Principles of Taxation: For Business and Investment Planning, 2020 Edition
By Sally M. Jones, Shelley C. Rhoades and Sandra R. Callaghan
Contents:
A Note from the Authors viii
Introduction to Students xxvi
PART ONE
EXPLORING THE TAX ENVIRONMENT
Chapter 1
Taxes and Taxing Jurisdictions 1–3
Some Basic Terminology 1–4
The Relationship between Base, Rate, and Revenue 1–5
Transaction- or Activity-Based Taxes 1–6
Earmarked Taxes 1–6
The Pervasive Nature of Taxation 1–7
Local Taxes 1–7
State Taxes 1–9
Federal Taxes 1–11
Taxes Levied by Foreign Jurisdictions 1–12
Jurisdictional Competition 1–13
Dynamic Nature of Taxation 1–14
Tax Base Changes 1–14
Taxes and the Political Process 1–15
Sources of Federal Tax Law 1–15
Statutory Authority 1–16
Administrative Authority 1–16
Judicial Authority 1–17
Conclusion 1–17
Key Terms 1–18
Questions and Problems for Discussion 1–18
Application Problems 1–19
Issue Recognition Problems 1–21
Research Problems 1–22
Tax Planning Cases 1–23
Chapter 2
Policy Standards for a Good Tax 2–1
Standards for a Good Tax 2–2
Taxes Should Be Sufficient 2–2
The National Debt 2–3
How to Increase Tax Revenues 2–3
Static versus Dynamic Forecasting 2–4
Behavioral Responses to Rate Changes 2–5
Taxes Should Be Convenient 2–7
Taxes Should Be Efficient 2–8
The Classical Standard of Efficiency 2–8
Taxes as an Instrument of Fiscal Policy 2–9
Taxes and Behavior Modification 2–10
Taxes Should Be Fair 2–12
Ability to Pay 2–12
Horizontal Equity 2–12
Vertical Equity 2–13
Distributive Justice 2–16
The Perception of Inequity 2–18
Conclusion 2–18
Key Terms 2–19
Questions and Problems for Discussion 2–19
Application Problems 2–21
Issue Recognition Problems 2–23
Research Problems 2–24
Tax Planning Case 2–24
PART TWO
FUNDAMENTALS OF TAX PLANNING
Chapter 3
Taxes as Transaction Costs 3–3
The Role of Net Present Value in Decision Making 3–4
Quantifying Cash Flows 3–4
The Concept of Present Value 3–4
The Issue of Risk 3–6
Net Present Value Example 3–7
Taxes and Cash Flows 3–7
The Significance of Marginal Tax Rate 3–8
Net Present Value Example Revisited 3–9
The Uncertainty of Tax Consequences 3–11
Structuring Transactions to Reduce Taxes 3–13
An Important Caveat 3–14
Transactional Markets 3–14
Conclusion 3–18
Key Terms 3–19
Questions and Problems for Discussion 3–19
Application Problems 3–20
Issue Recognition Problems 3–24
Tax Planning Cases 3–25
Chapter 4
Maxims of Income Tax Planning 4–1
Tax Avoidance—Not Evasion 4–2
What Makes Income Tax Planning Possible? 4–2
The Entity Variable 4–3
Income Shifting 4–4
Deduction Shifting 4–4
Constraints on Income Shifting 4–5
The Time Period Variable 4–5
Income Deferral and Opportunity Costs 4–7
Income Deferral and Rate Changes 4–8
The Jurisdiction Variable 4–9
The Character Variable 4–9
Determining the Value of Preferential Rates 4–10
Constraints on Conversion 4–11
Implicit Taxes 4–11
Developing Tax Planning Strategies 4–12
Additional Strategic Considerations 4–13
Tax Legal Doctrines 4–14
Conclusion 4–16
Key Terms 4–16
Questions and Problems for Discussion 4–17
Application Problems 4–18
Issue Recognition Problems 4–22
Research Problems 4–23
Tax Planning Cases 4–23
Chapter 5
Tax Research 5–1
Developing Tax Research Skills 5–1
The Tax Research Process 5–2
Step 1: Get the Facts 5–3
Step 2: Identify the Issues 5–4
Step 3: Locate Authority 5–5
Primary Authorities 5–5
Secondary Authorities 5–6
Strategies for Locating Relevant Authority 5–9
Step 4: Analyze Authority 5–11
Step 5: Repeat Steps 1 through 4 5–13
Step 6: Communicate Your Conclusions 5–14
Conclusion 5–17
Key Terms 5–18
Questions and Problems for Discussion 5–18
Application Problems 5–18
Issue Recognition Problems 5–21
Research Problems 5–22
Tax Planning Cases 5–25
PART THREE
THE MEASUREMENT OF TAXABLE INCOME
Chapter 6
Taxable Income from Business Operations 6–3
Business Profit as Taxable Income 6–4
The Taxable Year 6–5
Changing a Taxable Year 6–6
Tax Policy Objectives 6–8
The Cash Method 6–10
Constructive Receipt 6–11
Prepaid Expenses and Interest 6–12
Merchandise Inventories 6–13
Limitations on Use of the Cash Method by Corporations 6–14
The Accrual Method 6–14
Contrasting Perspectives on Income Measurement 6–15
Permanent versus Temporary Differences 6–15
Tax Expense versus Tax Payable 6–17
Temporary Book/Tax Accounting Differences 6–18
Net Operating Losses and Excess Business Losses 6–24
The Problem of Excess Deductions 6–24
Solution: The NOL Deduction 6–25
Valuing an NOL Deduction 6–26
Accounting for NOLs 6–27
Excess Business Losses 6–27
Conclusion 6–28
Sources of Book/Tax Differences 6–28
Key Terms 6–28
Questions and Problems for Discussion 6–29
Application Problems 6–30
Issue Recognition Problems 6–38
Research Problems 6–39
Tax Planning Cases 6–40
Chapter 7
Property Acquisitions and Cost Recovery Deductions 7–1
Deductible Expense or Capitalized Cost? 7–2
Repairs and Cleanup Costs 7–3
Deductions of Capital Expenditures as Subsidies 7–5
The Critical Role of Tax Basis 7–6
Basis, Cost Recovery, and Cash Flow 7–6
Cost Basis 7–7
Introduction to Cost Recovery Methods 7–9
Inventories and Cost of Goods Sold 7–9
The UNICAP Rules 7–10
Computing Cost of Goods Sold 7–10
Depreciation of Tangible Business Assets 7–11
Book and Tax Concepts of Depreciation 7–11
The MACRS Framework 7–11
Limited Depreciation for Passenger Automobiles 7–18
Section 179 Expensing Election 7–19
Bonus Depreciation 7–20
Purchase versus Leasing Decision 7–22
Amortization of Intangible Assets 7–23
Organizational and Start-Up Costs 7–24
Leasehold Costs and Improvements 7–25
Business Acquisition Intangibles 7–26
Comprehensive Example of a Lump-Sum Purchase 7–27
Depletion of Natural Resources 7–28
Percentage Depletion 7–28
Cost Recovery–Related Book/Tax Differences 7–30
Depreciation Book/Tax Differences 7–30
Inventory Book/Tax Differences 7–30
Book/Tax Difference for Organizational and Start-Up Costs 7–31
Book/Tax Difference for Goodwill 7–31
Conclusion 7–32
Sources of Book/Tax Differences 7–32
Key Terms 7–33
Questions and Problems for Discussion 7–33
Application Problems 7–34
Issue Recognition Problems 7–40
Research Problems 7–41
Tax Planning Cases 7–42
Appendix 7–A Midquarter Convention Tables 7–44
Chapter 8
Property Dispositions 8–1
Computation of Gain or Loss Recognized 8–2
Sales and Exchanges 8–3
Seller-Financed Sales 8–5
Disallowed Losses on Related Party Sales 8–8
Tax Character of Gains and Losses 8–9
Capital Asset Defined 8–10
Capital Loss Limitation 8–10
Taxation of Capital Gains 8–12
Capital Asset Definition Revisited 8–12
Dispositions of Noncapital Assets 8–13
Inventory 8–13
Business Accounts Receivable and Supplies 8–14
Section 1231 Assets 8–15
Depreciation Recapture 8–17
Comprehensive Example 8–21
Other Property Dispositions 8–23
Abandonment and Worthlessness 8–23
Foreclosures 8–25
Casualties and Thefts 8–25
Book/Tax Differences on Asset Dispositions 8–26
Gain or Loss Book/Tax Differences 8–26
Book/Tax Difference for Nondeductible Capital Loss 8–27
Conclusion 8–27
Sources of Book/Tax Differences 8–28
Key Terms 8–28
Questions and Problems for Discussion 8–28
Application Problems 8–29
Issue Recognition Problems 8–39
Research Problems 8–40
Tax Planning Cases 8–41
Chapter 9
Nontaxable Exchanges 9–1
Tax Neutrality for Asset Exchanges 9–1
A Generic Nontaxable Exchange 9–2
Exchanges of Qualifying Property 9–2
The Substituted Basis Rule 9–3
The Effect of Boot 9–4
Book/Tax Difference from Nontaxable Exchange 9–5
Summary 9–6
Like-Kind Exchanges 9–6
Exchanges of Mortgaged Properties 9–8
Involuntary Conversions 9–9
Formations of Business Entities 9–10
Corporate Formations 9–11
Partnership Formations 9–13
Wash Sales 9–13
Conclusion 9–14
Sources of Book/Tax Differences 9–14
Key Terms 9–14
Questions and Problems for Discussion 9–15
Application Problems 9–16
Issue Recognition Problems 9–23
Research Problems 9–24
Tax Planning Cases 9–25
Comprehensive Problems for Part Three 9–25
PART FOUR
THE TAXATION OF BUSINESS INCOME
Chapter 10
Sole Proprietorships, Partnerships, LLCs, and S Corporations 10–3
Sole Proprietorships 10–4
Overview of Schedule C 10–4
Employment Taxes 10–11
Self-Employment Tax 10–13
Partnerships 10–15
Forming a Partnership 10–15
Limited Liability Companies 10–16
Partnership Reporting Requirements 10–18
Tax Consequences to Partners 10–21
Adjusting the Basis of a Partnership Interest 10–24
Basis Limitation on Loss Deductions 10–26
Subchapter S Corporations 10–28
Eligible Corporations 10–28
Tax Consequences to Shareholders 10–31
Adjusting the Basis of S Corporation Stock 10–34
Conclusion 10–35
Key Terms 10–36
Questions and Problems for Discussion 10–36
Application Problems 10–37
Issue Recognition Problems 10–43
Research Problems 10–45
Tax Planning Cases 10–45
Chapter 11
The Corporate Taxpayer 11–1
Legal Characteristics of Corporations 11–2
Affiliated Groups 11–2
Nonprofit Corporations 11–4
Computing Corporate Taxable Income 11–4
The Dividends-Received Deduction 11–6
Reconciling Book Income and Taxable Income 11–7
Computing the Regular Corporate Tax 11–8
Tax Credits 11–9
Rehabilitation Credit 11–10
Minimum Tax Credit 11–12
Payment and Filing Requirements 11–12
Distributions of Profits to Investors 11–14
Alternatives to Double Taxation 11–14
Incidence of the Corporate Tax 11–15
Conclusion 11–16
Sources of Book/Tax Differences 11–16
Key Terms 11–16
Questions and Problems for Discussion 11–16
Application Problems 11–17
Issue Recognition Problems 11–23
Research Problems 11–24
Tax Planning Cases 11–25
Appendix 11–A Schedule M-3 for Reconciling Book and Taxable Income
11–26
Chapter 12
The Choice of Business Entity 12–1
Tax Planning with Passthrough Entities 12–2
Tax Benefit of Start-Up Losses 12–2
Avoiding a Double Tax on Business Income 12–4
Income Shifting among Family Members 12–5
Partnership or S Corporation? 12–8
Contrasting Characteristics 12–8
Two Planning Cases 12–9
Tax Planning with Closely Held Corporations 12–11
Getting Cash out of the Corporation 12–11
Rise and Fall of the Corporate Tax Shelter 12–14
Penalty Taxes on Corporate Accumulations 12–15
Conclusion 12–17
Key Terms 12–17
Questions and Problems for Discussion 12–17
Application Problems 12–19
Issue Recognition Problems 12–23
Research Problems 12–24
Tax Planning Cases 12–25
Chapter 13
Jurisdictional Issues in Business Taxation 13–1
State and Local Taxation 13–2
Gross Receipts Taxes 13–3
Constitutional Restrictions on State Jurisdiction 13–3
Apportionment of Business Income 13–5
Tax Planning Implications 13–7
Tax Consequences of International Business Operations 13–8
Income Tax Treaties 13–8
U.S. Jurisdiction to Tax Global Income 13–9
Foreign Tax Credit 13–10
Limitation on the Annual Credit 13–10
Reduced Tax Rate on Foreign-Derived Intangible Income 13–13
Organizational Forms for Overseas Operations 13–13
Branch Offices and Foreign Partnerships 13–14
Domestic Subsidiaries 13–14
Foreign Subsidiaries 13–14
Tax Consequences of Operating Abroad through a Foreign Corporation
13–15
Pre-2018 Deferral Regime for Foreign Corporations 13–15
Post-2017 Participation Exemption for Foreign Corporations 13–17
Transition from Deferral Regime to Participation Exemption 13–18
Controlled Foreign Corporations 13–20
Limitations on Cross-Border Income Shifting 13–23
Book/Tax Differences Related to Foreign Operations 13–25
Conclusion 13–25
Sources of Book/Tax Differences 13–26
Key Terms 13–26
Questions and Problems for Discussion 13–26
Application Problems 13–28
Issue Recognition Problems 13–34
Research Problems 13–35
Tax Planning Cases 13–36
Comprehensive Problems for Part Four 13–37
PART FIVE
THE INDIVIDUAL TAXPAYER
Chapter 14
The Individual Tax Formula 14–3
Filing Status for Individuals 14–4
Married Individuals and Surviving Spouses 14–4
Unmarried Individuals 14–5
Who Qualifies as a Dependent 14–5
Overview of the Taxable Income Computation 14–6
The Four-Step Procedure 14–7
Step 1: Calculate Total Income 14–7
Step 2: Calculate Adjusted Gross Income 14–7
Step 3: Subtract Standard Deduction or Itemized Deductions 14–8
Step 4: Subtract the QBI Deduction Amount 14–12
The Taxable Income Formula 14–13
Computing Individual Tax 14–13
Individual Tax Rate Schedules 14–14
The Elusive Marginal Tax Rate 14–16
The Marriage Penalty Dilemma 14–17
Individual Tax Credits 14–19
Child Credit 14–19
Dependent Care Credit 14–19
Earned Income Credit 14–20
Excess Social Security Tax Withholding Credit 14–21
Alternative Minimum Tax 14–22
Computing AMT 14–23
Payment and Filing Requirements 14–25
Conclusion 14–26
Key Terms 14–27
Questions and Problems for Discussion 14–27
Application Problems 14–28
Issue Recognition Problems 14–34
Research Problems 14–35
Tax Planning Cases 14–35
Chapter 15
Compensation and Retirement Planning 15–1
The Compensation Transaction 15–2
Employee or Independent Contractor? 15–2
Tax Consequences of Worker Classification 15–2
Worker Classification Controversy 15–3
Wage and Salary Payments 15–5
Tax Consequences to Employees 15–5
Tax Consequences to Employers 15–5
Reasonable Compensation 15–6
Foreign Earned Income Exclusion 15–8
Employee Fringe Benefits 15–9
Fringe Benefits and Self-Employed Individuals 15–11
Compensation Planning with Fringe Benefits 15–12
Equity-Based Compensation 15–13
Restricted Stock 15–13
Stock Options 15–15
Consequences to Corporate Employer 15–16
Incentive Stock Options 15–17
Retirement Planning 15–19
Tax Advantages of Qualified Retirement Plans 15–19
Premature Withdrawals 15–21
Types of Qualified Plans 15–22
Employer-Provided Plans 15–22
Keogh Plans for Self-Employed Individuals 15–26
Individual Retirement Accounts 15–27
Limits on IRA Contributions 15–27
Deduction of IRA Contributions 15–28
Withdrawals from IRAs 15–30
Rollovers to IRAs 15–32
Conclusion 15–33
Sources of Book/Tax Differences 15–33
Key Terms 15–33
Questions and Problems for Discussion 15–34
Application Problems 15–35
Issue Recognition Problems 15–41
Research Problems 15–43
Tax Planning Cases 15–43
Chapter 16
Investment and Personal Financial Planning 16–1
Business versus Investment Activities 16–2
Investments in Financial Assets 16–2
Dividend and Interest Income 16–2
Tax-Exempt Interest 16–5
Deferred Interest Income 16–6
Life Insurance Policies and Annuity Contracts 16–8
Gains and Losses from Security Transactions 16–10
Computing Gains and Losses 16–10
Tax Consequences of Capital Gains and Losses 16–13
Netting Capital Gains and Losses 16–13
Preferential Rates on Long-Term Capital Gains 16–14
Policy Reasons for a Preferential Rate 16–17
Capital Loss Limitation 16–18
Investments in Small Corporate Businesses 16–19
Qualified Small Business Stock 16–19
Section 1244 Stock 16–20
Investment Expenses 16–20
Investment Interest Expense 16–21
Investments in Real Property 16–21
Undeveloped Land 16–22
Rental Real Estate 16–22
Investments in Passive Activities 16–23
Passive Activity Loss Limitation 16–25
Planning with Passive Activity Losses 16–26
Unearned Income Medicare Contribution Tax 16–27
Wealth Transfer Planning 16–28
The Transfer Tax System 16–28
The Gift Tax 16–28
The Estate Tax 16–31
Conclusion 16–33
Key Terms 16–33
Questions and Problems for Discussion 16–34
Application Problems 16–35
Issue Recognition Problems 16–42
Research Problems 16–43
Tax Planning Cases 16–44
Appendix 16–A Comprehensive Schedule D Problem 16–46
Chapter 17
Tax Consequences of Personal Activities 17–1
Gross Income from Whatever Source Derived 17–1
Prizes, Awards, Gifts, and Inheritances 17–2
Legal Settlements 17–4
Government Transfer Payments 17–5
Gains on Sales of Personal Assets 17–6
Personal Expenses 17–8
Medical Expenses 17–8
Local, State, and Foreign Tax Payments 17–10
Charitable Contributions 17–11
Tax Subsidies for Education 17–12
Personal Losses 17–13
Losses on Sales of Personal Assets 17–13
Casualty Losses 17–13
Hobby and Gambling Losses 17–14
Tax Consequences of Homeownership 17–15
Home Mortgage Interest Deduction 17–16
Vacation Home Rental 17–17
Exclusion of Gain on Sale of Principal Residence 17–18
Conclusion 17–19
Key Terms 17–20
Questions and Problems for Discussion 17–20
Application Problems 17–21
Issue Recognition Problems 17–26
Research Problems 17–27
Tax Planning Cases 17–28
Comprehensive Problems for Part Five 17–29
Appendix 17–A Social Security Worksheet (Adapted from IRS Publication
915) 17–31
PART SIX
THE TAX COMPLIANCE PROCESS
Chapter 18
The Tax Compliance Process 18–3
Filing and Payment Requirements 18–4
Late-Filing and Late-Payment Penalty 18–5
Return Processing 18–6
The Audit Process 18–8
Your Rights as a Taxpayer 18–9
Noncompliance Penalties 18–10
Tax Return Preparer Penalties 18–14
Contesting the Result of an Audit 18–15
Litigation 18–15
A Case History: Lori Williams v. United States 18–16
Making the Legal System More Taxpayer Friendly 18–17
IRS Collection Procedures 18–18
The Innocent Spouse Rule 18–19
Conclusion 18–20
Key Terms 18–20
Questions and Problems for Discussion 18–21
Application Problems 18–22
Issue Recognition Problems 18–26
Research Problems 18–26
Tax Planning Cases 18–27
Appendix A Present Value of $1 A–2
Appendix B Present Value of Annuity of $1 A–3
Appendix C 2019 Income Tax Rates A–4
Glossary G
Index I–1