured as Ordinary Income on Form 4797 13-24

Reporting Casualty or Theft Gain or Loss on Form 4684 13-24

Problem Materials 13-28Discussion Questions 13-28Issue Identification Questions 13-29Problems 13-30Comprehensive Problem 13-35Tax Strategy Problems 13-35Tax Form/Return Preparation Problems 13-36Case Study Problems 13-36Tax Research Problem 13-37

C H A P T E R 1 4c SPECIAL TAX COMPUTATION METHODS, TAX CREDITS,

AND PAYMENT OF TAX 14-1

Alternative Minimum Tax 14-2AMT Computation 14-3AMT Tax Rates and Brackets 14-3AMT Exemption Amount 14-3AMT Tax Preference Items 14-4AMT Adjustments 14-4AMT Credits 14-6Summary Illustration of the AMT

Computation 14-7

Self-Employment Tax 14-8What Constitutes Self-Employment Income 14-9

Personal and Business Tax Credits 14-10Use and Importance of Tax Credits 14-10Value of a Credit Versus a Deduction 14-10Nonrefundable Personal Tax Credits 14-11Foreign Tax Credit 14-17Business Related Tax Credits 14-19Refundable Personal Credits 14-23

Provisions Related to Health Insurance 14-24Health Insurance Premium Assistance Credit (Also

Known as Premium Tax Credit) 14-24

Payment of Taxes 14-26Withholding of Taxes 14-27Estimated Tax Payments 14-28

Tax Planning Considerations 14-30Avoiding the Alternative Minimum Tax 14-30Avoiding the Underpayment Penalty for Estimated

Tax 14-31Cash-Flow Considerations 14-31Use of General Business Tax Credits 14-31Foreign Tax Credits and the Foreign Earned Income

Exclusion 14-32

Compliance and Procedural Considerations 14-32Alternative Minimum Tax (AMT) Filing

Procedures 14-32Withholdings and Estimated Tax

Payments 14-32General Business Tax Credits 14-33Nonrefundable Personal Tax Credits 14-33

Problem Materials 14-33Discussion Questions 14-33Issue Identification Questions 14-35


Contents ◀ Individuals ix

Problems 14-36Comprehensive Problem 14-40Tax Strategy Problem 14-41Tax Form/Return Preparation Problems 14-42Case Study Problems 14-43Tax Research Problem 14-43

C H A P T E R 1 5c TAX RESEARCH 15-1

Overview of Tax Research 15-2

Steps in the Tax Research Process 15-3

Importance of the Facts to the Tax Consequences 15-5Creating a Factual Situation Favorable to the

Taxpayer 15-6

The Sources of Tax Law 15-7The Legislative Process 15-7The Internal Revenue Code 15-8Treasury Regulations 15-9Administrative Pronouncements 15-11Judicial Decisions 15-14Tax Treaties 15-24Tax Periodicals 15-24

Tax Services 15-25

The Internet as a Research Tool 15-26Keyword Searches 15-27Search by Citation 15-28Noncommercial Internet Services 15-28

Citators 15-28Using the Citator 15-30

Professional Guidelines for Tax Services 15-30Treasury Department Circular 230 15-30AICPA’s Statements on Tax Standards 15-31

Sample Work Papers and Client Letter 15-34

Problem Materials 15-34Discussion Questions 15-34Problems 15-35Comprehensive Problem 15-38Tax Strategy Problem 15-38Case Study Problem 15-39Tax Research Problems 15-39

C H A P T E R 1 6c CORPORATIONS 16-1

Definition of a Corporation 16-2Similarities and Differences Between the Taxation of

Corporations and Individuals 16-3

Specific Rules Applicable to Corporations 16-4Capital Gains and Losses 16-4Dividends-Received Deduction 16-5Net Operating Losses 16-6Charitable Contributions 16-7Compensation Deduction Limitation for Publicly

Held Corporations 16-8

Computation of Tax 16-9Computation of Taxable Income 16-9Computation of Regular Tax 16-9The Corporate Alternative Minimum Tax (AMT)

and the Minimum Tax Credit (MTC) 16-10Penalty Taxes 16-11

Computation of Tax for Controlled Groups 16-14Consolidated Returns 16-16

Transfers of Property to Controlled Corporations 16-17Section 351 Nonrecognition Requirements 16-17Basis Considerations 16-18Treatment of Liabilities 16-19Corporate Capital Structure 16-21

Earnings and Profits 16-21Calculation of Earnings and Profits 16-21Current Versus Accumulated E&P 16-22

Noncash Distributions 16-24Tax Consequences to the Shareholders 16-24Tax Consequences to the Distributing

Corporation 16-24Stock Redemptions 16-25Determining Whether a Redemption Is a Dividend or

Capital Gain 16-26

Corporate Distributions in Complete Liquidation 16-28Tax Consequences to the Liquidating

Corporation 16-28Tax Consequences to the Shareholders 16-29Section 332: Liquidation of a Subsidiary

Corporation 16-29

Tax Planning Considerations 16-30Capital Structure and Section 1244 16-30Dividend Policy 16-31Use of Losses 16-31Charitable Contributions 16-31Dividends-Received Deduction 16-31Reduced Taxes on Taxpayer Stock Sales 16-32

Compliance and Procedural Considerations 16-32Filling Requirements 16-32Schedule M-1 and M-2 Reconciliations 16-33Schedule M-3 Reconciliation 16-34Maintenance of E&P Records 16-34

Problem Materials 16-34Discussion Questions 16-34Issue Identification Questions 16-39Problems 16-40Tax Strategy Problems 16-45Tax Form/Return Preparation Problems 16-46Case Study Problems 16-47Tax Research Problems 16-48

C H A P T E R 1 7c PARTNERSHIPS AND S CORPORATIONS 17-1

Types of Pass-Through Entities 17-2Partnerships 17-2S Corporations 17-3Limited Liability Companies 17-3Limited Liability Partnerships 17-4

Taxation of Partnerships 17-4Formation of a Partnership 17-4Partnership Operations 17-8Special Allocations 17-9Allocation of Partnership Income, Deductions, Losses,

and Credits to Partners 17-10


x Individuals ▶ Contents

Basis Adjustments for Operating Items 17-11Special Deductions and Limitations 17-12Limitations on Losses and Restoration of

Basis 17-14Transactions Between a Partner and the

Partnership 17-15Partnership Distributions 17-16Sale of a Partnership Interest 17-17Optional and Mandatory Basis Adjustments 17-19Partnership Elections 17-20

Taxation of S Corporations 17-21Qualification Requirements 17-21Election Requirements 17-23Termination Conditions 17-24S Corporation Operations 17-25Basis Adjustments to S Corporation

Stock 17-27S Corporation Losses and Limitations 17-28Other S Corporation Considerations 17-30

Tax Planning Considerations 17-33Use of Operating Losses 17-33Income Shifting Among Family Members 17-34Optional Basis Adjustment Election Under Sec.

754 17-34

Compliance and Procedural Considerations 17-35Partnership Filing Requirements and

Elections 17-35Reporting Partnership Items on Form

1065 17-35S Corporation Filing Requirements and Accounting

Method Elections 17-36Reporting S Corporation Items on Form

1120S 17-36Comparison of Alternative Forms of Business

Organizations 17-36

Problem Materials 17-36Discussion Questions 17-36Issue Identification Questions 17-41Problems 17-41Comprehensive Problem 17-47Tax Strategy Problems 17-48Tax Form/Return Preparation

Problems 17-49Case Study Problems 17-49Tax Research Problems 17-50

C H A P T E R 1 8c TAXES AND INVESTMENT PLANNING 18-1

Investment Models 18-2The Current Model 18-2The Deferred Model 18-5

The Exempt Model 18-10The Pension Model 18-10Multiperiod Strategies 18-14Summary and Comparison of Basic Investment

Models 18-15

Other Applications of Investment Models 18-15Roth Conversion Decision 18-16Pass-Through Entity Versus C Corporation 18-19

Implicit Taxes and Clienteles 18-24

Problem Materials 18-27Discussion Questions 18-27Problems 18-28

T A B L E S

2017 Tax Tables and Rate Schedules and 2018 Withholding Tables (Partial) T-1

A P P E N D I C E S

c APPENDIX A

Tax Research Working Paper File A-1

c APPENDIX B

Tax Forms B-1

c APPENDIX C

MACRS Tables C-1

c APPENDIX D

Glossary D-1

c APPENDIX E

AICPA Statements on Standards for Tax Services Nos. 1–7 E-1

c APPENDIX F

Index of Code Sections F-1

c APPENDIX G

Index of Treasury Regulations G-1

c APPENDIX H

Index of Government Promulgations H-1

c APPENDIX I

Index of Court Cases I-1

c APPENDIX J

Subject Index J-1


ABOUT THE EDITORS

Timothy J. Rupert is a Professor at the D’Amore-McKim School of Business at Northeast-ern University. He received his B.S. in Accounting and his Master of Taxation from the University of Akron. He also earned his Ph.D. from Penn State University. Professor Rupert’s research has been published in such journals as The Accounting Review, The Jour-nal of the American Taxation Association, Behavioral Research in Accounting, Advances in Taxation, Applied Cognitive Psychology, Advances in Accounting Education, and Jour-nal of Accounting Education. In 2010, he received the Outstanding Educator Award from the Massachusetts Society of CPAs. He also has received the University’s Excellence in Teaching Award and the D’Amore-McKim School’s Best Teacher of the Year award multi-ple times. He is active in the American Accounting Association and the American Taxation Association (ATA) and has served as president, vice president, and secretary of the ATA.

Kenneth E. Anderson is the Pugh CPAs Professor of Accounting at the University of Tennessee. He earned a B.B.A. from the University of Wisconsin–Milwaukee and subse-quently attained the level of tax manager with Arthur Young (now part of Ernst & Young). He then earned a Ph.D. from Indiana University. He teaches corporate taxation, partner-ship taxation, and tax strategy. Professor Anderson also is the Director of the Master of Accountancy Program. He has published articles in The Accounting Review, The Journal of the American Taxation Association, Advances in Taxation, the Journal of Accountancy, the Journal of Financial Service Professionals, and a number of other journals.

ABOUT THE AUTHORS

Thomas R. Pope is the Ernst & Young Professor of Accounting at the University of Kentucky. He received a B.S. from the University of Louisville and an M.S. and D.B.A. in busi-ness administration from the University of Kentucky. He teaches international taxation, partnership and S corporation taxation, tax research and policy, and introductory taxa-tion and has won outstanding teaching awards at the University, College, and School of Accountancy levels. He has published articles in The Accounting Review, the Tax Adviser, Taxes, Tax Notes, and a number of other journals. Professor Pope’s extensive profes-sional experience includes eight years with Big Four accounting firms. Five of those years were with Ernst & Whinney (now part of Ernst & Young), including two years with their National Tax Department in Washington, D.C. He subsequently held the position of Senior Manager in charge of the Tax Department in Lexington, Kentucky. Professor Pope also has been a leader and speaker at professional tax conferences all over the United States and is active as a tax consultant.

xi

TIMOTHY J. RUPERT

KENNETH E. ANDERSON


xii Individuals ▶ About the Authors

D. Dale Bandy is the Professor Emeritus in the School of Accounting at the University of Central Florida. He received a B.S. from the University of Tulsa, an M.B.A. from the University of Arkansas, and a Ph.D. from the University of Texas at Austin. He helped to establish the Master of Science in Taxation programs at the University of Central Florida and California State University, Fullerton, where he previously taught. In 1985, he was selected by the California Society of Certified Public Accountants as the Accounting Educator of the year. Professor Bandy has published 8 books and more than 30 arti-cles in accounting and taxation. His articles have appeared in the Journal of Taxation, the Journal of Accountancy, Advances in Taxation, the Tax Adviser, The CPA Journal, Management Accounting, and a number of other journals.

N. Allen Ford is the Larry D. Homer/KPMG Peat Marwick Distinguished Teaching Professor of Professional Accounting at the University of Kansas. He received an undergraduate de-gree from Centenary College in Shreveport, Louisiana, and both the M.B.A. and Ph.D. in Business from the University of Arkansas. He has published over 40 articles related to tax-ation, financial accounting, and accounting education in journals such as The Accounting Review, The Journal of the American Taxation Association, and The Journal of Taxation. He served as president of the American Taxation Association in 1979–80. Professor Ford has received numerous teaching awards, at the college and university levels. In 1993, he received the Byron T. Shutz Award for Distinguished Teaching in Economics and Business. In 1996 he received the Ray M. Sommerfeld Outstanding Tax Educator Award, which is jointly sponsored by the American Taxation Association and Ernst & Young, and in 1998 he received the Kansas Society of CPAs Outstanding Education Award.

David S. Hulse is an Associate Professor of Accountancy at the University of Kentucky, where he teaches introductory and corporate taxation courses. He received an undergrad-uate degree from Shippensburg University, an M.S. from Louisiana State University, and a Ph.D. from the Pennsylvania State University. Professor Hulse has published a number of articles on tax issues in academic and professional journals, including The Journal of the American Taxation Association, Advances in Taxation, the Journal of Financial Service Professionals, the Journal of Financial Planning, and Tax Notes.

LeAnn Luna is a Professor of Accounting at the University of Tennessee. She is a CPA and holds an undergraduate degree from Southern Methodist University, an M.T. from the University of Denver College of Law, and a Ph.D. from the University of Tennessee. She has taught introductory taxation, corporate and partnership taxation, and tax research. Professor Luna also holds a joint appointment with the Center for Business and Economic Research at the University of Tennessee, where she interacts frequently with state policy-makers on a variety of policy-related issues. She has published articles in the Journal of Accounting and Economics, National Tax Journal, The Journal of the American Taxation Association, and State Tax Notes.

Charlene Henderson is a faculty member in the Department of Accounting at Louisiana State University. She earned undergraduate and master’s degrees in accounting from Mississippi State University. After working in public accounting and banking, she earned a Ph.D. from Arizona State University. She has taught introductory taxation, corporate taxation, and tax research. Her research has appeared in several journals, including Journal of the American Taxation Association, Journal of Accounting Auditing and Finance, Auditing: A Journal of Practice and Theory, and a number of other journals.


About the Authors ◀ Individuals xiii

Jared Moore is the Mary Ellen Phillips Associate Professor of Accounting at Oregon State University (OSU). He earned his undergraduate, Master of Taxation, and Ph.D. degrees at Arizona State University. He is a CPA (AZ-inactive) and worked in both public and private accounting before pursuing his doctoral degree. Professor Moore has received sev-eral teaching awards, including the Byron L. Newton Award for Excellence in Teaching at OSU, and has taught individual and business taxation, introductory and intermediate fi-nancial accounting, and doctoral-level financial accounting research. His research interests include both tax and financial accounting, and he has published in journals including the Journal of the American Taxation Association and the National Tax Journal.

William D. Brink, Ph.D., CPA, CFP is an Assistant Professor in the Department of Accountancy at the Farmer School of Business at Miami University in Oxford, Ohio. He received his B.S. from Appalachian State University in 2005 and his Masters in Accountancy from The University of North Carolina Wilmington in 2007. Before attending the University of South Carolina to obtain his Ph.D. in Accountancy in 2014, he worked in public account-ing for RSM McGladrey. He teaches tax courses at both the undergraduate and graduate level focusing on individual taxation, business taxation, tax policy, tax academic research, and tax legal research. He has co-authored articles in Journal of Business Ethics, Journal of the American Taxation Association, Behavioral Research in Accounting, Advances in Accounting Education, Advances in Taxation, The Conversation, CGMA Magazine, and The Tax Advisor. He was the Winner of the Outstanding Author Contribution in the 2017 Emerald Literati Network Awards for Excellence for an article published in Advances in Accounting Education and has received numerous teaching awards.

Susan Porter is an Associate Professor of Commerce at the University of Virginia where she teaches both undergraduate and graduate tax courses. She earned her undergraduate degree from Babson College. After working in public and private accounting, she earned a Ph.D. from the University of Washington. She has published articles in the Journal of Accounting and Economics, Contemporary Accounting Research, Journal of Accounting, Auditing, and Finance, The Journal of the American Taxation Association, and a number of other journals.

Michael S. Schadewald, Ph.D., CPA, is a Clinical Associate Professor in the Fisher School of Accounting at the University of Florida, where he teaches courses in accounting and taxation. A graduate of the University of Minnesota, Professor Schadewald has published more than 50 articles in academic and professional journals, including The Accounting Review, Journal of Accounting Research, and Contemporary Accounting Research. He also has served on numerous editorial boards, including The Journal of the American Taxation Association, International Tax Journal, Journal of State Taxation, and Issues in Accounting Education. Prior to joining the faculty at the University of Florida, Professor Schadewald taught at the University of Wisconsin-Milwaukee, where he also served as the Director of the Deloitte Center for Multistate Taxation, and the University of Texas in Austin. Prior to entering academics, he worked in the Milwaukee office of Arthur Young (now EY).


PREFACE

New to this Edition

INDIVIDUALS

• Complete updating of the chapter material for the provisions in the Tax Cuts and Jobs Act of 2017 affecting individual taxpayers, including an explanation of the new rules and the related implications of the following items:• Reduction in marginal tax rates• Elimination of personal and dependency exemptions• Changes in the deductability of state and local taxes and casualty losses• Elimination of miscellaneous itemized deductions• Changes to the alternative minimum tax• Increase in the child tax credit

• Complete updating of significant court cases and IRS rulings and procedures during 2017 and early 2018• All tax rate schedules have been updated to reflect the rates and inflation adjustments for 2018• Whenever new updates become available, they will be accessible via MyLab Accounting• Updating of the end-of-chapter tax return problems to 2017 (2017 tax forms are included because the 2018 tax forms were not

available when this edition went to print), but also including a supplemental explanation for each tax return problem of how the solution will change for the 2018 tax year given the provisions of the Tax Cuts and Jobs Act.

CORPORATIONS

• Complete updating of the chapter material for the provisions in the Tax Cuts and Jobs Act of 2017 affecting corporations and other entities, including an explanation of the new rules and the related implications of the following items:• Reduced corporate tax rate• Qualified business income deduction• New limitations on interest, business losses, and NOLs• New rules for the taxation of international transactions• The comprehensive corporate tax return, Problem C:3-65, has all new numbers for the 2017 forms

• The comprehensive partnership tax return, Problem C:9-58, has all new numbers for the 2017 forms• The comprehensive S corporation tax return, Problem C:11-62, has all new numbers for the 2017 forms• All tax rate schedules have been updated to reflect the rates and inflation adjustments for 2018• Whenever new updates become available, they will be accessible via MyLab Accounting

SOLVING TEACHING AND LEARNING CHALLENGES

The Rupert/Anderson 2019 Series in Federal Taxation is appropriate for use in any first course in federal taxation, and comes in a choice of three volumes:• Federal Taxation 2019: Individuals• Federal Taxation 2019: Corporations, Partnerships, Estates & Trusts (the companion book to Individuals)• Federal Taxation 2019: Comprehensive (14 chapters from Individuals and 15 chapters from Corporations)

** For a customized edition of any of the chapters for these texts, contact your Pearson representative and he or she can create a custom text for you.

• The Individuals volume covers all entities, although the treatment is often briefer than in the Corporations and Comprehensive vol-umes. The Individuals volume, therefore, is appropriate for colleges and universities that require only one semester of taxation as well as those that require more than one semester of taxation. Further, this volume adapts the suggestions of the Model Tax Curriculum as promulgated by the American Institute of Certified Public Accountants.

• The Corporations, Partnerships, Estates & Trusts and Comprehensive volumes contain three comprehensive tax return problems whose data change with each edition, thereby keeping the problems fresh. Problem C:3-65 contains the comprehensive corporate tax return, Problem C:9-58 contains the comprehensive partnership tax return, and Problem C:11-62 contains the comprehensive S corporation tax return, which is based on the same facts as Problem C:9-58 so that students can compare the returns for these two entities.

• The Corporations, Partnerships, Estates & Trusts and Comprehensive volumes contain sections called Financial Statement Impli-cations, which discuss the implications of Accounting Standards Codification (ASC) 740. The main discussion of accounting for income taxes appears in Chapter C:3. The financial statement implications of other transactions appear in Chapters C:7, C:8, and C:16 (Corporations volume only).

xiv


Preface ◀ Individuals xv

Rupert/Anderson 2019 Series in Federal Taxation has an appropriate blend of technical content of the tax law with a high level of readability for students. It is focused on enabling students to apply tax principles within the chapter to real-life situations using many strong pedagogical aids:

Real-World ExampleThese comments relate the text material to events, cases, and statistics occurring in the tax and business environment. The statistical data presented in some of these comments are taken from the IRS’s Statistics of Income at www.irs.gov.

Book-to-Tax Accounting ComparisonThese comments compare the tax discussion in the text to the accounting and/or financial statement treatment of this material. Also, the last section of Chapter C:3 discusses the financial statement implications of federal income taxes.

What Would You Do in This Situation?Unique to the Rupert/Anderson series, these boxes place students in a decision-making role. The boxes include many controversies that are as yet unresolved or are currently being considered by the courts. These boxes make extensive use of Ethical Material as they represent choices that may put the practitioner at odds with the client.

Stop & ThinkThese “speed bumps” encourage students to pause and apply what they have just learned. Solutions for each issue are provided in the box.

Ethical PointThese comments provide the ethical implications of material discussed in the adjoining text. Apply what they have just learned.

Tax Strategy TipThese comments suggest tax planning ideas related to material in the adjoining text.

Additional CommentThese comments provide supplemental information pertaining to the adjacent text.

MyLab Accounting

Reach Every Student with MyLab AccountingMyLab is the teaching and learning platform that empowers you to reach every student. By combining trusted author content with digital tools and a flexible platform, MyLab personalizes the learning experience and improves results for each student. Learn more about MyLab Accounting at https://www.pearsonmylabandmastering.com/

Powerful Homework and Test Manager Create, import, and manage online homework and media assignments, quizzes, and tests. Create assignments from online questions directly correlated to this and other textbooks. Homework questions include “Help Me Solve This” guided solutions to help students understand and master concepts. You can choose from a wide range of assignment options, including time limits and maximum number of attempts allowed. In addition, you can create your own questions—or copy and edit ours—to customize your students’ learning path.

Deliver Trusted ContentYou deserve teaching materials that meet your own high standards for your course. That’s why we partner with highly respected au-thors to develop interactive content and course-specific resources that you can trust — and that keep your students engaged.

Dynamic Study Modules Dynamic Study Modules help students study effectively on their own by continuously assessing their activity and performance in real time. Here’s how it works: students complete a set of questions with a unique answer format that also asks them to indicate their confidence level. Questions repeat until the student can answer them all correctly and confidently. Once com-pleted, Dynamic Study Modules explain the concept using materials from the text. These are available as graded assignments prior to class, and accessible on smartphones, tablets, and computers. Instructors can now remove questions from Dynamic Study Modules to better fit their course. Available for select titles.

Empower Each LearnerEach student learns at a different pace. Personalized learning pinpoints the precise areas where each student needs practice, giving all students the support they need — when and where they need it — to be successful.

Study Plan The Study Plan acts as a tutor, providing personalized recommendations for each of your students based on his or her ability to master the learning objectives in your course. This allows students to focus their study time by pinpointing the precise areas they need to review, and allowing them to use customized practice and learning aids—such as videos, eText, tutorials, and more—to get them back on track. Using the report available in the Gradebook, you can then tailor course lectures to prioritize the content where students need the most support—offering you better insight into classroom and individual performance.


xvi Individuals ▶ Preface

Teach Your Course Your WayYour course is unique. So whether you would like to build your own assignments, teach multiple sections, or set prerequisites, MyLab gives you the flexibility to easily create your course to fit your needs.

Improve Student ResultsWhen you teach with MyLab, student performance improves. That’s why instructors have chosen MyLab for over 15 years, touching the lives of over 50 million students.

Instructor Teaching Resources

This program comes with the following teaching resources.

Supplements available to instructors atwww.pearsonhighered.com/pearsontax

Features of the Supplement

Instructor’s Resource Manualauthored by Mitchell Franklin from LeMoyne College and Joshua Coyne from University of Memphis

• Sample syllabi• Instructor outlines• Information regarding problem areas for students• Solutions to the tax form/tax return preparation problems

Instructor’s Solutions Manualauthored by Kenneth Anderson from University of Tennessee and Timothy Rupert from Northeastern University

• Solutions to discussion questions• Solutions to problems• Solutions to comprehensive and tax strategy problems

Test Bankauthored by Anthony Masino from East Tennessee State University and Ann Burstein Cohen from SUNY at Buffalo

Over 2,000 multiple-choice, true/false, short-answer, essays, and worked problems.• Type (Multiple-choice, true/false, short-answer, essay)• Page references to where content is found in the text

Computerized TestGen TestGen allows instructors to:• Customize, save, and generate classroom tests• Edit, add, or delete questions from the Test Item Files• Analyze test results• Organize a database of tests and student results.

PowerPoint Presentationsauthored by Allison McLeod from University of North Texas

Slides include key graphs, tables, and equations in the textbook.PowerPoints meet accessibility standards for students with dis abilities. Features include, but not limited to:• Keyboard and Screen Reader access• Alternative text for images• High color contrast between background and foreground colors

Multistate Tax Chapterauthored by Michael Schadewald from University of Florida

An entire chapter, complete with problems (and solutions) dedi cated to multi-state tax practices.

TaxAct 2017 Professional Software Available online with Individuals, Corporations, and Comprehensive Texts—please contact your Pearson representative for assistance with the registration process.This user-friendly tax preparation program includes more than 80 tax forms, schedules, and worksheets. TaxAct calculates returns and alerts the user to possi-ble errors or entries. Consists of Forms 990, 1040, 1041, 1065, 1120 and 1120S.

Acknowledgments

Our policy is to provide annual editions and to prepare timely updated supplements when major tax revisions occur. We are most ap-preciative of the suggestions made by outside reviewers because these extensive review procedures have been valuable to the authors and editors during the revision process.

We also are grateful to the various graduate assistants, doctoral students, and colleagues who have reviewed the text and supple-mentary materials and checked solutions to maintain a high level of technical accuracy. In particular, we would like to acknowledge the following colleagues who assisted in the preparation of supplemental materials for this text: Ann Burstein Cohen, SUNY at Buf-falo; Joshua G. Coyne, University of Memphis; Kate Demarest, Carroll Community College; Allison McLeod, University of North Texas; Mitchell Franklin, LeMoyne College; and Anthony Masino, East Tennessee State University.

In addition, we want to thank Myron S. Scholes, Mark A. Wolfson, Merle M. Erickson, M. L. Hanlon, Edward L. Maydew, and Terry J. Shevlin for allowing us to use the model discussed in their text, Taxes and Business Strategy: A Planning Approach, as the basis for material in Chapter I:18.

Please send any comments to Kenneth E. Anderson or Timothy J. Rupert.


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