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COnTEnTs
PREFACE xiv Problem Materials 1-32

Discussion Questions 1-32
CHAPTER 1 Problems 1-34
c an inTROduCTiOn TO TaXaTiOn 1-1 Tax Strategy Problem 1-36
History of Taxation in the United States 1-2 Case Study Problem 1-36
Early Periods 1-2 Tax Research Problem 1-36
Revenue Acts from 1913 to the Present 1-3
Revenue Sources 1-3 CHAPTER 2
Types of Tax Rate Structures 1-4 c dETERMinaTiOn OF TaX 2-1
The Structure of Individual Income Tax Rates 1-4 Formula for Individual Income Tax 2-2
The Structure of Corporate Tax Rates 1-5 Basic Formula 2-2
Marginal, Average, and Effective Tax Rates for Definitions 2-3
Taxpayers 1-5 Tax Formula Illustrated 2-6
Determination of Taxable Income and
Deductions from Adjusted Gross Income 2-7
Tax Due 1-6
Itemized Deductions 2-7
Other Types of Taxes 1-7 Standard Deduction 2-10
State and Local Income and Franchise Taxes 1-7 Personal Exemptions 2-12
Wealth Transfer Taxes 1-7 Dependency Exemptions 2-13
Other Types of Taxes 1-11 Child Credit 2-19
Criteria for a Tax Structure 1-12 Determining the Amount of Tax 2-20
Equity 1-12 Filing Status 2-20
Certainty 1-13 Joint Return 2-21
Convenience 1-13 Surviving Spouse 2-22
Economy 1-13 Head of Household 2-22
Simplicity 1-14 Single Taxpayer 2-23
Objectives of the Federal Income Tax Law 1-14 Married Filing a Separate Return 2-23
Entities in the Federal Income Tax System 1-16 Abandoned Spouse 2-23
Taxpaying Entities 1-17 Children with Unearned Income 2-24
Flow-Through Entities 1-20 Business Income and Business Entities 2-27
Other Entities 1-23
Treatment of Capital Gains and Losses 2-30
Tax Law Sources 1-24 Definition of Capital Assets 2-30
Enactment of a Tax Law 1-24 Tax Treatment of Gains and Losses 2-30
Steps in the Legislative Process 1-24 Provisions Applicable to Higher-Income Taxpayers 2-31
Administration of the Tax Law and Tax Practice Tax Planning Considerations 2-32
Issues 1-26 Shifting Income Between Family Members 2-32
Organization of the Internal Revenue Service 1-26 Splitting Income 2-32
Enforcement Procedures 1-27 Maximizing Itemized Deductions 2-33
Selection of Returns for Audit 1-27 Filing Joint or Separate Returns 2-33
Statute of Limitations 1-28
Compliance and Procedural Considerations 2-35
Interest 1-28
Who Must File 2-35
Penalties 1-28
Due Dates and Extensions 2-35
Administrative Appeal Procedures 1-29
Use of Forms 1040, 1040EZ, and 1040A 2-36
Components of a Tax Practice 1-29 System for Reporting Income 2-36
Tax Compliance and Procedure 1-29
Problem Materials 2-37
Tax Research 1-30
Tax Planning and Consulting 1-30
Issue Identification Questions 2-38
Financial Planning 1-31
Problems 2-38
Computer Applications in Tax Practice 1-31 Tax Strategy Problems 2-43
Tax Return Preparation 1-31 Tax Form/Return Preparation Problems 2-43
Tax Planning Applications 1-31 Case Study Problems 2-44
Tax Research Applications 1-31 Tax Research Problems 2-44
iii
iv Individuals ▶ Contents
CHAPTER 3 CHAPTER 4
c GROss inCOME: inClusiOns 3-1 c GROss inCOME: EXClusiOns 4-1
Economic, Accounting, and Tax Concepts of Income 3-2 Items That Are Not Income 4-2
Economic Concept 3-2 Unrealized Income 4-2
Accounting Concept 3-2 Self-Help Income 4-3
Tax Concept of Income 3-3 Rental Value of Personal-Use Property 4-3
Selling Price of Property 4-3
To Whom Is Income Taxable? 3-6
Assignment of Income 3-6 Major Statutory Exclusions 4-4
Gifts and Inheritances 4-4
Allocating Income Between Married People 3-6
Life Insurance Proceeds 4-5
Income of Minor Children 3-8
Awards for Meritorious Achievement 4-7
When Is Income Taxable? 3-8 Scholarships and Fellowships 4-7
Cash Method 3-8 Distributions from Qualified Tuition Programs 4-7
Accrual Method 3-11 Payments for Injury and Sickness 4-8
Hybrid Method 3-12 Employee Fringe Benefits 4-10
Items of Gross Income: Sec. 61(a) 3-13 Foreign-Earned Income Exclusion 4-19
Compensation 3-13 Income from the Discharge of a Debt 4-20
Business Income 3-13 Exclusion for Gain from Small Business Stock 4-22
Other Exclusions 4-22
Gains from Dealings in Property 3-13
Interest 3-13 Tax Planning Considerations 4-23
Rents and Royalties 3-15 Employee Fringe Benefits 4-23
Dividends 3-16 Self-Help Income and Use of Personally Owned
Alimony and Separate Maintenance Payments 3-18 Property 4-24
Pensions and Annuities 3-20 Compliance and Procedural Considerations 4-24
Income from Life Insurance and Endowment Problem Materials 4-25
Contracts 3-22 Discussion Questions 4-25
Income from Discharge of Indebtedness 3-23 Issue Identification Questions 4-26
Income Passed Through to Taxpayer 3-23 Problems 4-26
Other Items of Gross Income 3-23 Comprehensive Problem 4-30
Prizes, Awards, Gambling Winnings, and Treasure Tax Strategy Problems 4-30
Finds 3-24 Tax Form/Return Preparation Problems 4-31
Illegal Income 3-24 Case Study Problems 4-31
Unemployment Compensation 3-24 Tax Research Problems 4-32
Social Security Benefits 3-24
Insurance Proceeds and Court Awards 3-26 CHAPTER 5
c PROPERTY TRansaCTiOns: CaPiTal Gains
Recovery of Previously Deducted Amounts 3-26
and lOssEs 5-1
Claim of Right 3-27
Determination of Gain or Loss 5-3
Tax Planning Considerations 3-27 Realized Gain or Loss 5-3
Shifting Income 3-27 Recognized Gain or Loss 5-5
Alimony 3-28 Basis Considerations 5-5
Prepaid Income 3-28 Cost of Acquired Property 5-5
Taxable, Tax-Exempt, or Tax-Deferred Bonds 3-29 Property Received as a Gift: Gifts After 1921 5-7
Reporting Savings Bond Interest 3-29 Property Received from a Decedent 5-8
Deferred Compensation Arrangements 3-30 Property Converted from Personal Use to Business
Compliance and Procedural Considerations 3-30 Use 5-10
Allocation of Basis 5-11
Discussion Questions 3-31 Definition of a Capital Asset 5-13
Influence of the Courts 5-14
Other IRC Provisions Relevant to Capital Gains and
Problems 3-35
Losses 5-15
Comprehensive Problems 3-38
Tax Strategy Problems 3-38 Tax Treatment for Capital Gains and Losses of
Noncorporate Taxpayers 5-16
Tax Form/Return Preparation Problem 3-39
Capital Gains 5-17
Case Study Problems 3-39
Adjusted Net Capital Gains (ANCG) 5-18
Tax Research Problem 3-40
Capital Losses 5-19
Contents ◀ Individuals v
Tax Treatment of Capital Gains and Losses: Corporate Special Disallowance Rules 6-23
Taxpayers 5-21 Wash Sales 6-23
Sale or Exchange 5-22 Transactions Between Related Parties 6-26
Worthless Securities 5-23 Hobby Losses 6-29
Retirement of Debt Instruments 5-23 Vacation Home 6-31
Options 5-26 Expenses of an Office in the Home 6-35
Patents 5-27 Tax Planning Considerations 6-36
Franchises, Trademarks, and Trade Names 5-27 Hobby Losses 6-36
Lease Cancellation Payments 5-28 Unreasonable Compensation 6-36
Holding Period 5-29 Timing of Deductions 6-37
Property Received as a Gift 5-29 Compliance and Procedural Considerations 6-37
Property Received from a Decedent 5-29 Proper Classification of Deductions 6-37
Nontaxable Exchanges 5-30 Proper Substantiation 6-37
Receipt of Nontaxable Stock Dividends and Stock Business Versus Hobby 6-37
Rights 5-30
Justification for Preferential Treatment of Net Capital
Gains 5-30
Mobility of Capital 5-31
Problems 6-40
Mitigation of the Effects of Inflation and the Progressive
Comprehensive Problems 6-45
Tax System 5-31
Tax Strategy Problems 6-46
Lowers the Cost of Capital 5-31
Tax Form/Return Preparation Problems 6-47
Tax Planning Considerations 5-32 Case Study Problem 6-49
Selection of Property to Transfer by Gift 5-32 Tax Research Problem 6-50
Selection of Property to Transfer at Time of Death 5-33 Tax Research Case 6-50
Documentation of Basis 5-33 CHAPTER 7
Reporting of Capital Gains and Losses on c iTEMiZEd dEduCTiOns 7-1
Schedule D 5-34
Medical Expenses 7-2
Qualified Individuals 7-2
Qualified Medical Expenses 7-3
Amount and Timing of Deduction 7-6
Problems 5-42
Comprehensive Problem 5-47 Taxes 7-9
Tax Strategy Problems 5-47 Definition of a Tax 7-9
Tax Form/Return Preparation Problems 5-48 Deductible Taxes 7-9
Case Study Problems 5-49 State and Local Income Taxes 7-10
Tax Research Problems 5-49 State and Local Sales Taxes 7-10
Personal Property Taxes 7-10
CHAPTER 6 Real Estate Taxes 7-10
c dEduCTiOns and lOssEs 6-1 Self-Employment Tax 7-11
Nondeductible Taxes 7-12
Classifying Deductions as For Versus From Adjusted Gross
Income (AGI) 6-3 Interest 7-12
Definition of Interest 7-12
Criteria for Deducting Business and Investment
Classification of Interest Expense 7-13
Expenses 6-5
Business or Investment Activity 6-5 Timing of the Interest Deduction 7-19
Ordinary Expense 6-7 Charitable Contributions 7-21
Necessary Expense 6-8 Qualifying Organization 7-21
Reasonable Expense 6-8 Type of Property Contributed 7-22
Expenses and Losses Incurred Directly by the Deduction Limitations 7-25
Taxpayer 6-9 Application of Carryovers 7-26
General Restrictions on the Deductibility of Expenses 6-10 Special Rules for Charitable Contributions Made by
Capitalization Versus Expense Deduction 6-10 Corporations 7-26
Expenses Related to Exempt Income 6-12 Summary of Deduction Limitations 7-27
Expenditures Contrary to Public Policy 6-12 Casualty and Theft Losses 7-28
Other Expenditures Specifically Disallowed 6-14 Miscellaneous Itemized Deductions 7-28
Proper Substantiation Requirement 6-17 Certain Employee Expenses 7-28
When an Expense Is Deductible 6-18 Expenses to Produce Investment Income 7-28
Cash Method 6-18 Cost of Tax Advice 7-29
Accrual Method 6-21 Reduction of Certain Itemized Deductions 7-29
vi Individuals ▶ Contents
Tax Planning Considerations 7-30 Tax Planning Considerations 8-34

Medical Expense Deduction 7-30 Bad Debts 8-34
Interest Expense Deduction 7-30 Casualties 8-34
Deduction for Charitable Contributions 7-31 Net Operating Losses 8-34
Compliance and Procedural Considerations 7-32 Compliance and Procedural Considerations 8-34
Medical Expenses 7-32 Casualty Losses 8-34
Charitable Contributions 7-32 Net Operating Losses 8-35
Taxes 7-34 Worthless Securities 8-35
Problem Materials 7-36 Problem Materials 8-35
Discussion Questions 7-36 Discussion Questions 8-35
Issue Identification Questions 7-37 Issue Identification Questions 8-37
Problems 7-38 Problems 8-37
Comprehensive Problem 7-42 Tax Strategy Problems 8-41
Tax Strategy Problems 7-42 Tax Form/Return Preparation Problems 8-42
Tax Research Problems 7-45
CHAPTER 9
CHAPTER 8 c EMPlOYEE EXPEnsEs and dEFERREd
c lOssEs and Bad dEBTs 8-1 COMPEnsaTiOn 9-1
Transactions That May Result in Losses 8-2 Classification and Limitations of Employee Expenses 9-2
Sale or Exchange of Property 8-2 Nature of the Employment Relationship 9-2
Expropriated, Seized, Confiscated, or Condemned Limitations on Unreimbursed Employee
Property 8-3 Expenses 9-4
Abandoned Property 8-3 Travel Expenses 9-5
Worthless Securities 8-3 Deductibility of Travel Expenses 9-5
Demolition of Property 8-4 Definition of Travel Expenses 9-5
General Qualification Requirements 9-6
Classifying the Loss on the Taxpayer’s Tax Return 8-4 Business Versus Pleasure 9-7
Ordinary Versus Capital Loss 8-5 Foreign Travel 9-8
Disallowance Possibilities 8-6 Additional Limitations on Travel Expenses 9-9
Passive Losses 8-7 Transportation Expenses 9-9
Computation of Passive Losses and Credits 8-7 Definition and Classification 9-9
Carryovers 8-8 Treatment of Automobile Expenses 9-11
Definition of a Passive Activity 8-10 Reimbursement of Automobile Expenses 9-12
Taxpayers Subject to Passive Loss Rules 8-12 Entertainment Expenses 9-13
Real Estate Businesses 8-14 50% Disallowance for Meal and Entertainment
Other Rental Real Estate Activities 8-15 Expenses 9-13
Casualty and Theft Losses 8-17 Classification of Expenses 9-13
Casualty Defined 8-17 Business Meals 9-14
Theft Defined 8-19 Entertainment Facilities and Club Dues 9-15
Deductible Amount of Casualty Loss 8-19 Business Gifts 9-16
Limitations on Personal-Use Property 8-20 Limitations on Entertainment Tickets 9-16
Netting Casualty Gains and Losses on Personal-Use Reimbursed Employee Business Expenses 9-17
Property 8-21 Moving Expenses 9-19
Casualty Gains and Losses Attributable to Business and Expense Classification 9-20
Investment Property 8-22 Definition of Moving Expenses 9-20
Timing of Casualty Loss Deduction 8-22 Treatment of Employer Reimbursements 9-21
Bad Debts 8-24 Education Expenses 9-21
Bona Fide Debtor-Creditor Relationship 8-24 Classification of Education Expenses 9-22
Taxpayer’s Basis in the Debt 8-25 General Requirements for a Deduction 9-23
Debt Must Be Worthless 8-26 Office in Home Expenses 9-24
Nonbusiness Bad Debts 8-26 General Requirements for a Deduction 9-24
Business Bad Debts 8-28 Deductions and Limitations 9-25
Deposits in Insolvent Financial Institutions 8-28 Deferred Compensation 9-27
Net Operating Losses 8-29 Qualified Pension and Profit-Sharing Plans 9-28
Computing the Net Operating Loss for Individuals 8-30 Qualification Requirements for a Qualified Plan 9-29
Carryback and Carryover Periods 8-32 Tax Treatment to Employees and Employers 9-30
Recomputation of Taxable Income in the Carryover Nonqualified Plans 9-32
Year 8-33 Employee Stock Options 9-34
Contents ◀ Individuals vii
Plans for Self-Employed Individuals 9-36 CHAPTER 11

Simplified Employee Pensions (SEP IRAs) 9-38 c aCCOunTinG PERiOds and METHOds 11-1
Simple Retirement Plans 9-38
Accounting Periods 11-2
Individual Retirement Accounts (IRAs) 9-38
Required Payments and Fiscal Years 11-3
Traditional IRA 9-39
Changes in the Accounting Period 11-4
Roth IRA 9-40 Returns for Periods of Less than 12 Months 11-5
Coverdell Education Savings Account 9-43
Health Savings Accounts 9-44 Overall Accounting Methods 11-7
Cash Receipts and Disbursements
Tax Planning Considerations 9-44
Method 11-7
Moving Expenses 9-44
Accrual Method 11-9
Providing Nontaxable Compensation
Hybrid Method 11-10
to Employees 9-45
Rollovers to Roth IRA 9-45 Inventories 11-11
Determination of Inventory Cost 11-11
Substantiating Travel and Entertainment Expenses 9-46 Special Accounting Methods 11-15
Reporting Employee Business Expenses 9-46 Long-Term Contracts 11-15
Reporting Moving Expenses 9-49 Installment Sales Method 11-17
Reporting Office in Home Expenses 9-49 Deferred Payment Sales 11-21
Qualification of Pension and Profit-Sharing Plans 9-50 Imputed Interest 11-22
Problem Materials 9-50 Imputed Interest Computation 11-23
Discussion Questions 9-50 Accrual of Interest 11-23
Issue Identification Questions 9-53 Gift, Shareholder, and Other Loans 11-24
Problems 9-53 Change in Accounting Methods 11-25
Comprehensive Problem 9-61 Amount of Change 11-26
Tax Strategy Problem 9-62 Reporting the Amount of the Change 11-27
Tax Form/Return Preparation Problems 9-62 Obtaining IRS Consent 11-27
Accounting Periods 11-28
Accounting Methods 11-28
CHAPTER 10 Installment Sales 11-28
c dEPRECiaTiOn, COsT RECOvERY, aMORTiZaTiOn,
and dEPlETiOn 10-1
Reporting Installment Sales on Form 6252 11-28
Depreciation and Cost Recovery 10-2 Procedures for Changing to LIFO 11-30
General Considerations 10-2
Depreciation Methods 10-4 Problem Materials 11-30
Calculation of Depreciation 10-5 Discussion Questions 11-30
MACRS Restrictions 10-12 Issue Identification Questions 11-31
Problems 11-32
Amortization 10-17
Comprehensive Problem 11-34
Sec. 197 Intangibles 10-17
Tax Strategy Problems 11-35
Research and Experimental Expenditures 10-19
Tax Form/Return Preparation Problem 11-35
Computer Software 10-20
Depletion, Intangible Drilling and Development Costs 10-21 Tax Research Problems 11-36
Depletion Methods 10-22
Treatment of Intangible Drilling and Development
Costs 10-23 CHAPTER 12
c PROPERTY TRansaCTiOns: nOnTaXaBlE
EXCHanGEs 12-1
Alternative Depreciation System Under MACRS 10-24
Use of Units of Production Depreciation 10-24 Like-Kind Exchanges 12-2
Structuring a Business Combination 10-24 Like-Kind Property Defined 12-2
Compliance and Procedural Considerations 10-25 A Direct Exchange Must Occur 12-5
Reporting Cost Recovery, Depreciation, Depletion, and Three-Party Exchanges 12-5
Amortization Deductions 10-25 Receipt of Boot 12-6
Basis of Property Received 12-7
Exchanges Between Related Parties 12-8
Issue Identification Questions 10-30 Transfer of Non–Like-Kind Property 12-9
Problems 10-30 Holding Period for Property Received 12-9
Comprehensive Problem 10-35 Involuntary Conversions 12-10
Tax Strategy Problem 10-36 Involuntary Conversion Defined 12-11
Tax Form/Return Preparation Problems 10-36 Tax Treatment of Gain Due to Involuntary Conversion
Case Study Problems 10-37 into Boot 12-12
Tax Research Problem 10-37 Replacement Property 12-13
viii Individuals ▶ Contents
Obtaining Replacement Property 12-14 Intangible Drilling Costs and Depletion 13-21
Time Requirements for Replacement 12-15 Gain on Sale of Depreciable Property Between Related
Sale of Principal Residence 12-16 Parties 13-22
Principal Residence Defined 12-17 Tax Planning Considerations 13-23
Sale of More than One Principal Residence Within a Avoiding the Recapture Provisions 13-23
Two-Year Period 12-18 Compliance and Procedural Considerations 13-24
Nonqualified Use After 2008 12-20 Reporting Sec. 1231 Gains and Losses on Form 4797 13-24
Involuntary Conversion of a Principal Residence 12-21 Reporting Gains Recaptured as Ordinary Income on
Tax Planning Considerations 12-21 Form 4797 13-24
Avoiding the Like-Kind Exchange Provisions 12-21 Reporting Casualty or Theft Gain or Loss on
Sale of a Principal Residence 12-22 Form 4684 13-24
Compliance and Procedural Considerations 12-23 Problem Materials 13-28
Reporting of Involuntary Conversions 12-23 Discussion Questions 13-28
Reporting of Sale or Exchange of a Principal Issue Identification Questions 13-29
Residence 12-24 Problems 13-30
Problem Materials 12-24 Comprehensive Problem 13-35
Discussion Questions 12-24 Tax Strategy Problems 13-35
Issue Identification Questions 12-25 Tax Form/Return Preparation Problems 13-36
Problems 12-26 Case Study Problems 13-36
Comprehensive Problem 12-30 Tax Research Problem 13-37
Tax Strategy Problem 12-30
Case Study Problem 12-32
CHAPTER 14
c sPECial TaX COMPuTaTiOn METHOds, TaX CREdiTs,
and PaYMEnT OF TaX 14-1
CHAPTER 13 Alternative Minimum Tax 14-2
c PROPERTY TRansaCTiOns: sECTiOn 1231 AMT Computation 14-3
and RECaPTuRE 13-1 AMT Tax Rates and Brackets 14-3
History of Sec. 1231 13-2 AMT Exemption Amount 14-3
Overview of Basic Tax Treatment for Sec. 1231 13-3 AMT Tax Preference Items 14-4
Net Gains 13-3 AMT Adjustments 14-4
Net Losses 13-3 AMT Credits 14-6
Tax Rate for Net Sec. 1231 Gain 13-4 Summary Illustration of the AMT Computation 14-7
Section 1231 Property 13-5 Self-Employment Tax 14-8
Section 1231 Property Defined 13-5 What Constitutes Self-Employment Income 14-9
Real or Depreciable Property Used in Trade or Personal and Business Tax Credits 14-10
Business 13-5 Use and Importance of Tax Credits 14-10
Involuntary Conversions 13-6 Value of a Credit Versus a Deduction 14-10
Condemnations 13-6
Nonrefundable Personal Tax Credits 14-11
Other Involuntary Conversions 13-7
Foreign Tax Credit 14-18
Procedure for Sec. 1231 Treatment 13-7 Business Related Tax Credits 14-19
Recapture Provisions of Sec. 1245 13-8 Refundable Personal Credits 14-23
Purpose of Sec. 1245 13-9 Provisions Related to Health Insurance 14-24
Recapture Provisions of Sec. 1250 13-10 Health Insurance Premium Assistance Credit (Also
Purpose of Sec. 1250 13-11 Known as Premium Tax Credit) 14-24
Section 1250 Property Defined 13-11 Shared Responsibility Payment 14-26
Unrecaptured Section 1250 Gain 13-12
Payment of Taxes 14-27
Taxation of Gains on Sale or Exchange of Depreciable
Withholding of Taxes 14-27
Real Property 13-12
Estimated Tax Payments 14-29
Low-Income Housing 13-15
Additional Recapture for Corporations 13-16 Tax Planning Considerations 14-30
Summary of Secs. 1231, 1245, and 1250 Gains 13-17 Avoiding the Alternative Minimum Tax 14-30
Avoiding the Underpayment Penalty for Estimated
Recapture Provisions—Other Applications 13-18
Tax 14-31
Gifts of Property Subject to Recapture 13-18
Cash-Flow Considerations 14-32
Transfer of Property Subject to Recapture at Death 13-18
Charitable Contributions 13-18 Use of General Business Tax Credits 14-32
Like-Kind Exchanges 13-19 Foreign Tax Credits and the Foreign Earned Income
Involuntary Conversions 13-19 Exclusion 14-32
Installment Sales 13-19 Compliance and Procedural Considerations 14-33
Section 179 Expensing Election 13-20 Alternative Minimum Tax (AMT) Filing
Conservation and Land Clearing Expenditures 13-20 Procedures 14-33
Contents ◀ Individuals ix
Withholdings and Estimated Tax Payments 14-33 Specific Rules Applicable to Corporations 16-4
General Business Tax Credits 14-33 Capital Gains and Losses 16-4
Nonrefundable Personal Tax Credits 14-33 Dividends-Received Deduction 16-5
Problem Materials 14-34 Net Operating Losses 16-6
Discussion Questions 14-34 Charitable Contributions 16-7
Issue Identification Questions 14-36 Compensation Deduction Limitation for Publicly Held
Problems 14-37 Corporations 16-8
U.S. Production Activities Deduction 16-8
Tax Strategy Problem 14-42 Computation of Tax 16-10
Tax Form/Return Preparation Problems 14-43 Computation of Taxable Income 16-10
Case Study Problems 14-43 Computation of Regular Tax 16-10
Tax Research Problem 14-44 Computation of the Corporate Alternative Minimum Tax
(AMT) 16-12
Penalty Taxes 16-14
Computation of Tax for Controlled Groups 16-17
CHAPTER 15 Consolidated Returns 16-19
c TaX REsEaRCH 15-1 Transfers of Property to Controlled
Overview of Tax Research 15-2 Corporations 16-20
Steps in the Tax Research Process 15-3 Section 351 Nonrecognition Requirements 16-20
Basis Considerations 16-21
Importance of the Facts to the Tax Treatment of Liabilities 16-22
Consequences 15-5 Corporate Capital Structure 16-24
Creating a Factual Situation Favorable to the
Earnings and Profits 16-25
Taxpayer 15-6
Calculation of Earnings and Profits 16-25
The Sources of Tax Law 15-7 Current Versus Accumulated E&P 16-25
The Legislative Process 15-7
Noncash Distributions 16-27
The Internal Revenue Code 15-8
Tax Consequences to the Shareholders 16-27
Treasury Regulations 15-9
Tax Consequences to the Distributing
Administrative Pronouncements 15-11
Corporation 16-27
Judicial Decisions 15-14
Stock Redemptions 16-28
Tax Treaties 15-24 Determining Whether a Redemption Is a Dividend or
Tax Periodicals 15-24 Capital Gain 16-29
Tax Services 15-25 Corporate Distributions in Complete
The Internet as a Research Tool 15-26 Liquidation 16-31
Keyword Searches 15-27 Tax Consequences to the Liquidating
Search by Citation 15-28 Corporation 16-31
Noncommercial Internet Services 15-28 Tax Consequences to the Shareholders 16-32
Citators 15-28 Section 332: Liquidation of a Subsidiary
Using the Citator 15-30 Corporation 16-32
Professional Guidelines for Tax Services 15-30 Tax Planning Considerations 16-33
Capital Structure and Section 1244 16-33
Treasury Department Circular 230 15-30
Dividend Policy 16-34
AICPA’s Statements on Tax Standards 15-31
Use of Losses 16-34
Sample Work Papers and Client Letter 15-34 Charitable Contributions 16-34
Problem Materials 15-34 Dividends-Received Deduction 16-34
Discussion Questions 15-34 Reduced Taxes on Taxpayer Stock Sales 16-35
Problems 15-35 Compliance and Procedural Considerations 16-35
Comprehensive Problem 15-38 Filling Requirements 16-35
Tax Strategy Problem 15-38 Schedule M-1 and M-2 Reconciliations 16-36
Case Study Problem 15-39 Schedule M-3 Reconciliation 16-37
Tax Research Problems 15-39 Maintenance of E&P Records 16-37
CHAPTER 16 Problems 16-43
c CORPORaTiOns 16-1 Tax Strategy Problems 16-49
Definition of a Corporation 16-2 Tax Form/Return Preparation Problems 16-50
Similarities and Differences Between the Taxation of Case Study Problems 16-51
Corporations and Individuals 16-3 Tax Research Problems 16-52
x Individuals ▶ Contents
CHAPTER 17 The Exempt Model 18-10

cPaRTnERsHiPs and s CORPORaTiOns 17-1 The Pension Model 18-10
Types of Pass-Through Entities 17-2 Multiperiod Strategies 18-14
Partnerships 17-2 Summary and Comparison of Basic Investment
S Corporations 17-3 Models 18-15
Limited Liability Companies 17-3 Other Applications of Investment Models 18-15
Limited Liability Partnerships 17-4 Flow-Through Entity Versus C Corporation 18-16
Taxation of Partnerships 17-4 Current Salary Versus Deferred
Formation of a Partnership 17-4 Compensation 18-20
Partnership Operations 17-8 Implicit Taxes and Clienteles 18-27
Special Allocations 17-8 Problem Materials 18-29
Allocation of Partnership Income, Deductions, Losses, Discussion Questions 18-29
and Credits to Partners 17-10 Problems 18-30
Basis Adjustments for Operating Items 17-10
Limitations on Losses and Restoration of Basis 17-11
Transactions Between a Partner and the T A B l E S
Partnership 17-12 2015 Tax Tables and Rate Schedules and 2016 Withholding
Partnership Distributions 17-13 Tables (Partial) T-1
Sale of a Partnership Interest 17-14
Optional and Mandatory Basis Adjustments 17-16
Electing Large Partnerships 17-17
Partnership Elections 17-18 A P P E N d i C E S
Taxation of S Corporations 17-20
c aPPEndiX a
Qualification Requirements 17-20
Election Requirements 17-21 Tax Research Working Paper File A-1
Termination Conditions 17-22
S Corporation Operations 17-23 c aPPEndiX B
Basis Adjustments to S Corporation Stock 17-25
S Corporation Losses and Limitations 17-26 Tax Forms B-1
Other S Corporation Considerations 17-28
Tax Planning Considerations 17-31 c aPPEndiX C
Use of Operating Losses 17-31 MACRS Tables C-1
Income Shifting Among Family Members 17-32
Optional Basis Adjustment Election Under Sec. 754 c aPPEndiX d
17-32
Compliance and Procedural Considerations 17-33 Glossary D-1
Partnership Filing Requirements and Elections 17-33 c aPPEndiX E
Reporting Partnership Items on Form 1065 17-33
S Corporation Filing Requirements and Accounting AICPA Statements on Standards for
Method Elections 17-34 Tax Services Nos. 1–7 E-1
Reporting S Corporation Items on Form 1120S 17-34
Comparison of Alternative Forms of Business c aPPEndiX F
Organizations 17-34
Index of Code Sections F-1
c aPPEndiX G
Problems 17-39 Index of Treasury Regulations G-1
Tax Strategy Problems 17-46 c aPPEndiX H
Index of Government Promulgations H-1
c aPPEndiX i
Index of Court Cases I-1
CHAPTER 18
c TaXEs and invEsTMEnT PlanninG 18-1 c aPPEndiX J
Investment Models 18-2
Subject Index J-1
The Current Model 18-2
The Deferred Model 18-5
aBOuT THE EdiTORs
Timothy J. Rupert is a Professor and the Golemme Administrative Chair at the D’Amore-
McKim School of Business at Northeastern University. He received his B.S. in Ac-
counting 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 Journal of the American Taxation Association,
Behavioral Research in Accounting, Advances in Taxation, Applied Cognitive
Psychology, Advances in Accounting Education, and Journal of Accounting Education.
He currently is the co-editor of Advances in 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
TIMOTHY J. RUPERT School’s Best Teacher of the Year award multiple 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.
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
business administration from the University of Kentucky. He teaches international taxa-
tion, partnership and S corporation taxation, tax research and policy, and introductory
taxation 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
professional 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
THOMAS R. POPE 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.
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 subsequently 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, partnership 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.
KENNETH E. ANDERSON
xi
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 articles 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.
Robert L. Gardner is the Robert J. Smith Professor of Accounting in the School of Accountancy
at Brigham Young University (BYU). He received a B.S. and M.B.A. from the University of
Utah and a Ph.D. from the University of Texas at Austin. He has authored or coauthored two
books and over 25 articles in journals such as The Tax Adviser, Journal of Corporate Taxa-
tion, Journal of Real Estate Taxation, Journal of Accounting Education, Journal of Taxation
of S Corporations, and the International Tax Journal. Professor Gardner has received several
teaching awards. In 2001, he received the Outstanding Faculty Award in the Marriott School
of Management at BYU. He has served on the Board of Trustees of the American Taxation
Association and served as President of the ATA in 1999–2000.
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 undergraduate
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.
xii
About the Authors ◀ Individuals xiii
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 visiting faculty member in the Department of Accountancy at the

University of Illinois at Urbana-Champaign. 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.
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 pri-
vate accounting before pursuing his doctoral degree. Professor Moore has received several
teaching awards, including the Byron L. Newton Award for Excellence in Teaching at OSU,
and has taught individual and business taxation, introductory and intermediate financial
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.
Michael S. Schadewald, Ph.D., CPA, is on the faculty of the University of Wisconsin–

Milwaukee, where he teaches graduate and undergraduate courses in business taxation. A
graduate of the University of Minnesota, Professor Schadewald is a co-author of several
books on multistate and international taxation and has published more than 40 articles in
academic and professional journals, including The Accounting Review, Journal of
Accounting Research, Contemporary Accounting Research, The Journal of the American
Taxation Association, CPA Journal, Journal of Taxation, and The Tax Adviser. Professor
Schadewald also has served on the editorial boards of The Journal of the American Taxation
Association, Journal of State Taxation, International Tax Journal, The International Journal
of Accounting, Issues in Accounting Education, and Journal of Accounting Education.
PREFaCE
Why is the Rupert/Pope/anderson series the best choice for
you and your students?
The Rupert/Pope/Anderson 2017 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 2017: Individuals
Federal Taxation 2017: Corporations, Partnerships, Estates & Trusts (the companion book to Individuals)
Federal Taxation 2017: 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 they can create
a custom text for you.
• The Individuals volume covers all entities, although the treatment is often briefer than in the Corporations and Com-
prehensive volumes. 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 re-
turn problems whose data change with each edition, thereby keeping the problems fresh. Problem C:3-66 contains the
comprehensive corporate tax return, Problem C:9-58 contains the comprehensive partnership tax return, and Problem
C:11-64 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 Implications, 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:5, C:7, C:8, and C:16 (Corporations volume only).
What’s new to this Edition?
INDIVIDUALS
• Complete updating of significant court cases and IRS rulings and procedures during 2015 and early 2016.
• Complete updating for the Protecting Americans from Tax Hikes Act of 2015, the Trade Preferences Extension Act
of 2015, and the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015.
• Discussion of tax extender deductions and credits in 2016.
• All tax rate schedules have been updated to reflect the rates and inflation adjustments for 2016.
• Whenever new updates become available, they will be accessible via MyAccountingLab.
C O R P O R AT I O N S
• The comprehensive corporate tax return, Problem C:3-66, has all new numbers for the 2015 forms.
• The comprehensive partnership tax return, Problem C:9-58, has all new numbers for the 2015 forms.
• The comprehensive S corporation tax return, Problem C:11-64, has all new numbers for the 2015 forms.
• Changes affecting 2016 tax law have been incorporated into the text where appropriate, including the tax legislation
listed in the second Individuals bullet item above.
• All tax rate schedules have been updated to reflect the rates and inflation adjustments for 2016.
• Whenever new updates become available, they will be accessible via MyAccountingLab.
MyAccountingLab is an online homework, tutorial, and assessment program designed to work with Pearson’s Federal Tax-
ation 2017 to engage students and improve results. MyAccountingLab’s homework and practice questions are correlated
xiv
Preface ◀ Individuals xv
to the textbook, they regenerate algorithmically to give students unlimited opportunity for practice and mastery, and they
offer helpful feedback when students enter incorrect answers. Combining resources that illuminate content with accessible
self-assessment, MyAccountingLab with eText provides students with a complete digital learning experience—all in one
place. To register, go to http://www.pearsonmylabandmastering.com.
For instructors
MyAccountingLab provides instructors with a rich and flexible set of course materials, along with course-management
tools that make it easy to deliver all or a portion of your course online.
• Powerful Homework and Test Manager Create, import, and manage online homework and media assignments, quiz-
zes, and tests. Create assignments from online questions directly correlated to this and other textbooks. Homework ques-
tions 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, proctoring, 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.
• Comprehensive Gradebook Tracking MyAccountingLab’s online gradebook automatically tracks your students’
results on tests, homework, and tutorials and gives you control over managing results and calculating grades. All
MyAccountingLab grades can be exported to a spreadsheet program, such as Microsoft® Excel. The MyAccount-
ingLab Gradebook provides a number of student data views and gives you the flexibility to weight assignments, select
which attempts to include when calculating scores, and omit or delete results for individual assignments.
• department-Wide solutions Get help managing multiple sections and working with Teaching Assistants using
MyAccountingLab Coordinator Courses. After your MyAccountingLab course is set up, it can be copied to create
sections or “member courses.” Changes to the Coordinator Course flow down to all members, so changes only need
to be made once.
We will add the most current tax information to MyAccountingLab as it becomes available.
For students
MyAccountingLab provides students with a personalized interactive learning environment, where they can learn at their
own pace and measure their progress.
• interactive Tutorial Exercises MyAccountingLab’s homework and practice questions are correlated to the text-
book, and “similar to” versions regenerate algorithmically to give students unlimited opportunity for practice and
mastery. Questions offer helpful feedback when students enter incorrect answers, and they include “Help Me Solve
This” guided solutions as well as other learning aids for extra help when students need it.
• study Plan for self-Paced learning MyAccountingLab’s study plan helps students monitor their own progress, letting
them see at a glance exactly which topics they need to practice. MyAccountingLab generates a personalized study plan
for each student based on his or her test results, and the study plan links directly to interactive, tutorial exercises for
topics the student hasn’t yet mastered. Students can regenerate these exercises with new values for unlimited practice,
and the exercises include guided solutions and multimedia learning aids to give students the extra help they need.
• dynamic study Modules MyAccountingLab’s Dynamic Study Modules work by continuously assessing student per-
formance and activity, then using data and analytics to provide personalized content in real time to reinforce concepts
that target each student’s particular strengths and weaknesses.
strong Pedagogical aids

• Appropriate blend of technical content of the tax law with a high level of readability for students.
• Focused on enabling students to apply tax principles within the chapter to real-life situations.
Real-World Example
These 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 Comparison
These 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.
xvi Individuals ▶ Preface
What Would You Do in This Situation?

Unique to the Rupert/Pope/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 & Think
These “speed bumps” encourage students to pause and apply what they have just learned. Solutions for each issue are
provided in the box.
Ethical Point
These comments provide the ethical implications of material discussed in the adjoining text. Apply what they have just learned.
Tax Strategy Tip
These comments suggest tax planning ideas related to material in the adjoining text.
Additional Comment
These comments provide supplemental information pertaining to the adjacent text.
Program Components
Materials for the instructor may be accessed at the Instructor’s Resource Center (IRC) online, located at
www.pearsonhighered.com/phtax or within the Instructor Resource section of MyAccountingLab. You may contact your
Pearson representative for assistance with the registration process.
• TaxAct 2015 Software: Available via online purchase with Individuals, Corporations, and Comprehensive Texts. This
user-friendly tax preparation program includes more than 80 tax forms, schedules, and worksheets. TaxAct calculates
returns and alerts the user to possible errors or entries. Consists of Forms 990, 1040, 1041, 1065, 1120, and 1120S.
• Instructor’s Resource Manual: Contains sample syllabi, instructor outlines, and information regarding problem areas
for students. It also contains solutions to the tax form/tax return preparation problems.
• Solutions Manual: Contains solutions to discussion questions, problems, and comprehensive and tax strategy prob-
lems. It also contains all solutions to the case study problems, research problems, and “What Would You Do in This
Situation?” boxes.
• Test Bank: Offers a wealth of true/false, multiple-choice, and calculative problems. A computerized program is available
to adopters.
• PowerPoint Slides: Consists of chapter outlines, featuring images, examples, and problems throughout, to aid in class
lectures.
• Image Library: Figures, tables, and tax forms featured in the book are provided as individual files for the convenience
of instructors and students.
• Multi-State Tax Chapter: An entire chapter, complete with problems (and solutions) dedicated to multi-state tax practices.
acknowledgments
Our policy is to provide annual editions and to prepare timely updated supplements when major tax revisions occur. We
are most appreciative 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 supplementary 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 Buffalo
Craig J. Langstraat University of Memphis
Kate Demarest Carroll Community College
Allison McLeod University of North Texas
Mitchell Franklin LeMoyne College
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.
CHAPTER
1
An IntroductIon
to tAxAtIon
LEARNING OBJECTIVES
After studying this chapter, you should be able to
▶ Discuss the history of taxation in the United States

1
▶ Describe the three types of tax rate structures

2
▶ Describe the various types of taxes

3
▶ Discuss
4 the criteria for a “good” tax structure, the objectives of the
federal income tax law, and recent tax reform proposals
▶ Describe the tax entities in the federal income tax system

5
▶ Identify
6 the various tax law sources and understand their implications
for tax practice
▶ Describe the legislative process for the enactment of the tax law
7
▶ Describe the administrative procedures under the tax law

8
▶ Describe the components of a tax practice

9
▶ Understand the importance of computer applications in taxation

10
1-2 Individuals ▶ Chapter 1
CHAPTER OUTLINE Federal income taxes have a significant effect on business, investor, and personal decisions
History of Taxation in the United in the United States. Because tax rates can be as high as 35% on corporations and over
States...1-2 40% on individuals, virtually every transaction is impacted by income taxes. The follow-
Types of Tax Rate Structures...1-4 ing examples illustrate the impact of the tax law on various decisions in our society:
Other Types of Taxes...1-7
Criteria for a Tax Structure...1-12 c Because of the deductibility of home mortgage interest and real estate taxes, an indi-
Entities in the Federal Income Tax vidual may decide to purchase a home rather than to continue to rent an apartment.
System...1-16
c An investor may decide to delay selling some stock because of the significant taxes that
Tax Law Sources...1-24
Enactment of a Tax Law...1-24
may result from the sale.
Administration of the Tax Law c A corporation may get a larger tax deduction if it leases property rather than purchas-
and Tax Practice Issues...1-26 ing the property.
Components of a Tax
Practice...1-29 The purpose of this text is to provide an introduction to the study of federal income
Computer Applications in Tax taxation. However, before discussing the specifics of the U.S. federal income tax law, it is
Practice...1-31
helpful to have a broad conceptual understanding of the taxation process. This chapter
provides an overview of the following topics:
c Historical developments of the federal tax system
Key Point c Types of taxes levied and structural considerations
In many situations, the use of c Objectives of the tax law, including a discussion of recent tax reform proposals
the tax laws to influence human
behavior is deliberate. As will be c Taxpaying entities in the federal income tax system
seen later in this chapter, tax laws
are often used to achieve social c Tax law sources and the legislative process
and economic objectives.
c Internal Revenue Service (IRS) collection, examination, and appeals processes
c The nature of tax practice, including computer applications and tax research
HIstory of tAxAtIon
In tHe unIted stAtes
OBJECTIVE 1
E A r ly P E r i o d s
Discuss the history of The federal income tax is the dominant form of taxation in the United States. In addition,
taxation in the United most states and some cities and counties also impose an income tax. Both corporations
States and individuals are subject to such taxes.
Prior to 1913 (the date of enactment of the modern-day federal income tax), the federal
government relied predominantly on customs duties and excise taxes to finance its opera-
tions. The first federal income tax on individuals was enacted in 1861 to finance the Civil
HiStoRiCAL note
War but was repealed after the war. The federal income tax was reinstated in 1894, how-
The reinstatement of the income
ever, that tax was challenged in the courts because the U.S. Constitution required that an
tax in 1894 was the subject of income tax be apportioned among the states in proportion to their populations. This type
heated political controversy. In of tax system, which would be both impractical and difficult to administer, would mean
general, the representatives in
Congress from the agricultural that different tax rates would apply to individual taxpayers depending on their states of
South and West favored the residence.
income tax in lieu of customs
duties. Representatives from the
In 1895, the Supreme Court ruled that the tax was in violation of the U.S.
industrial eastern states were Constitution.1 Therefore, it was necessary to amend the U.S. Constitution to permit the
against the income tax and passage of a federal income tax law. This was accomplished by the Sixteenth Amendment,
favored protective tariff
legislation. which was ratified in 1913. The Sixteenth Amendment, while being an extraordinarily
important amendment, consists of one sentence.
sixteenth Amendment to the constitution of the united states

The Congress shall have the power to lay and collect taxes on incomes, from whatever
source derived, without apportionment among the several States, and without regard to any
census or enumeration.
1Pollock v. Farmers’ Loan & Trust Co., 3 AFTR 2602 (USSC, 1895). Note, was held to be constitutional because it was treated as an excise tax. See
however, that a federal income tax on corporations that was enacted in 1909 Flint v. Stone Tracy Co., 3 AFTR 2834 (USSC, 1911).
An Introduction to Taxation ◀ Individuals 1-3
rEvEnuE Acts From 1913 to thE PrEsEnt

HiStoRiCAL note The Revenue Act of 1913 imposed a flat 1% tax (with no exemptions) on a corporation’s
The Revenue Act of 1913 con- net income. The rate varied from 1% to 6% for individuals, depending on the individual’s
tained sixteen pages. income level. However, very few individuals paid federal income taxes because a $3,000
personal exemption ($4,000 for married individuals) was permitted as an offset to taxable
income. These amounts were greater than the incomes of most individuals in 1913.
HiStoRiCAL note Various amendments to the original law were passed between 1913 and 1939 as separate
Before 1939, the tax laws were revenue acts. For example, a deduction for dependency exemptions was provided in 1917. In
contained in the most current rev- 1939, the separate revenue acts were codified into the Internal Revenue Code of 1939. A simi-
enue act, a reenactment of a prior
revenue act plus amendments. In lar codification was accomplished in 1954. The 1954 codification, which was known as the
1939, a permanent tax code was Internal Revenue Code of 1954, included the elimination of many “deadwood” provisions, a
established; it was revised in 1954
and 1986. rearrangement and clarification of numerous code sections, and the addition of major tax
law changes. Whenever changes to the Internal Revenue Code (IRC) are made, the old
language is deleted and the new language added. Thus, the statutes are organized as a single
document, and a tax advisor does not have to read through the applicable parts of all previ-
ous tax bills to find the most current law. In 1986, major changes were made to the tax law,
and the basic tax law was redesignated as the Internal Revenue Code of 1986.
The federal income tax became a “mass tax” on individuals during the early 1940s.
This change was deemed necessary to finance the revenue needs of the federal govern-
ment during World War II. In 1939, less than 6% of the U.S. population was subject to
the federal income tax; by 1945, 74% of the population was taxed.2 To accommodate the
broadened tax base and to avoid significant tax collection problems, Congress enacted
pay-as-you-go withholding in 1943.
A major characteristic of the federal income tax since its inception to today is the manner
in which the tax law is changed or modified. The federal income tax is changed on an incre-
mental basis rather than a complete revision basis. Under so-called incrementalism, when a
change in the tax law is deemed necessary by Congress, the entire law is not changed, but
specific provisions of the tax law are added, changed, or deleted on an incremental basis.
Thus, the federal income tax has been referred to as a “quiltwork” of tax laws, referring to
the patchwork nature of the law. Without question, one of the principal reasons for the com-
plexity of the federal income tax today is the incremental nature of tax legislation.
AdditionAL Comment rEvEnuE sourcEs

In 2013, 147 million individual As mentioned earlier, the largest source of federal revenues is individual income taxes. Other
income tax returns were filed, major revenue sources include Social Security (FICA) taxes and corporate income taxes (see
and collections from individuals
totaled $1.23 trillion. Table I:1-1). Two notable trends from Table I:1-1 are (1) the gradual increase in social insur-
ance taxes from 1960 to 2015 and (2) the gradual decrease in corporate income taxes for the
same period. Individual income taxes have remained fairly stable during the past 50 years.
tyPiCAL miSConCePtion . tABlE i:1-1

It is often assumed that the tax Breakdown of Federal revenues
revenue from corporation income
taxes is the largest source of tax
revenue. However, the revenue
generated from this tax only rep- 1960 1975 2000 2015
resents approximately 11% of
total federal revenues in 2015.
Individual income taxes 44% 45% 50% 47%
Social insurance taxes and contribution 16 32 32 33
Corporation income taxes 23 15 10 11
Other 17 8 8 9
Total 100% 100% 100% 100%
Source: Council of Economic Advisers, Economic Indicators (Washington, DC: U.S. Government Printing Office, 1967,
1977, 2015).
2
Richard Goode, The Individual Income Tax (Washington, DC: The
Brookings Institution, 1964), pp. 2–4.
1-4 Individuals ▶ Chapter 1
types of tAx rAte structures

OBJECTIVE 2
thE structurE oF individuAl
Describe the three types i n c o m E tA x r At E s
of tax rate structures Virtually all tax structures are comprised of two basic parts: the tax base and the tax rate.
The tax base is the amount to which the tax rate is applied to determine the tax due. For
example, an individual’s tax base for the federal income tax is taxable income, as defined
and determined by the income tax law. Similarly, the tax base for the property tax is gener-
ally the fair market value of property subject to the tax. The tax rate is merely the percent-
age rate applied to the tax base.
AdditionAL Comment
Tax rates may be progressive, proportional, or regressive. A progressive rate structure
In the 1950s, the top marginal tax
is one where the rate of tax increases as the tax base increases. The most notable tax that
rate for individual taxpayers incorporates a progressive rate structure is the federal income tax. Thus, as a taxpayer’s
reached 92%. This astonishingly taxable income increases, a progressively higher rate of tax is applied. For 2016, the fed-
high rate only applied to taxpay-
ers with very high taxable eral income tax rates for individuals begin at 10% and increase to 15%, 25%, 28%, 33%,
incomes but still is an extremely 35%, and 39.6% as a taxpayer’s taxable income increases.3 Examples I:1-1 and I:1-2
confiscatory tax rate.
show how the progressive rate structure of the federal income tax operates.
eXAmPLe i:1-1 c Alice, who is single, has $30,000 taxable income in 2016. Her federal income taxes for the year
are $4,036, computed as follows: the first $9,275 of taxable income is taxed at 10% and the
remaining $20,725 at 15%. (For tax rates, see the inside front cover.)
LeGiSLAtiVe Allen, who also is single, has taxable income of $60,000. A 10% rate applies to the first
BACKGRoUnd $9,275 of taxable income, 15% on the next $28,375, and a 25% rate applies to the taxable
Beginning with tax year 2013, income over $37,650. Thus, Allen’s total tax is $10,771 [(0.10 × $9,275) + (0.15 × $28,375) +
the top rate for high-income indi- (0.25 × $22,350)].
vidual taxpayers was increased to
39.6% from 35%. If Allen’s taxable income is $120,000, a 28% rate applies to $28,850 of his taxable income
($120,000 − $91,150) because the 28% rate applies to taxable income above $91,150 for
a single individual and his total tax for the year is $26,637. Thus, the tax rates are progressive
because the rate of tax increases as a taxpayer’s taxable income increases. b
Notice in Example I:1-1 that taxable income has doubled in size in the three cases, but
the income taxes have more than doubled (i.e., $4,036 to $10,771 to $26,637). This
demonstrates how a progressive rate structure operates.
eXAmPLe i:1-2 c Assume the same facts as in Example I:1-1 except that Alice has taxable income of $200,000. Of
Alice’s taxable income, $9,850 ($200,000 − $190,150) is subject to the 33% rate. Alternatively, if
Allen has taxable income of $450,000, $34,950 ($450,000 − $415,050) is subject to the top mar-
ginal rate of 39.6%. b
A proportional tax rate, sometimes called a flat tax, is one where the rate of tax is the
same for all taxpayers, regardless of the level of their tax base. This type of tax rate is
generally used for real estate taxes, state and local sales taxes, personal property taxes,
customs duties, and excise taxes. A flat tax has been the subject of considerable discus-
sion over the past twenty years and promises to be a controversial topic as the debate on
federal income tax reform continues into the future.
eXAmPLe i:1-3 c Assume the same facts as in Example I:1-1, except that a 17% tax rate applies to all amounts
of taxable income. Based on the assumed flat tax rate structure, Alice’s federal income tax is
$5,100 on $30,000 of taxable income; Allen’s tax is $10,200 on $60,000 of taxable income and
$20,400 on $120,000 of taxable income. The tax rate is proportional because the 17% rate ap-
plies to both taxpayers without regard to their income level. As you can see, a proportional tax
rate results in substantially lower taxes for higher income taxpayers.4 b
3 See the inside front cover for the 2016 tax rates and Chapter I:2 for a discus- 4 This example assumes the same tax base (taxable income) for the flat tax as
sion of the computation procedures. 2015 rate schedules and tax tables are with the current federal tax. Most flat tax proposals allow only a few deduc-
located immediately before Appendix A. tions and, therefore, would generate higher taxes than in the example.
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latter comprise business capacity of the very highest order, essential
to the care of his troops; keen perceptions, which even in
extraordinary circumstances or sudden emergencies are not to be
led astray; the ability to think as quickly and accurately in the turmoil
of battle as in the quiet of the bureau; the power to foresee to its
ultimate conclusion the result of a strategic or tactical manœuvre; the
capacity to gauge the efforts of men and of masses of men; the
many-sidedness which can respond to the demands of every detail
of the battle-field, while never losing sight of the one object aimed at;
the mental strength which weakens not under the tax of hours and
days of unequalled strain. For, in truth, there is no position in which
man can be placed which asks so much of his intellect in so short a
space as that of the general, the failure or success, the decimation
or security of whose army hangs on his instant thought and
unequivocal instruction under the furious and kaleidoscopic ordeal of
the field. To these qualities of heart and head add one factor more—
opportunity—and you have the great soldier.
Now, Alexander was the first man, the details of whose history
have been handed down to us, who possessed these qualities in the
very highest measure; whose opportunities were coextensive with
his powers; and who out of all these wrought a methodical system of
warfare from which we may learn lessons to-day. Look at what he
accomplished with such meagre means! He alone has the record of
uniform success with no failure. And this, not because he had weak
opponents, for while the Persians were far from redoubtable, except
in numbers, the Tyrians, the tribes beyond the Caucasus, and the
Indians, made a bold front and good fight.
Alexander’s movements were always made on a well-conceived,
maturely-digested plan; and this he kept in view to the end, putting
aside all minor considerations for the main object, but never losing
sight of these. His grasp was as large as his problem. His base for
his advance into the heart of the then known world was the entire
coast-line of the then known sea. He never advanced, despite his
speed, without securing flanks and rear, and properly garrisoning the
country on which he based. Having done this he marched on his
objective,—which was wont to be the enemy’s army,—with a
directness which was unerring. His fertility in ruse and stratagem
was unbounded. He kept well concentrated; his division of forces
was always warranted by the conditions, and always with a view of
again concentrating. His rapidity was unparalleled. It was this which
gave him such an ascendant over all his enemies. Neither winter
cold nor summer heat, mountain nor desert, the widest rivers nor the
most elaborate defences, ever arrested his course; and yet his
troops were always well fed. He was a master of logistics. He lived
on the country he campaigned in as entirely as Napoleon, but was
careful to accumulate granaries in the most available places. He was
remarkable in being able to keep the gaps in his army filled by
recruits from home or enlistments of natives, and in transforming the
latter into excellent soldiers. Starting from home with thirty-five
thousand men, he had in the Indian campaigns no less than one
hundred and thirty-five thousand, and their deeds proved the stuff
that was in them.
Alexander’s battles are tactically splendid examples of
conception and execution. The wedge at Arbela was more splendid
than Macdonald’s column at Wagram. It was a scintillation of genius.
Alexander saw where his enemy’s strength and weakness lay, and
took prompt advantage of them. He utilized his victories to the full
extent, and pursued with a vigor which no other has ever reached.
He was equally great in sieges as in battles. The only thing he was
never called on to show was the capacity to face disaster. He
possessed every remarkable military attribute; we can discover in
him no military weakness.
As a captain, he accomplished more than any man ever did. He
showed the world, first of all men, and best, how to make war. He
formulated the first principles of the art, to be elaborated by
Hannibal, Cæsar, Gustavus Adolphus, Frederick, and Napoleon. His
conditions did not demand that he should approach to the
requirements of modern war. But he was easily master of his trade,
as, perhaps, no one else ever was. For, as Napoleon says, “to guess
at the intentions of the enemy; to divine his opinion of yourself; to
hide from him both your own intentions and opinion; to mislead him
by feigned manœuvres; to invoke ruse, as well as digested
schemes, so as to fight under the best conditions,—this is, and
always was, the art of war.”
LECTURE II.
HANNIBAL.
TWO generations after the death of Alexander, the power of the

Mediterranean world was divided between Aryan Rome and
Carthage, the vigorous daughter of Semitic Tyre. Carthage was first
on the sea; Rome, on land. But Rome, always intolerant of powerful
neighbors, fell to quarrelling with her great rival, and at the end of a
twenty-three years’ struggle,—the first Punic War,—imposed her own
terms on defeated Carthage (241 B.C.). There were two parties bred
of these hostilities in Carthage,—the war party, headed by Hamilcar
Barca; the peace party, headed by Hanno. Hamilcar knew that peace
with Rome meant oppression by Rome, and final extinction, and was
ready to stake all on renewing the struggle. But he saw that present
war was impossible; that opposition could only be in the future, and
that it must be quietly prepared for. With a view of doing this,
Hamilcar got the consent of the Carthaginian Senate to attempt the
subjugation of Spain, a land of great natural resources, in
conquering and holding which an army could be created which by
and by might again cope with the Italian tyrant.
The Carthaginian fleet had been destroyed. Rome would not
permit the building of a new one. Hamilcar’s army was obliged to
march overland from Carthage along the north coast of Africa and
ship across the strait,—now Gibraltar. This was a bold thing to do,
but it succeeded, and, in a series of campaigns, Hamilcar reduced
the southern half of Spain, and (B.C. 236–227) firmly planted the
Carthaginian power there. So conciliatory as well as vigorous had
been his policy, that, on his death, the native tribes elected
Hasdrubal, his son-in-law, general-in-chief of the allied Carthaginian
and Spanish forces, which then amounted to nearly seventy
thousand men and two hundred elephants.
Hasdrubal continued the policy of Hamilcar, and largely
increased the Spanish influence and territory. But as Rome had
colonies in northern Spain, the two powers were sure soon again to
clash. In fact, Rome, after awhile, woke up to this new danger, and
notified Carthage that she would extend her colonies north of the
Ebro at her peril.
Hannibal was the son of Hamilcar. His father gave him the best
Greek education, and this the lad’s remarkable intellect readily
assimilated. He trained him to arms under his own eye. Hannibal
received his first schooling as a soldier at the age of nine, in his
father’s camps in Spain, and later his brother, Hasdrubal, made him
his chief of cavalry at the age of twenty-one. A pen-picture by
Hannibal’s arch enemy, Livy, tells us what he then was: “No sooner
had he arrived than Hannibal drew the whole army towards him. The
old soldiers fancied they saw Hamilcar in his youth given back to
them; the same bright look, the same fire in his eye, the same trick of
countenance and features. But soon he proved that to be his father’s
son was not his highest recommendation. Never was one and the
same spirit more skilful to meet opposition, to obey or to command. It
was hard to decide whether he was more dear to the chief or the
army. Neither did Hasdrubal more readily place any one at the head
when courage or activity was required, nor were the soldiers under
any other leader so full of confidence and daring. He entered danger
with the greatest mettle, he comported himself in danger with the
greatest unconcern. By no difficulties could his body be tired, his
ardor damped. Heat and cold he suffered with equal endurance; the
amount of his food and drink was gauged by natural needs, and not
by desire. The time of waking and sleeping depended not on the
distinction of day and night. What time was left from business he
devoted to rest, and this was not brought on by either a soft couch or
by quiet. Many have often seen him covered by a short field-cloak
lying on the ground betwixt the outposts and sentinels of the
soldiers. His clothing in no wise distinguished him from his fellows;
his weapons and horses attracted every one’s eye. He was by long
odds the best rider, the best marcher. He went into battle the first, he
came out of it the last.... Hannibal served three years under
Hasdrubal’s supreme command, and left nothing unobserved which
he who desires to become a great leader ought to see and to do.”
Hannibal and his brothers had been brought up with an intensity
of hatred of Rome which it is hard to describe. Every schoolboy
knows the anecdote of the lad’s swearing never to make peace with
Rome. The feeling grew with his years. When Hannibal was twenty-
four, Hasdrubal died, and he himself was unanimously elected his
successor.
Hamilcar had planned an invasion of Italy by way of the Alps; but
the scheme was left inchoate at his death. Hannibal at once began
definitely to pave the way for such an enterprise by completing the
conquest of Spain. The original conception of crossing the Alps was
Hamilcar’s, just as Philip originally planned the invasion of Asia. But
it was the fertile brain of Hannibal which gave the undertaking birth.
The colossal nature of the plan, its magnificent daring, the boundless
self-confidence and contempt of difficulty and danger which it
implies, no less than the extraordinary manner of its execution, are
equalled only by Alexander’s setting forth—also but a lad—to
conquer the illimitable possessions of the Great King.
In three years (B.C. 221–218) Hannibal had subjugated all
Spain, and after a long siege captured Saguntum. He finally set out,
with fifty thousand foot, nine thousand horse, and thirty-seven
elephants, across the Pyrenees, whence his route was almost as
unknown to him as the Atlantic to Columbus. It is impossible to follow
him in this wonderful march,—the first crossing of the Alps by any
but isolated merchants,—and probably the most daring enterprise
ever set on foot. After toils and dangers impossible to gauge, even
by the losses, Hannibal reached the Po in October, B.C. 218, with
but twenty-six thousand men and a few elephants, less than half the
force with which he had left Spain. With this handful he was to face a
nation capable with its allies of raising seven hundred thousand men;
and yet the event—as well as our knowledge of Hannibal—shows
that he had contemplated even this vast odds.
But Rome was not ready. Hannibal gained numberless
confederates among the Gauls in northern Italy, and that same fall
and winter won two victories over the Romans at the Ticinus and
Trebia. Next year (B.C. 217) he again defeated the Romans, by an
ambuscade at Lake Trasymene, killing or capturing their entire army
of thirty thousand men. These three victories were due to the over-
eagerness of the Roman generals to fight, their careless methods,
and Hannibal’s skill in handling his troops and his aptness at
stratagem.
The campaign preceding, and the battle of Lake Trasymene,
taught the Romans two valuable lessons. The instruction given the
world by Alexander had not reached self-important, republican
Rome, though Hannibal was familiar enough with the deeds of the
great Macedonian. The Romans knew nothing of war except crude,
hard knocks. The first lesson showed them that there is something in
the art of war beyond merely marching out to meet your enemy and
beating him by numbers, better weapons, or greater discipline.
Hannibal’s Flank March. B.C. 217
It was thus: The Romans had retired into Etruria. In March, B.C.
217, Hannibal, who was in Liguria, desired to cross the Appenines
and move upon them. There were but two roads he could pursue.
The highway would take him across the mountains, but by a long
circuit. This was the route by which the Consul Flaminius, at Aretium,
with his forty thousand men, was expecting him, and, therefore, the
way Hannibal did not choose to march, for Flaminius could easily
block the mountain roads. The other route was so difficult that
Flaminius never dreamed that Hannibal knew of, or could by any
possibility pursue it. Hannibal’s crossing of the Alps had taught
Flaminius nothing of his daring or his skill. This route lay along the
coast to near the mouth of the Arnus, and thence up the right bank. It
ran through an immense marsh, which, for an army, was all but as
difficult an obstacle as the Alps. But it was the lesser evil, and
promised the greater results; and Hannibal chose it, as Napoleon did
the Great St. Bernard in 1800. No better description of the task can
be given than to say that for four days and three nights the army
marched through water where only the wagons, dead animals, or
abandoned packs afforded the men any chance for rest. But the
Carthaginian general reached his goal, turned Flaminius’ left flank,
and cut him off from Rome. Here was the conception of turning the
enemy’s strategic flank as clearly carried out as ever Napoleon did it.
Such was lesson one.
The result of this turning manœuvre was the battle of Lake
Trasymene,—where Hannibal taught the Romans, and us through
them, the second lesson. The Romans had always marched in
careless open order, without any idea of van or rear guard, or of
flankers. This Hannibal knew. He placed his whole army in hiding at
both ends of a defile at Lake Trasymene, through which the Romans
must march, in such a manner that, when he made his attack, it was
on an unsuspecting column,—in front, rear, and one flank; and the
lake being on the other flank, the result was utter annihilation. After
this the Romans marched with proper precautions. Hannibal had
inflicted three staggering blows on his enemy.
But Rome now appointed a Dictator,—Quintus Fabius,—truly
surnamed Maximus, and nicknamed Cunctator, because,
recognizing that he was not able to cope with Hannibal on the battle-
field, he wisely chose to conduct a campaign of delays and small
war, the one thing Hannibal could not afford, but also the one thing
the Romans could not tolerate or understand; for the Romans had
always won by crisp fighting. Still, it was the policy shaped by Fabius
which eventually defeated Hannibal, and next to Hannibal himself,
he was the best master the Romans then had.
It is impossible, even slightly, to touch on many of Hannibal’s
campaigns and battles. I prefer to give a short description of the
battle of Cannæ, which, in its conduct and results, is typical of
Hannibal’s methods. And first, a few words about the organization of
either army.
The Carthaginian discipline was based on the Macedonian idea,
and the formation of the troops was phalangial, that is, in close
masses. But Hannibal’s army contained troops of all kinds, from the
Numidian horseman, whose only clothing was a tiger-skin, on his
tough little runt of a pony, or the all but naked Gaul with his long,
curved sword, to the Carthaginian heavy-armed hypaspist. All these
diverse tribes had each its own manner of fighting, and it required a
Hannibal to keep up discipline or tactical efficiency in such a motley
force. The Roman army, on the contrary, was wonderfully
homogeneous, carefully disciplined, in all parts organized and drilled
in the same manner, and the legion was a body which was the very
opposite of the phalanx. It had much more mobility, the individual
soldiers were more independent in action, and instead of relying on
one shock or on defence, the several lines could relieve each other,
and renew a failing battle three or even four times with fresh troops.
After Trasymene, Hannibal not only armed his men with captured
Roman weapons, but modified his organization somewhat to the
legion pattern.
The legion was at this time formed in three lines of maniples (or
companies) placed checkerwise. In front were the hastati, the least
efficient; behind this the principes; and in the rear the triarii, or
veterans. Each maniple was an excellent tactical unit. Each of these
lines could relieve the other, and thus give a succession of hammer-
like blows.
The phalanx we already know, and while it was wonderful for
one shock, it had no reserve, and if demoralization set in, it was
gone. The tendency of formation in ancient days, as now, was
towards greater mobility, and later on the Roman legion in Greece,
particularly at Pydna (168 B.C.), proved that it was superior, if
properly handled, to the phalanx.
In B.C. 216, Æmilius Paulus and Varro were consuls. The former
was a man of high character and attainments; Varro came of
plebeian stock, was overbearing and self-sufficient. The Roman and
Carthaginian armies lay facing each other near the Aufidus, Hannibal
backing on Cannæ. His position here had been the result of an
admirable manœuvre. The consuls commanded on alternate days.
There had been a serious combat on the last day of Varro’s
command, in which the Carthaginians had been outnumbered two to
one, and been defeated. This had greatly elated Varro, and whetted
his appetite for battle. He left the troops at evening in such a manner
that next day his associate was badly placed. Æmilius scarcely
wished to withdraw, lest his men should be disheartened; he could
not remain where he was, as he was exposed to Hannibal’s better
cavalry. He took a middle course, on the whole unwise. He sent a
third of his force to the north of the Aufidus, a trifle up-stream, to
sustain some foragers he had there, and make a secondary camp,
from which to annoy Hannibal’s parties in search of corn. This
division of forces was very risky. Hannibal had long been trying to
bring the consuls to battle, and now saw that the moment had come,
for Varro was precipitate, and would probably draw Æmilius into
active measures.
Battle of Cannæ B.C. 216, I

Each general made a stirring address to his army. Polybius gives
both. Hannibal’s has the true ring of the great captain. “Let us hasten
into action. I promise you victory, and, the gods willing, I will make
my promise good.” Two days later Hannibal offered Æmilius battle.
But Æmilius declined it, and Hannibal sent his Numidians to the
other side to annoy the Roman foragers. The succeeding day,
knowing Varro to be in command, Hannibal again offered battle,
aware that the hot-tempered Roman would be burning to avenge the
yesterday’s taunt. He left eight thousand men to guard his camp.
There has been much discussion as to which bank of the Aufidus
was the scene of the battle. It seems to me that the plan in the
diagram comes nearest to fitting all the statements, however
conflicting, of the several authorities. Near Hannibal’s camp the
Aufidus makes a bold, southerly sweep. Here Hannibal forded the
stream in two columns, drew up his army, and leaned his flanks on
the river-banks so as to prevent the Romans, with their numerical
superiority, from overlapping them. His front he covered with archers
and slingers, so as to hide his formation from the Roman generals.
Varro, as Hannibal anticipated, thought the Carthaginians were
crossing to attack the lesser camp, and leaving eleven thousand
men to guard the larger one, with orders to attack Hannibal’s camp
during the battle, he also crossed and drew up in the plain opposite
the Carthaginians, he and every Roman in the ranks craving to come
to blows with the hated invaders.
Varro also threw out his light troops in advance. He had sixty-five
thousand foot and seven thousand horse, to Hannibal’s thirty-two
thousand foot and ten thousand horse. He could not overlap
Hannibal’s flanks, so he determined to make his line heavier, and
seek to crush him at the first impact. He changed the formation of
the maniples so as to make them sixteen men deep and ten men
front, instead of sixteen men front by ten deep, as usual. This was a
grievous error. His men were unapt to manœuvre or fight well in this
unwonted form. He should have employed his surplus, say twenty-
five thousand men, as a reserve for emergencies. His army was in
the usual three lines, fifteen legions in all, the Roman on the right,
the allied on the left. The intervals between the maniples always
equalled their front, and the distance between the lines the depth of
the maniples. The Roman cavalry, twenty-four hundred strong, was
on the right. The allied, forty-eight hundred strong, on the left. It
would have been better massed in one body. But such was the only
formation then known. Æmilius commanded the right, Varro the left
wing.
Hannibal placed on his left, opposite the Roman cavalry, his
heavy Spanish and Gallic horse, eight thousand strong, two-thirds in
a first, and one-third in a second line. This body was strong enough
to crush the Roman horse, and thus cut off the retreat of the legions
to their camps and towards Rome. In other words, Hannibal’s
fighting was to be forced on the Romans’ strategic flank. He had a
perfectly lucid idea of the value of a blow from this direction. On his
right, facing the allied cavalry, were his Numidians, two thousand
strong. Of the infantry, the Spaniards and Gauls were in the centre in
alternate bodies. His best troops, the African foot, he placed on their
either flank. He expected these veterans to leaven the whole lump.
The foot was all in phalanxes of one thousand and twenty-four men
each, the African foot in sixteen ranks, as usual, the Spaniards and
Gauls in ten. Hannibal had been obliged thus to make his centre
thin, from lack of men, but he had seething in his brain a manœuvre
by which he proposed to make this very weakness a factor of
success. He had been on the ground and had seen Varro strengthen
the Roman centre. This confirmed him in his plan.
Hannibal commanded the centre in person, Hanno the right,
Hasdrubal the left, Maharbal the cavalry of the left. Hannibal relied
on Maharbal to beat the Roman cavalry, and then, riding by the rear
of the Roman army, to join the Numidians on the Carthaginian right,
like Coenus at the Hydaspes. His cavalry was superior in numbers,
and vastly outranked in effectiveness the Roman horse.
Hannibal was, no doubt, familiar with Marathon. He proposed to
better the tactics of that day. Remember that Miltiades had opposed
to him Orientals; Hannibal faced Roman legions. His general plan
was to withdraw his centre before the heavy Roman line,—to allow
them to push it in,—and then to enclose them in his wings and fall on
their flanks. This was a highly dangerous manœuvre, unless the
withdrawal of the centre could be checked at the proper time; but his
men had the greatest confidence in him; the river in his rear would
be an aid, if he could but keep his men steady; and in war no
decisive result can be compassed without corresponding risk.
Hannibal had fully prepared his army for this tactical evolution, and
rehearsed its details with all his subordinates. He not only had the
knack of making his lieutenants comprehend him, but proposed to
see to the execution of the work himself.
The Carthaginians faced north, the Romans south. The rising
sun was on the flank of either. The wind was southerly, and blew the
dust into the faces of the Romans. The light troops on either side
opened the action, and fiercely contested the ground for some time.
During the preliminary fighting, Hannibal advanced his centre, the
Spanish and Gallic foot, in a salient or convex order from the main
line, the phalanxes on the right and left of the central one being, it is
presumed, in echelon to it. The wings, of African foot, kept their
place.
While this was being done, Hannibal ordered the heavy horse on
his left to charge down on the Roman horse in their front. This they
did with their accustomed spirit, but met a gallant resistance. The
Roman knights fought for every inch with the greatest obstinacy,
when dismounted, continuing the contest on foot. The fighting was
not by shocks, it was rather hand to hand. But the weight and
superior training of the Carthaginian horse soon told. They rode
down the Romans and crushed them out of existence. Æmilius was
badly wounded, but escaped the ensuing massacre and made his
way to the help of the Roman centre, hoping there to retrieve the
day. On the Carthaginian right the Numidians had received orders to
skirmish with the allied horse and not come to a decisive combat till
they should be joined by the heavy horse from the Carthaginian left.
This they did in their own peculiar style, by riding around their
opponents, squadron by squadron, and by making numberless
feigned attacks. The battle in the centre had not yet developed
results, when Maharbal, having destroyed the Roman cavalry, and
ridden around the Roman army, appeared in the rear of the allied
horse. The Numidians now attacked seriously, and between them, in
a few minutes, there was not a Roman horseman left upon the field
alive. The Numidians were then sent in pursuit, Maharbal remaining
upon the field.
While this was going on, the light troops of both sides had been
withdrawn through the intervals, and had formed in the rear and on
the flanks of legion and phalanx, ready to fill gaps and supply the
heavy foot with weapons. This had uncovered Hannibal’s salient.
Varro had committed still another blunder. In the effort to make his
line so strong as to be irresistible, he had ordered his maniples of
principes from the second line forward into the intervals of the
maniples of hastati in first line, thus making one solid wall and
robbing the legionaries of their accustomed mobility, as well as
lending them a feeling of uncertainty in their novel formation. Still,
with its wonted spirit, the heavy Roman line advanced on Hannibal’s
salient. The Carthaginian wings could not yet be reached, being so
much refused. Striking the apex, the fighting became furious.
Hannibal’s salient, as proposed, began to withdraw, holding its own
in good style. Varro, far too eager, and seeing, as he thought,
speedy victory before him, was again guilty of the folly of ordering
the third line, the triarii, and even the light troops, up to the support of
the already overcrowded first and second lines. The Carthaginian
centre, supported by its skirmishers, held the ground with just
enough tenacity to whet the determination of the Romans to crush it.
Varro now insanely ordered still more forces in from his wings to
reënforce his centre, already a mass so crowded as to be unable to
retain its organization, but pressing back the Carthaginians by mere
weight of mass. He could not better have played into Hannibal’s
hands. The Romans—three men in the place of one—struggled
onward, but became every moment a more and more jumbled body.
Its maniple formation, and consequent ease of movement, was quite
lost. Still, it pushed forward, as if to certain victory, and still the
Carthaginian salient fell back, till from a salient it became a line, from
a line a reëntering angle or crescent. Hannibal, by great personal
exertions, had in an extraordinary manner preserved the steadiness
and formation of his centre, though outnumbered four to one. The
Carthaginian wings he now ordered slowly to advance, which all the
more edged the Roman centre into the cul-de-sac Hannibal had
prepared. The Roman legionaries were already shouting their eager
cry of victory; but so herded together had they got that there was no
room to use their weapons. Hannibal had kept the Carthaginian
centre free from any feeling of demoralization, and ready at his
command to turn and face the enemy. The wings, by their advance,
had hustled the Roman legions into the form of a wedge without a
vestige of maniple formation left. The decisive moment had come.
Hannibal seized it with the eye of the born soldier. Arresting the
backward movement of the centre, which still had elbow-room to
fight, as the Romans had not, he gave the orders to the wings which
they were impatiently awaiting. These veteran troops, in perfect
order, wheeled inward to right and left, on the flanks of the struggling
mass of legionaries. The Roman army was lost beyond a ray of
hope, for, at the same instant, Maharbal, having finished the
destruction of the cavalry, rode down upon its rear. The cry of victory
changed to a cry of terror. Defeat degenerated into mere slaughter.
The Carthaginian cavalry divided into small troops and rode into the
midst of the Roman soldiers, sabring right and left. Some squadrons
galloped around to the flanks and lent a hand to the African phalanx
in its butchery. No quarter was given, or indeed asked. The Romans
died with their faces to the foe. The bloody work continued till but a
handful was left. Livy and Polybius place the killed at from forty to
seventy thousand men. Varro had already escaped with a mere
squad of horse. Æmilius Paullus died, sword in hand, seeking to
stem the tide of disaster. Three proconsuls, two quæstors, twenty-
one military tribunes, a number of ex-consuls, prætors, and ædiles,
and eighty senators, perished with the army.
Battle of Cannæ B.C. 216, II
Hannibal’s loss had been barely six thousand men, but he had
annihilated the splendid army of eighty-seven thousand men—the
flower of Rome. It had vanished as if swallowed up in an earthquake.
The battle had been won by crisp tactical skill and the most effective
use of cavalry,—as fine as that at the Hydaspes. It was, indeed, the
gorgeous handling of the cavalry which made the infantry manœuvre
possible.
Few battles in history are more marked by ability on the one side
and crass blundering on the other than the battle of Cannæ. The
handling of the cavalry was quite beyond praise. The manner in
which the far from reliable Spanish and Gallic foot was advanced in
a wedge in echelon, and, under the mettlesome attack of the Roman
legions, was first held there, and then withdrawn step by step, until it
had reached the converse position of a reëntering angle and was
then steadied in place by ordering up the light troops into its
intervals,—all this being done under the exultant Roman shouts of
victory—is a simple chef d’œuvre of battle-tactics, due solely to
Hannibal’s magnificent personality; and the advance at the decisive
instant of the African infantry, and its wheel right and left upon the
flanks of the disordered and overcrowded legionaries, caps the
master-stroke. The whole battle, from the Carthaginian standpoint, is
a consummate piece of art, having no superior, few equals in the
history of war.
It is usual for historians to blame Hannibal for not at once
marching on Rome after this victory. Let us see what his chances
were. We have no hint of what he himself thought, of what his
reasons were for not so doing. We must content ourselves with
collecting a few guesswork items, and endeavoring to argue as he
did.
Two facts are peculiarly prominent in Hannibal’s campaign in
Italy. First, he had opposed to him the troops of the strongest and
most intelligent military power of the world, some of which were, to
be sure, comparatively raw in active duty, but yet trained to war from
their youth, mixed with legionaries of many campaigns, and instinct
with the ardor of fighting for their household gods. It is often
assumed that Hannibal’s troops were veterans, the Romans levies of
a day. During the first three years this was in part true, and defeat
had somewhat drawn the temper of the Roman blade; but
throughout the rest of Hannibal’s campaigns the Roman army was
much superior to his own in all but one quality,—that strange
influence which a great man exercises over men. It will be noticed
that whenever the fighting was on equal terms, from the beginning
the Roman soldier gave a good account of himself. But Hannibal’s
victories were won by stratagem, or by tactical genius and skilful use
of his cavalry arm, not by brute fighting. In the latter act the legionary
was fully the equal of the phalangite. One cannot compare the task
of any other great captain with that of Hannibal. No one ever faced
such odds. Secondly, Hannibal had calculated absolutely upon being
able to detach the allies—the socii—from their fealty. We cannot
imagine him to have set out on his marvellous expedition without
having made this the prime factor in his calculations. Hannibal was
no madman. He was a keen, close calculator. But he would have
been insane, indeed, if he had undertaken his hazardous campaign
without such expectation. He was well justified in reckoning on such
defection. There had always been a good deal of opposition to high-
handed Rome among all her allies, municipal cities, and colonies,
and it was a fair assumption that many, if not most, of them would be
glad to free themselves and humble their proud conqueror and
mistress. In this expectation Hannibal had been entirely
disappointed. None of the socii, who were the brawn of the Roman
body, had shown any disposition to meet him otherwise than with the
sword; none of the colonies, except in distant Gaul, had met him
even half way. He had captured towns and territory and had
garrisoned citadels. But the aid he received was not that which
enables a conqueror to hold what he takes except with the strong
hand. And without just such aid, Hannibal could not only not win, but
could not be otherwise than defeated, in his contest with the mighty
republic. To assume that Hannibal did not see all this, and that he
was not fighting against hope almost from the second year, is to
underrate this man’s intellectual ability. No one ever fathomed
Hannibal’s purpose. He was so singularly reticent that Roman
historians called him perfidious, because no one could, from his face
or conduct, gauge either his thought or intention, or calculate upon
his acts. He had no Hephæstion as had Alexander. But no doubt he
was keenly alive to the failure, so far, of his calculation on the
disaffection of the allies.
And now, after the overwhelming victory of Cannæ, he had to
weigh not only the strategic and tactical difficulties, but the still more
serious political ones. If the allies, or a good part of them, could be
induced to join his cause, Rome would fall sooner or later. If not, he
could never take Rome, nor permanently injure the Roman cause.
The chances were, in a military sense, all against his capturing
Rome by a coup de main. Rome was over two hundred miles distant,
well walled, and with a large force which could be quietly gathered to
protect it. If he failed, the game was lost. It was far wiser for him to
still try to influence the allies, which he could now do with a record of
wonderful victories such as the world had not yet seen. Hannibal
was not a military gambler. He never risked his all on a bare chance,
as some other soldiers have done. He always reckoned his chances
closely. And every reason prompted him not to risk the loss of his all
on the chances of a brilliant march on the enemy’s capital, which had
only its boldness to commend it, and every military reason as well as
the stanch Roman heart to promise failure as its result; for there was
no obsequious satrap to open its gates and welcome the conquering
hero, as it had been Alexander’s fortune to meet. If Hannibal
marched on Rome, he must be prepared to besiege the city; and he
had neither siege equipment, nor were sieges consonant with his
peculiar ability. If the story be true that Maharbal asked of Hannibal,
after Cannæ, that he might march on Rome with five thousand
horse, promising that he should sup in the Capitol in four days, and
that on Hannibal’s declining, Maharbal exclaimed, “Truly, Hannibal,
thou knowest how to win a victory, but knowest not how to use one!”
it may tend to show that Maharbal possessed indeed the daring
recklessness of a true general of cavalry, but it also proves that
Hannibal had the discretion, as he had shown in abundant measure
the enterprise, of the great captain.
Hannibal probably at this time harbored the hope that, after this
fourth and overwhelming defeat of the Romans, the allies would
finally see that their interests lay with him. In fact, Capua, the
Samnites, Lucanians, and many cities of Lower Italy did join his
cause, and the unexplained time which he spent in the vicinity of his
late battle-field was no doubt devoted to political questions, the
favorable solution of which could be better brought about by not for
the moment risking his now unquestioned military supremacy.
The institutions and laws which gave Rome strength never
demonstrated her greatness so well as now. The people which had
created these institutions, which had made these laws, never rose
superior to disaster, never exhibited the strength of character of
which the whole world bears the impress, so well as now. The
horrible disaster to both state and society—for there was not a house
in which there was not one dead—by no means changed the
determination of the Roman people, however horrified the cool-
headed, however frightened the many. Not that among the ignorant
there was not fear and trembling; but it was not the ignorant who had
made or ruled Rome. The more intelligent and courageous element
spoke with a single voice. The prætors at once called the Senate
together to devise means of defence, and it remained in constant

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Taxation 2017 Individuals 30th

PREFACE xiv Problem Materials 1-32

Tax Planning Considerations 7-30 Tax Planning Considerations 8-34

Plans for Self-Employed Individuals 9-36 CHAPTER 11

CHAPTER 17 The Exempt Model 18-10

David S. Hulse is an Associate Professor of Accountancy at the University of Kentucky, where

Charlene Henderson is a visiting faculty member in the Department of Accountancy at the

Michael S. Schadewald, Ph.D., CPA, is on the faculty of the University of Wisconsin–

What’s new to this Edition?

strong Pedagogical aids

What Would You Do in This Situation?

▶ Discuss the history of taxation in the United States

▶ Describe the three types of tax rate structures

▶ Describe the various types of taxes

▶ Describe the tax entities in the federal income tax system

▶ Describe the administrative procedures under the tax law

▶ Describe the components of a tax practice

▶ Understand the importance of computer applications in taxation

sixteenth Amendment to the constitution of the united states

rEvEnuE Acts From 1913 to thE PrEsEnt

AdditionAL Comment rEvEnuE sourcEs

tyPiCAL miSConCePtion . tABlE i:1-1

types of tAx rAte structures

TWO generations after the death of Alexander, the power of the

Battle of Cannæ B.C. 216, I

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