McGraw Hill’s Essentials of Federal Taxation 2022 Edition 13th Edition by Brian Spilker Solution ma

[LO 4, LO 5] Compare the federal income tax to sales taxes using the “certainty” criterion.

Certainty means that taxpayers should be able to determine when to pay the tax, where to pay the tax, and how to determine the tax.  It is relatively easy to determine when and where to pay the federal income tax and sales taxes.  For example, individual federal income tax returns and the remaining balance of taxes owed must be filed with the Internal Revenue Service each year on or before April 15th (or the first business day following April 15th if the 15th falls on a weekend).  Likewise, sales taxes are paid to retailers when items are purchased, and property taxes are typically paid annually to local governments.  The ease of “how to determine the tax,” however, varies by tax system.  Sales taxes are determined with relative ease – i.e., they are based on the value of taxable purchases.  In contrast, income taxes are often criticized as being complex.  What are taxable/nontaxable forms of income?  What are deductible/nondeductible expenses?  When should income or expense be reported?  For many taxpayers (e.g., wage earners with few investments), the answers to these questions are straightforward.  For other taxpayers (e.g., business owners, individuals with a lot of investments), the answers to these questions are nontrivial.  Constant tax law changes enacted by Congress also add to the difficulty in determining the proper amount of income tax to pay.  These changes can make it difficult to determine a taxpayer’s current tax liability much less plan for the future.     


[LO 5] Many years ago a famous member of Congress proposed eliminating federal income tax withholding.  What criterion for evaluating tax systems did this proposal violate?  What would likely have been the result of eliminating withholding?

Eliminating withholding would violate the convenience criterion – i.e., a tax system should be designed to facilitate the collection of tax revenues without undue hardship on the taxpayer or the government (i.e., a tax system should make collection as easy as possible).  Eliminating withholding would most likely have slowed collection of taxes and increased taxpayer aggressiveness (or tax evasion).  Prior research suggests that taxpayers are more likely to take more aggressive tax positions when they owe additional taxes when filing their return.


[LO 5] “The federal income tax scores very high on the economy criterion because the current IRS budget is relatively low compared to the costs of a typical collection agency.”  Explain why this statement may be considered wrong.

This statement ignores the economy criterion from the taxpayer’s perspective.  The income tax is often criticized for the compliance costs imposed on the taxpayer.  Indeed, for certain taxpayers, record-keeping costs, accountant fees, attorney fees, etc. can be quite substantial.  Advocates of alternative tax systems often challenge the income tax on this criterion. 
 
 
Problems
 
[LO 3] Chuck, a single taxpayer, earns $75,000 in taxable income and $10,000 in interest from an investment in City of Heflin bonds.  Using the U.S. tax rate schedule, how much federal tax will he owe?  What is his average tax rate?  What is his effective tax rate?  What is his current marginal tax rate?
Chuck will owe $12,249 in federal income tax this year computed as follows:
$12,249 = $4,664 + 22% ($75,000 - $40,525)—rounded up to the nearest dollar. 

Chuck’s average tax rate is 16.33 percent. 
Average Tax Rate = Total Tax/Taxable Income = $12,249/$75,000 = 16.33%
 
Chuck’s effective tax rate is 14.41 percent. 
 
Effective tax rate = Total Tax/Total Income = $12,249/($75,000 + $10,000) = 14.41%
 
Chuck is currently in the 22 percent tax rate bracket.  His marginal tax rate on increases in income up to $11,375 and deductions from income up to $34,475 is 22 percent.
 
 
[LO 3] Using the facts in problem 34, if Chuck earns an additional $40,000 of taxable income, what is his marginal tax rate on this income?  What is his marginal rate if, instead, he had $40,000 of additional deductions?
If Chuck earns an additional $40,000 of taxable income, his marginal tax rate on the income is 23.43 percent. 
Marginal Tax Rate = Change in Tax/Change in Taxable Income = ($21,621 - $12,249)/($115,000 - $75,000) = 23.43%
Where $21,621 for the revised tax is computed as follows: $21,621 = $14,751 + 24% ($115,000 - $86,375). 

If Chuck instead had $40,000 of additional tax deductions, his marginal tax rate on the deductions would be 20.62 percent.