AC435

Grantham University

Chapter 1
1. What is meant by revenue neutrality? Revenue neutrality is a change in the tax system
that results in the same amount of revenue. Revenue neutral, however, does not mean
that any one taxpayer pays the same amount of tax as before. Thus, as a result of a tax
law change, corporations could pay more taxed, but the excess revenue will be offset by
lower taxes on individuals.

2. In terms of asset acquisitions, what tax provisions can Congress use to control the
economy? Depreciation changes such as short asset lives and accelerated methods should
encourage additional investments.

3. List some tax provisions that encourage particular industries. Farmers are allowed to
elect to expense rather than capitalize certain expenditures for soil and water conservation
and fertilizers and the election to defer the recognition of gain on the receipt of crop
insurance proceeds. For the manufacturing sector, Congress enacted a tax incentive
based on profits from manufacturing. Known as the domestic production activities
deduction, the benefit is structured in such a manner as to stimulate the creation of jobs.

4. What economic objective is encouraged by favorable tax treatment of research and
development expenditures? The desire to foster technological progress.

5. List three tax provisions that can be justified by social considerations. Group term life
insurance, earned income tax credit, contributions to pension plans, and accident and
health plans.

6. What purpose is served by the refundable earned income credit? Reduce the number of
people on the welfare rolls and to cut funding for welfare programs.

7. What purpose is served by allowing a deduction for charitable contributions? Shifts
financial and administrative burden of socially desirable programs from the public to the
private sector.


8. What is the reason for the disallowance of certain fines and penalties? The reason is to
not encourage those activities by permitting a deduction.
9. What is the justification for the favorable treatment of home ownership? It is justified on
both social and economic grounds. Equity helps mitigate the effect of the application of
the annual accounting period concept and helps taxpayers cope with the eroding result of
inflation.

10. What is the justification for the various credits, deductions, and exclusions that are
designed to encourage taxpayers to obtain additional education? A better educated
workforce carries a positive economic impact.

11. In mitigating the effect of the double taxation of income at the Federal level, what relief
does a deduction for state income taxes paid provide? Would a credit be preferable?
Allows a taxpayer to claim a deduction for state and local income taxes. A tax credit,
rather than a deduction, would eliminate the effects of multiple taxation on the same
income.

12. Some states that impose a state income tax allow the taxpayer a deduction for any Federal
income taxes paid. What is the justification for such an approach? The justification is to
mitigate the effect of having the same income be taxed twice.

13. A provision of the Code allows a deduction for Federal income tax purposes for state and
local income taxes paid. Does this provision eliminate the effect of multiple taxation of
the same income? Why or why not? In this connection, consider the following. The
deduction allowed for Federal income tax purposes for state and local income taxes is not
designed to neutralize the effect of multiple taxation on the same income. At most, this
deduction provides only partial relief. Only the allowance of a full tax credit would
achieve complete neutrality
a. Taxpayer, an individual, has itemized deductions that are less than the standard
deduction. With the standard deduction, a taxpayer is, indirectly, obtaining the
benefit of a deduction for any state or local income taxes he or she may have paid.
This is so because the standard deduction is in lieu of itemized deductions, which
include the deductions for state and local income taxes.
b. Taxpayer is in the 10% bracket for Federal income tax purposes. The 33% tax
bracket. If the taxpayer is in the 10% tax bracket, one dollar of a deduction for state
or local taxes would save ten cents of Federal income tax liability. In the 33% tax
bracket, the saving becomes thirty-three cents. The deduction approach (as opposed
to the allowance of a credit) favors high bracket taxpayers.

14. Stacey and her partners operate a profitable partnership. Because the business is
expanding, the partners would like to transfer it to a newly created corporation. Stacey is
concerned, however, over the possible tax consequences that would result from
incorporating. Please comment. They would run the risk of being double or even triple
taxed on the income earned and distributed to the shareholders.
15. Assume the same facts as in Question 14. Stacey is also worried that once the partnership
incorporates, the business will be subject to the Federal corporate income tax. Any
suggestions? Yes, once incorporated, the business may be subject to the Federal
corporate income tax. However, the corporate tax rates might be lower than Heathers
individual tax rates, especially if dividends are not paid to Heather.
The corporate income tax could be avoided altogether by electing to be an S corporation.
An S corporation is generally not taxed at the corporate level; instead, the income flows
through the corporate veil and is taxed at the shareholder level. An S election allows a
business to operate as a corporation but be taxed like a partnership

16. Give some examples of the wherewithal to pay concept. Examples would be like-kind
exchanges, transfer of property to a partnership and involuntary conversions.

17. Can recognized gain exceed the realized gain? No it cannot.

18. In a like-kind exchange, recognized gain is postponed and not avoided. Explain.
Recognition of gain ultimately occurs when the property is disposed of.

19. Under the annual accounting period concept, what time period is normally selected for
final settlement of most tax liabilities? One year

20. How does the installment method overcome the harsh treatment of the annual accounting
treatment concept? Allows a taxpayer to spread tax consequences over the payout period.

21. Why is there a grace period for contributions to a Keogh retirement plan? Requiring a
taxpayer to make a contribution to a Keogh retirement plan by the end of the year would
force an accurate determination of net self-employment income long before the income
tax return must be prepared and filed.

22. What is bracket creep? Any wage adjustment to compensate for inflation that increases
the income tax bracket of the recipient.

23. List the community property states. Louisiana, Texas, New Mexico, Arizona, California,
Washington, Idaho, Nevada, Wisconsin and Alaska if elected by the spouses.

24. Contrast the tax treatment between a community property state and a common law state.
In a common law system, each spouse owns whatever he or she earns. Under a
community property system, one-half of the earnings of each spouse is considered owned
by the other spouse.


25. List some tax provisions used to deter affluent taxpayers from obtaining preferential tax
treatment. Imputed interest rules, alternative minimum tax, personal holding company
tax.

26. How does the $13,000 annual gift tax exclusion help the IRS? It decreases the number of
tax returns that must be filed as well as reduces the taxes paid and thereby saves audit
efforts.

27. Explain the continuity of interest concept. The concept permits tax free treatment only if
the taxpayer retains a substantial continuing interest in the property transferred to the new
business.

28. Black Corporation lends $205,000 to Red Corporation with no provision for interest.
Black Corporation and Red Corporation are owned by the same shareholders. How
might the IRS restructure this transaction with adverse tax consequences?

29. What are the primary sources of tax laws? The 3 branches of government; legislative,
executive, and judicial.

30. To what factor can the complexity of the current tax Code be attributed? The
rearrangement of the tax code in various years.

31. Presuming IRS Regulations have not yet been issued, what do practitioners and
taxpayers look to in order to ascertain congressional intent?

32. Give an example of a tax provision that was named after a member of Congress. Keogh
Act

33. Determine the subparts of subsection 166(d) (1) (B).

166 (d) (1) (B)


Abbreviation of Section
Section number
Subsection number
Paragraph designation
Subparagraph designation

34. Is subsection 212 (1) a proper Code Section citation? Yes, some Code Sections omit the
subsection designation and use, instead, the paragraph designation as the first subpart

35. Why are certain Code Section numbers missing from the Internal Revenue code (e.g.
SS6, 7, 8, 9, 10)? They were intentionally omitted to provide flexibility to incorporate
later changes into the Code.

36. Where can a researcher find newly issued Proposed, final, and Temporary Regulations?
Proposed, final, and Temporary Regulations are published in the Federal Register and are
reproduced in major tax services. Final Regulations are issue as Treasury Decisions
(TDs).

37. Interpret each of the following citations:
a. Prop.Reg. 1.381 (b) -1(a). Proposed Regulation under Code 1
b. Rev.Rul. 72-171, 1972-1 C.B. 208 Revenue ruling 171, appearing on page 208 of
volume 1 of the Cumulative Bulletin for 1972
c. TAM 200803017 Technical advice memorandum issued in 2008, the third week
and 17
th
ruling in the third week

38. Sammy Young calls you requesting an explanation of the fact-finding determination of a
Federal Court of Appeals. Prepare a letter to be sent to Sammy answering this query.
His address is 1072 Richmond Lane, Keene, NH 01720.
August 4, 3014

Mr. Sammy Young
1072 Richmond Lane
Acton, MA 01720

Dear Mr. Young:

In response to your recent request, the fact-finding determination of a lower trial court is
binding on a Federal Court of Appeals. A Federal Court of Appeals is limited to a review
of the record of trial compiled by a trial court. Rarely will an appellate court disturb a
lower courts fact-finding determination.
Should you need more information, do not hesitate to contact me.
Sincerely,
Bethella Phillips



39.
TAX FILE MEMORANDUM
DATE: August 4, 2014
FROM: Bethella Phillips
RE: Telephone conversation with Cody Pappas regarding the failure of the IRS to
appeal
I explained to Mr. Pappas that there were numerous reasons why the IRS may decide not
to appeal a decision it loses in a District Court. For example, the work load may be too
heavy. Or the IRS may have decided that this particular case is not a good decision to
appeal (e.g., sympathetic taxpayer). Third, the IRS might not wish to appeal this case to
the appropriate Court of Appeals. I stressed that the failure to appeal does not necessarily
mean that the IRS agrees with the results reached.


40.

a. If the taxpayer decides to choose a District Court as the trial court for litigation,
the District Court of Wyoming would be the forum to hear the case. Unless the
prior decision has been reversed on appeal, one would expect the same court to
follow its earlier holding.
b. If the taxpayer decides to choose the Court of Federal Claims as the trial court for
litigation, the decision previously rendered by this Court should have a direct
bearing on the outcome. If the taxpayer selects a different trial court (i.e., the
appropriate U.S. District Court or the U.S. Tax Court), the decision rendered by
the Court of Federal Claims would be persuasive but not controlling. It is assumed
that the results reached by the Court of Federal Claims were not reversed on
appeal.
c. The decision of a Court of Appeals will carry more weight than one rendered by a
trial court. Since the taxpayer lives in California, however, any appeal from a
District Court or the U.S. Tax Court would go to the Ninth Court of Appeals.
Although the Ninth Court of Appeals might be influenced by what the Second
Court of Appeals has decided, it is not compelled to follow such holding.
d. Since the U.S. Supreme Court is the top appellate court, complete reliance can be
placed on its decisions. Nevertheless, one should investigate any decision to see
whether or not the Code has been modified to change the results reached. There
also exists the rare possibility that the Court may have changed its position in a later
decision.
e. When the IRS acquiesces in a decision of the Tax Court, it agrees with the results
reached. As long as such acquiescence remains in effect, taxpayers can be assured
that this represents the position of the IRS on the issue involved. Keep in mind,
however, that the IRS can change its mind and can, at any time, withdraw the
acquiescence and substitute a nonacquiescence.
f. The issuance of a nonacquiescence reflects that the IRS does not agree with the
results reached by a Tax Court decision. Consequently, taxpayers are placed on
notice that the IRS will continue to challenge the issue involved.

Chapter 2
1.

Chapter 3
3. a. DPAD cannot exceed 50% of W-2 wages.
b. DPAD is a percentage (3%, 6%, or 9%depending on the year involved) of the
lesser of QPAI or TI, but not to exceed 50% of W-2 wages.
c. DPAD is limited to a percentage of TI if less than the percentage of QPAI.
d. DPGR, when reduced by CGS and direct and indirect expenses, becomes QPAI.
e. DPAD is allowed for purposes of the AMT.
f. When an EAG is involved, DPAD is determined as if the group is a single
corporation.
4. A company with an NOL carryforward for a tax year is ineligible for the DPAD if
such
carryforward eliminates current taxable income.

5. DPAD is limited by 50% of the W-2 wages paid by the taxpayer that are allocable to
domestic production gross receipts (DPGR), including the sum of the aggregate
amount
of wages and elective deferrals required to be included on the W-2 wage statement for
the employees during the employers taxable year. If an employer has employees
whose
activities are applicable to providing services or other activities that do not create
DPGR or QPAI, such W-2 wages are not included in the favorable category.

6.



7.
8.
9.
10.
11. Only the party that has ownership of the property being produced can claim the
DPAD.
a. Much manufacturing takes place on a contract basis with more than one party
participating in the production process. Consequently, those who do not have title
to the property will not be able to claim the DPAD.
b. Title to the property should be placed with the taxpayer that wants to claim the
DPAD.

12.

13. a. Section 199(c)(4)(B)(i) specifically excludes from DPGR any receipts
from the sale of food and beverages by a taxpayer at retail. Frozen prepared foods
sold to grocery stores, however, will qualify.
b. No, it would not matter. Reg. 1.1993(o) makes it quite clear that take-
out and delivery services will be treated the same as prepared meals served on the
premises.

14. According to Reg. 1.199-3(i)(5)(iii), Ex. 3, the gross receipts derived by Mash
from licensing the first television program to Clear, Inc., are DPGR. Thus, under this
provision, all of Mashs product placement and advertising income for the first television
program is treated as gross receipts that are derived from the license of the qualified film.
The gross receipts derived by Mash from licensing the second television program to
Zebra are non-DPGR because they are related parties (e.g., members of an EAG). Thus,
none of Mashs product placement and advertising income for the second television
program is treated as gross receipts derived from a qualified film.

15. The most likely reasons why Kathleen has a lower DPAD would be due to the
taxable income or W-2 wage limitations. She might have some losses that offset the
QPAI that passes through. Also, the W-2 wage pass through from Blue might not, by
itself, be enough to allow the full DPAD to be used. But Justin has other W-2 wages he
can count to allow for a larger DPAD than Kathleen.

16. The DPAD is allowed for purposes of the alternative minimum tax (AMT), except
that the deduction is equal to 9% of the smaller of (1) QPAI or (2) alternative minimum
taxable income (without considering the DPAD) for the tax year. In the case of an
individual, modified AGI (ignoring the DPAD) is substituted for AMTI.

17. This statement is incorrect. The AMT is a separate tax system with a quasi-flat tax
rate which is applied each year to a corporations economic income. If the tentative
alternative minimum tax is greater than the regular corporate income tax under 11, then
the corporation must pay the regular tax plus this excess, the alternative minimum tax
(AMT).

18. A corporation initially qualifies as a small corporation in its first tax year in existence
regardless of its gross receipts. After the initial year, the exemption applies if two
requirements are met.
The corporation must have been treated as a small corporation exempt from the AMT
for all prior years beginning after 1997, and
Average annual gross receipts for the three-year tax period (or portion thereof during
which the corporation was in existence) ending before its tax year beginning in 2012
did not exceed $7.5 million ($5 million if the corporation has only one prior year).
Thus, the $5 million rule only applies in testing for the second year of a new
corporations life. So if a corporation had gross receipts of $5 million or less its first year,
the second year is exempted.

19. Tax preference items are only positive. Adjustments are often timing differences and
may be positive or negative.

20. Only the percentage depletion claimed in excess of the adjusted basis of the property
is a tax preference item. This item is not a tax preference for independent oil and
gas
producers and royalty owners.

21. Although an NOL is an adjustment, it is separately stated on Form 4626 because it
may not exceed more than 90% of AMTI.

22. a. I. (Add)
b. N. (No impact)
c. N. (No impact)
d. N. (No impact)
e. I. (Add)
f. I. [Add (net of cash surrender value previously accounted for)]
g. I. (Add)

23. a. E.
b. E.
c. D.
d. E.
e. D.
f. E.
g. I.
h. N.
i. I. .

24. August 4, 2014

TAX FILE MEMORANDUM
SUBJECT: Alice Tiras
RE: ACE versus Current E & P

I told Ms. Tiras in auditing that ACE should not be confused with current E & P. Many
items are treated in the same manner, but certain items that are deductible in computing
E & P (but are not deductible in calculating taxable income) generally are not deductible in
computing ACE (e.g., Federal income taxes). The impact of various transactions on ACE
and E & P vary.
The starting point for computing ACE is AMTI, which is defined as regular taxable
income after AMT adjustments (other than the NOL and ACE adjustments) and after tax
preferences. See 56(g). The resulting figure is adjusted for a number of items in order to
determine ACE (e.g., life insurance proceeds).

25.
a. Add.
b. Add.
c. No effect.
d. Add.
e. No effect.
f. Add.
g. No effect.
h. Subtract.
26. Foreign tax credit
27.
28.
a. . A decrease in taxable income.
b. NE. Only a taxable stock dividend would result in a reduction in ATI.
c. NE. Only excess charitable contributions are subtracted.
d. +.
e. +.

29. The formula is wrong. Dividends received should not be added, but dividends paid
should be subtracted
30. The corporation should attempt to avoid bunching positive adjustments and tax
preferences in any one year.
If a corporation expects to be subject to the AMT, accelerate income and defer
deductions for the remainder of the year.
During an AMT year, sell any major assets to obtain the favorable 20% AMT rate.
31. Any increase in the dividend tax rate will have an adverse impact on a corporation
subject to the accumulated earnings or personal holding company tax.
For the years of 2011 and 2012, the dividend tax rate and capital gain tax rate will remain
the same as they were for the year of 2010. Likewise, for the years of 2011 and 2012,
both of the penalty tax rates remain at 15% as they were for the year of 2010. Thus, for a
company with $2.2 million of accumulated taxable income, it will owe $330,000
($2,200,000 15%) of penalty tax in 2012 (the same as would be owed on this same
amount in 2011). This penalty tax is above and beyond the regular corporate income
taxes. A similar result would occur for a personal holding company.
32. Assuming the marginal corporate rate is 35% in 2012, the maximum DPAD savings
is $346,500 ($11,000,000 9% 35%)
33. a. $54,000. The taxable income limitation of $54,000 (9% $600,000) is less than
the QPAI computation of $72,000 (9% $800,000) and is under the W-2
limitation of $60,000 (50% $120,000).
b. $10,000. The W-2 limitation of $10,000 (50% $20,000) is less than the QPAI
computation of $36,000 (9% $400,000).
c. $72,000. After the NOL carryover of $100,000, taxable income becomes
$800,000 ($900,000 $100,000). Now, the taxable income limitation of $72,000
(9% $800,000) is less than the QPAI computation of $81,000 (9% $900,000)
and is under the W-2 limitation of $150,000 (50% $300,000).
d. $63,000. The QPAI computation of $63,000 (9% $700,000) is less than the
taxable income limitation of $81,000 (9% $900,000) and is under the W-2
limitation of $100,000 (50% $200,000).
e. $30,000. The QPAI computation of $81,000 (9% $900,000) is the same as the
taxable income limitation of $81,000 (9% $900,000) but is not under the W-2
limitation of $30,000 (50% $60,000). For purposes of the W-2 limitation, the wages
considered do have to relate to the manufacturing activities in 2012
34. a. Terns DPGR is $8.2 million. The $1 million derived from the Nicaragua facility
cannot be included under the de minimis rule, as the amount exceeds 5%$1
million/$9.2 million = 10.87%.
b. Terns DPGR now becomes $8.6 million. The $400,000 from Nicaragua is
included under the de minimis rule$400,000/$8.6 million = 4.65%, which is
less than 5%.
35. Cowbird can treat all of its receipts as non-DPGR and thereby avoid the application
of
199.

36. a. Although the basic warranty is an embedded service, it is not separately priced or
bargained for; the warranty is included as part of the cost of the product.
Therefore, the full $3,000 is DPGR.
b. Because the warranty is separately priced, the de minimis rule is not available.
DPGR still is $3,000.
c. Because the warranty is separately priced, it does not constitute DPGR. DPGR
still is $3,000.
d. If the price of the product were raised to $3,300 and every item sold was under a
10-year warranty, the full sales price becomes DPGR. Doves extended warranties
should not be separately priced or bargained for, so as to maximize its DPGR.
37. a. The full $2,800 selling price represents DPGR. The foreign components ($1,600)
can be included as the domestic source contribution ($400) represents at least
20% ($400/$2,000) of CGS and meets the safe harbor rule.
b. QPAI is $750 ($2,800 $1,600 $400 $50).